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June 2010  2.Reserve Bank Announcement - Official Cash Rate 4.Accident Compensation Amendment Act 2010 5.ETS - Transport Fuels, Electricity and Industrial Processes Sectors 8. Association Rules - Land Transaction 9. Commissioner of Inland Revenue v Ian David Penny and Gary John Hooper (4 June 2010) 1. BUDGET 2010The Taxation (Budget Measures) Act 2010 received the Royal assent on 27 May 2010 and gives effect to the tax reforms announced on 20 May 2010 in Budget 2010.The Act makes changes to personal and company tax rates and other business rates, a rise in the GST rate and changes around the taxation of investment property. The Budget 2010 also announced proposed changes to tighten the rules around loss attributing qualifying companies and qualifying companies as a forerunner to legislation planned for later this year. PERSONAL TAX CUTSPersonal income tax rates will reduce from 1 October 2010.The table below shows the new marginal tax rates. Marginal income tax rates for the 2011–12 income year
Because the new rates start halfway through the tax year, there will be composite annual tax rates that will apply only for the first year. Those are also shown in the table. Composite income tax rates for the 2010–11 income year
The secondary rates are aligned to the reduced tax rates as follows: PAYE rates from 1 October 2010: secondary employment income
The new individual tax rates bring the tax payable on income for middle income earners more in line with Australia. Prior to the changes individuals paid less tax in Australia on income up to $250,000 and more on income over that threshold. After the changes the income level reduces to $55,000, making New Zealand more competitive with Australia from a taxation perspective.
Provisional Tax
The formulas used to calculate provisional tax will change and allow individuals that pay provisional tax based on the uplift method to reduce their provisional tax payments from 1 October 2010. |
| Post 10/10 for 2010–11 | 2011–12 | 2012-13 | 2013-14 | |
|
Standard method adjustment - 10% uplift method decreases to: - 5% uplift method decreases to: |
95% 95% |
95% 95% |
100% No change |
No change No change |
|
GST ratio method adjustment - Two years before preceding year RIT decreases to: - Year before preceding year RIT decreases to: - Preceding year’s RIT decreases to: |
80% 85% 90% |
80% 85% 90% |
80% 85% 90% |
90% No change No change |
Portfolio investment entity (PIE) rates
The tax rates that apply to investors in portfolio investment entities (PIEs) reduce as follows:| Taxable income | Taxable + PIE income | PIE Tax rate |
| $0 – $14,000 | $0 – $48,000 | 10.5% |
| $0 – $14,000 | $48,001 – $70,000 | 17.5% |
| $14,001 – $48,000 | $0 – $70,000 | 17.5% |
| $48,001 and over | Any | 28% |
| Any | $70,001 and over | 28% |
New FBT rates
The new fringe benefit tax (FBT) rates and thresholds for attributed fringe benefits change as follows to reflect the new personal tax rates.Composite FBT rates for the 2010–11 income year
| Income range | Tax rate |
| $0 – $12,390 | 12.99% |
| $12,391 – $39,845 | 23.84% |
| $39,846 – $54,915 | 45.99% |
| $54,916 and over | 55.04% |
FBT rates for the 2011–12 income year
| Income range | Tax rate |
| $0 – $12,530 | 11.71% |
| $12,531 – $40,580 | 21.21% |
| $40,581 – $55,980 | 42.86% |
| $55,981 and over | 49.25% |
Employers will still have the option of paying FBT at a single rate and that rate will reduce from 61% to 49.25%.
For close companies and small businesses that are able to file FBT returns annually, the applicable rate will reduce to 49.25% from the 2011–12 income year, and there will be a composite rate of 55.04% for the 2010–11.
New Employer Superannuation Contribution Tax Rates
The table below summarises the new employer superannuation contribution tax (ESCT) rates.The changes will apply from the first pay period that ends on or after 1 October 2010. The new rates will be:
ESCT rates from 1 October 2010
| Income range | Tax rate |
| $0 – $16,800 | 10.50% |
| $16,801 – $57,600 | 17.50% |
| $57,601 – $84,000 | 30.00% |
| $84,001 and over | 33.00% |
It should be noted that the income ranges at which the ESCT rates apply are higher than the income ranges that apply for personal tax rates. This is to reduce the risk that employer contributions made to employees whose income is close to a threshold are not overtaxed.
