The new top personal tax rate of 39%
As many of you will know by now, the new 39% top tax rate comes into effect on 1 April 2021 for personal income in excess of $180,000.
We thought it worthwhile to highlight a few things you may need to consider and also note where there may be potential risks for what the Inland Revenue Department could view as “bad behaviour” or possibly tax avoidance.
Dividend payments before 1 April 2021?
Companies that have either a large Retained Earnings balance or individual ownership should consider the timing of dividends. Over the next few weeks, we will be contacting clients to see if there is a benefit for them in declaring a dividend before 1 April 2021.
We will assess the implications and steps that need to be taken, checking that the payment of a dividend won’t be seen as being “bad behaviour” and/or tax avoidance.
Areas of concerns include paying a greater dividend than would otherwise be expected; having a future dividend policy to reduce dividends paid in the future; borrowing to pay for a dividend; and creation of loans where dividends are not physically paid and loans that are reduced over a period of time.
We are of the view that Inland Revenue Department will be looking at dividends or behaviours that are outside the normal dividend policy of the company, as this is more likely to attract attention from them and to be challenged. We do suggest that a common-sense approach needs to be taken as a dividend exceeding what you would consider the norm could be looked at unfavourably.
Paying a salary to your spouse?
The Inland Revenue can deem the amount payable to a spouse as being excessive and not commensurate with market rates. Paying a spouse is an option to consider to take advantage of lower marginal tax rates but it does need to be a bona fide payment for services provided that have not been remunerated adequately in the past.
You will need to think carefully, if you are currently paid a salary from your company and are looking to reduce this to $180,000 from 1 April 2021.
A reduction in salary should only be considered, where there are commercial reasons to justify it, such as working reduced hours or a change in role within the business.
There is also the Penny and Hooper case to consider, when providing personal services through a company that you control. The case highlighted that if you work in the business you should be rewarded for your exertion and how much will depend on a number of factors:
- the controller or owner’s personal skill, judgement, and exertion, i.e., the more marketable these attributes are, the greater the remuneration should be;
- the use of capital assets;
- services provided by other staff;
- intangible assets;
- return on business risk;
- paying yourself should not result in the business being in an overall tax loss position.
Inland Revenue will more likely review situations where the personal service provider receives less than 80% of the net personal services profit (before their salary).
What can be taken from this case is where there is a significant benefit in the form of tax savings arising from a restructure, there is a risk that the general anti-avoidance provisions will apply. Unless there are very solid non-tax related reasons for a restructure, we recommend specialist tax advice is sought before proceeding.
Changes to the ownership structure?
There are often many structures to use when moving from a sole trader through to a partnership, company and company transferring personal ownership to trust ownership.
The government has not signalled at this stage an increase to the trustee tax rate but has said it may be considered if behaviours change and it’s warranted for discussion. There is some benefit to be had, as dividends received by a trust are currently taxed at 33%, compared to a maximum of 39% for those whose personal income is in excess of $180,000.
If a change was to be made, you would need to consider:
- Shareholder continuity – A change in shareholder can result in the loss of imputation credits and tax losses. Often dividends would be paid in advance to clear out Retained Earnings prior to the change and to avoid any continuity issues.
- You need a good reason for any change made, especially now where there is risk of Inland Revenue reviewing shareholder changes in the future. The reasons for a restructure need to be considered and shown as being sound, making good business sense, and having been planned for some time.
There is some risk of being challenged by the Inland Revenue if you are doing something outside of what you would normally do and don’t have sufficient commercial grounds for this change.
We suggest that if you are looking at changes to your business structure, reducing salaries, and changes as to how dividends are paid, that you get in touch with us so that we can discuss any potential issues that may arise.