Withholding tax rates
There are consequential changes to some withholding tax rates.The RWT rate on interest prior to 1 October 2010 will automatically change to the new rate equivalent (e.g. 38% will move to 33%). The default rate will change to 17.5% for those that have not provided a payment election rate and have RWT withheld at 19.5% prior to 1 April 2010. The default rate for new accounts opened after 31 March 2010 will be 33% for those that do not elect a rate.
The withholding tax rates for casual agricultural employees and election day workers will reduce from 21% to 17.5%, to reflect the second-to-lowest marginal tax rate.
There is no change to the withholding tax rate that applies to Maori authorities and horticultural workers.
Fund withdrawal tax
Fund withdrawal tax will not apply to withdrawals that relate to contributions made to employer superannuation schemes on or after 1 October 2010. Fund withdrawal tax is 5% tax payable on those parts of certain fund withdrawals which comprise employer superannuation cash contributions for members whose salaries exceed $70,000.Redundancy tax credit
Redundancy tax credits will not be available for redundancy payments derived after 1 October 2010. A tax credit is available for recipients of redundancy payments for loss of employment. The amount of the rebate is the lesser of $3,600 or 6% of the redundancy payment.NEW TAX RATES FOR COMPANIES AND SAVINGS
The Act provides for the following changes to the tax rules for business and investments:- The company tax rate will reduce from 30% to 28% from 1 April 2010.
- The top tax rate for people saving through PIEs, including KiwiSaver funds and other managed funds will also reduce from 30% to 28% from 1 October 2010.
- Other tax rates that apply to KiwiSaver funds and other PIEs will reduce in line with the changes to personal income tax rates.
- The safe harbour in the thin capitalisation rules that apply to foreign-controlled entities will reduce from 75% to 60%. Thin capitalisation applies to limit the amount of interest deductions against the New Zealand tax base. There is no loss of interest deductibility if the applicable New Zealand group debt percentage does not exceed 75% (pre-1 April 2011 and 60% post 31 March 2011) or the world group debt percentage does not exceed 110% (no change post-31 March 2011 to 110%).
Transitional provisions
A number of transitional arrangements will accompany the reduction in the company tax rate. These are based on similar arrangements that accompanied the previous reduction in the company tax rate to 30%. The transitional rules will:- allow companies to continue to pay out imputation credits at the current 30/70 credit-to-dividend ratio until 31 March 2013, provided the credits arose when the company tax rate was 30% or 33%. The new maximum rate that will apply to income derived from 1 April 2011 is 28/72; and
- allow shareholders, other than those eligible for the new 28% tax rate (i.e. companies & managed funds using PIEs) to use these additional imputation credits to offset their tax.
Provisional tax
The formula used to calculate company provisional tax will change and allow companies to reduce provisional tax payments for the 2012 year.For the 2011–12, 2012–13 and 2013–14 income years, the relevant income tax amount is to be multiplied by 0.95 as set out in the following table:
| Tax year | Previous year | Year before previous year | 2 years before previous year |
| 2011–12 | 0.95 | 0.95 | 0.95 |
| 2012–13 | No change | 0.95 | 0.95 |
| 2013–14 | No change | No change | 0.95 |
Dividend Resident Withholding Tax (RWT) Rate
There is no change to the dividend RWT rate of 33% for companies. Without a change companies will be required to pay RWT of 5% on distribution for 2012 and later year profits.The Government has indicated that it will consider a change in a Bill due in November 2010.
Multi-rate PIEs tax rates
For investments through multi-rate PIEs, including most KiwiSaver funds, the reduced tax rates — including the new 28% top rate — will apply from 1 October 2010.For companies, and for investments through other managed funds, the reduction in the tax rate to 28% will apply for the 2011/12 and subsequent income years.
GST RATE INCREASE
The rate of goods and services tax (GST) will increase from 12.5% to 15% from 1 October 2010.Under the proposed rate change, businesses and organisations registered for GST will be required to account for GST at the new rate of 15% from 1 October 2010. The rate of increase will also apply to goods imported on or after 1 October 2010.
The new tax fraction will be 3/23. This fraction can be applied to the price of goods or services to see how much GST is included in the price. The GST amount is 3/20 of the value of the GST exclusive supply.
Transitional rules
The transitional rules that applied in 1989 when the GST rate was last increased, will, with some minor modification, apply to this latest rate change. Those rules are based on the time of supply and will ensure that GST is accounted for correctly for supplies on or about the date.
Time of supply rules
The GST Act contains rules that determine the point in time when a GST-registered person must recognise a supply of goods and services that give rise to an output tax liability. In most cases this will be when the supplier issues an invoice or receives payment. The rules attempt to approximate when a transaction has been concluded and economic control of the goods and services has passed from the supplier to the recipient.In general, the normal time of supply rules will apply over the transition period. There will be issues with those registered on a payments basis in accounting for GST supplies for invoices dated prior to 1 October 2010 but paid after that date, or where there is one invoice issued for the year prior to 1 October 2010 for payment by instalments. There are special rules for those registered on a payments basis and these require all payments made or received after the date to account for the GST using the new tax fraction, and to the taxpayer will account for GST on creditors and debtors as at 30 September 2010.
Reliance on the normal time of supply rules may allow businesses to bring forward invoicing so they can take advantage of the old lower GST rate. In excessive cases the general anti-avoidance provision in the GST Act may be applicable if it is clearly evident that businesses are restructuring their business practices to bring forward a material number of transactions.
The Government has established a special GST advisory panel to assist with the transition to the rate increase.
DEPRECIATION AND CAPITAL CONTRIBUTIONS
The Act makes the following changes to the depreciation rules:- The annual depreciation rate for buildings will be set to 0% if they have estimated useful lives of 50 years or more, as determined by the Commissioner.
- This new rate will apply from 1 April 2011 regardless of when a building was acquired.
- Building owners that have previously claimed a depreciation deduction on their buildings will still be required to pay depreciation recovered if they sell a building for more than its tax book value.
- Certain buildings (e.g. barns, carpark buildings, chemical works, fertiliser works, powder drying buildings, site huts) that have been treated as structures, and were purchased on or before 30 July 2009, will continue to be treated as structures for tax depreciation purposes.
- Any improvements to these buildings made after 30 July 2009 will be treated as buildings for depreciation purposes.
- No depreciation loading for assets acquired after 20 May 2010:
- Depreciation loading will continue to apply to qualifying assets purchased on or before 20 May 2010 provided there is a binding contract for acquisition or construction prior to that date.
- Any improvements to assets that continue to receive loading made after 20 May 2010 will have to be treated as a separate asset and will not qualify for loading.
Taxpayers will no longer be able to apply for special depreciation rates for buildings from 20 May 2010.
The income tax treatment of capital contributions to fund the acquisition or construction of capital assets will change for contributions made after 20 May 2010.
Businesses that receive a capital contribution will be required to choose how to treat the receipt for income tax purposes - either as income or as a reduction in their depreciation base. Different treatments can be elected for each capital contribution. Once an election is made it may not be changed.
A capital contribution is an amount that is paid, under express terms and conditions of an agreement, as a contribution for depreciable property owned or to be acquired by the recipient. It excludes a contract of insurance payments made by settler, partner or shareholder of the recipient, and payments that are not income to the recipient for tax purposes.
For example a Lines company reimbursement for the cost of installation of reticulation lines to a building on private land.
If a business decides to treat a contribution as income, then it would return 1/10th of the contribution as taxable income every year for 10 years. If a business decides to reduce its depreciation base, it would reduce the tax book value of the relevant assets to the extent that they have been funded through the capital contribution.
This proposed change only affects new capital contribution arrangements. It will not affect contributions derived on or before 20 May 2010.
WORKING FOR FAMILIES (WFF)
The Act makes the following changes to entitlements to WFF tax credits.
- The calculation of income for WFF will exclude investment losses, such as losses from rental properties and trading of shares on revenue account. This measure is intended to prevent higher income people gaining access to assistance they would not normally be entitled to. The amendment will take effect from 1 April 2011.
- The indexation of the income threshold for WFF will be removed. That means that the income threshold at which WFF begins to abate will be set at the current threshold of $36,827 and that threshold will no longer be automatically indexed to inflation. However, the amounts of Family Tax Credit will continue to be automatically indexed to inflation. The amendment to remove the automatic indexation of the income threshold for WFF tax credits will take effect from 20 May 2010.
- The Government will also undertake a wider review of the rules determining entitlements for social assistance, especially arrangements that have the effect of increasing entitlements beyond what people’s true economic circumstances justify. An example is income from trusts. This review will cover WFF tax credits, student allowances and community services cards. An officials’ issues paper will be released later this year seeking public feedback on proposed legislative solutions that will make arrangements that undermine the intent of social assistance ineffective.
QUALIFYING COMPANIES (QCS) & LOSS ATTRIBUTING QUALIFYING COMPANIES (LAQCS)
The Government has released an Officials’ Issue paper -Qualifying Companies: Implementation of flow through tax treatment that outlines the proposed changes to legislation so that from 1 April 2011 QCs and LAQCs will be effectively taxed as limited partnerships. Submissions to the paper close 5 July 2010.It is proposed that:
- Existing qualifying company rules be replaced with new rules making QCs and LAQCs flow-through entities for income tax purposes. QCs are currently subject to company tax treatment, whereby income is taxable and losses deductible by the company at the company tax rate. In addition, LAQCs are partially transparent entities in which income is retained at the company level but losses can flow through to individual shareholders. Attributed losses are treated as if they were incurred by a shareholder in deriving their income, and so can be offset against the shareholder’s other income or be carried forward to future years.
- With flow-through treatment for income tax purposes, a QC’s income and losses will both be passed on to shareholders and not be retained at the company level. Instead, income will be taxed and losses deducted at a shareholder’s marginal tax rate. Flow-through will be based on the rules currently applying to limited partnerships. The limited partnership and qualifying company tax rules will be largely aligned, with limited partners and qualifying company shareholders being treated the same for income tax purposes.
- The basis for the allocation of a qualifying company’s income tax liability and losses to a shareholder, as well as certain shareholder elections, is the shareholder’s “effective interest” in the company. It generally means the shareholder’s voting interest in the company. QC losses will be ring-fenced to limit the amount of the loss that can be passed through from an LAQC to the shareholder. The amount will be limited to the shareholder’s investment in the LAQC (in much the same way as losses of limited partners are restricted). The shareholder’s investment (or “membership base”) would include the initial equity invested, along with undistributed earnings of the LAQC and the share of any debt guaranteed by the shareholder. Disallowed losses in any year (the loss that exceeds the carrying tax value of that partner’s investment) may be carried forward in the company to future years.
- The change will erase the distinction between QCs and LAQCs, as both entities will be transparent. There will be only one classification under the new qualifying company rules.
- QCs will no longer, for income tax purposes, pay dividends to shareholders, as no income will be retained by the company under the new rules. Instead, profits and losses will be allocated directly to shareholders without going through the imputation system.
- The shareholders debt guarantee for unpaid company income tax will be removed.
- There will be similar anti-streaming rules to those that apply to partnerships. Assessable income, exempt income, excluded income, expenditure, capital gains and capital losses will be apportioned by the qualifying company to each shareholder in accordance with each shareholder’s effective interest in the company.
- There will be anti-avoidance provision that provides that any investment in a company within 60 days of the end of the year which is subsequently reduced within 60 days after the year end will be disregarded for the purposes of calculating a shareholder’s membership basis.
- It is likely the submission will focus on retaining existing rules relating to QCs. There is support for the abolition of LAQCs and the transfer of the structure to a partnership, and to allow the transfer of the business structure without tax consequence.
OTHER MATTERS
The Government decided not to take up the following recommendations of the Tax Working Group (TWG) in Budget 2010.- Capital Gains Tax
- Land Tax
- Deemed rate of return on Rental Properties
- Loss Ring Fencing (rental losses)
- Bright Line Test (rental properties purchased with the intention of resale)
- Align company rates with the top individual tax rate and trustee tax rate.
- Budget Day Integrity Measures (deferred to issues paper due in August relating to assignment of income to trusts and qualifying for WFF).
2. RESERVE BANK ANNOUNCEMENT - OFFICIAL CASH RATE
The Reserve Bank announced an increase in the Official Cash Rate (OCR) by 25 basis points to 2.75% on 10 June 2010.The Reserve Bank reported a second year of recovery with growth progressively more broad based over the period, and expects growth of around 3.5% this year and next. The main drivers are higher export prices and volume growth, an improving labour market and a pick-up in residential and business investment. The housing market and credit growth is expected to remain subdued over the period.
The underlying CPI inflation is expected to track within the target range even as the economy expands further. The CPI inflation will be boosted temporarily by the announced increase in GST and other government-related price changes, and provided there is minimal flow on effect on wages and price-setting behaviours, the impact on inflation is expected to be short lived.
Although it is expected that the June increase will be the first in a run of increases over the coming year, the Reserve Bank suggest that as the banks are offering long-term interest rates that are higher than short-term rates, and a greater proportion of borrowers are using floating rate mortgages there may not be the need for further increases in the OCR as in previous cycles.
3. GST BILL - FOOD EXEMPTION
- fruit and vegetables (including fresh, frozen, canned, and dried)
- breads and cereals (including all bread, grains, rice, and pasta)
- milk and milk products (including cheese, yoghurt, and plain milk, but excluding ice cream, cream products, condensed, and flavoured milk), and
- lean meat, poultry, seafood, eggs, nuts, seeds, and legumes.
4. ACCIDENT COMPENSATION AMENDMENT ACT 2010
The Accident Compensation Amendment Act 2010 (No 1 of 2010) received the Royal Assent on 2 March 2010 to shorten the name of the Injury Prevention, Rehabilitation, and Compensation Act 2001 to the Accident Compensation Act 2001.5. ETS - TRANSPORT FUELS, ELECTRICITY AND INDUSTRIAL PROCESSES SECTORS
Transport fuels, electricity production and industrial processes enter the Emission Trading Scheme (ETS) on 1 July 2010. Those sectors will include oil companies for fossil fuels sold, electricity generators for gas or coal consumed in generation of electricity and manufacturing industries (cement, steel or aluminium producers) for the chemistry of operations.The timeframe for all sectors to the ETS is outlined in the table below.
| Sector | Voluntary reporting | Mandatory reporting | Full obligations |
| Forestry | - | - | 1 Jan 2008 |
| Transport fuels | - | 1 Jan 2010 | 1 July 2010 |
| Electricity production | - | 1 Jan 2010 | 1 July 2010 |
| Industrial processes | - | 1 Jan 2010 | 1 July 2010 |
| Synthetic gases | 1 Jan 2011 | 1 Jan 2012 | |
| Waste | 1 Jan 2011 | 1 Jan 2012 | |
| Agriculture | 1 Jan 2011 | 1 Jan 2012 |
Participants are required to:
- monitor, record and report activities that produce or remove greenhouse gas emissions;
- surrender to the Government emission units to cover emissions associated with their activities each year. An emission unit is a unit of trade within the emissions trading scheme. The primary unit of trade in the New Zealand Emissions Trading Scheme is a New Zealand unit (NZU) issued by the Crown. Participants surrender NZUs to the Crown to meet their obligations under the scheme. During the transition phase (July 2010 to December 2012) one NZU will be required to cover every two metric tonnes of greenhouse gas emissions in a calendar year. After this, one emission unit will be equal to one tonne of emissions. Participants can also surrender a range of ‘Kyoto units’ which they can buy overseas.
Emission Units
During the transition phase (July 2010 to December 2012), participants will be able to buy emission units from the Government for NZ$25 each.In addition, participants and secondary market traders can buy emission units from the following sources:
- approved overseas sources (such as the Certified Emission Reduction Units (CERS) created under the Kyoto Protocol’s Clean Development Mechanism); and
- another Units participant or secondary market trader, either directly or by trading through a broker or trading exchange (such as OM Financial and Westpac Institutional Bank).
NZUs are currently trading on the spot market at $NZ18.00/tonne
After the transition phase, the price of an NZU will be determined in the trading market and will tend to match the international price of emission units. Participants can sell NZUs internationally by exchanging them for Kyoto units, within the limits on international sales set by the Kyoto Protocol.Emission Units Register (NZEUR)
The NZEUR is an electronic register that records who holds emission units and is similar to a share registry. It recordswho holds emission units and the number of units they hold;
transfers of emission units between holders both within the NZEUR and between international unit registers; and
emission units surrendered by participants to meet their obligations under the emissions trading scheme.
The Ministry of Economic Development administers the NZEUR.
Free Allocation of Emission
There is expected to be an immediate impact on price in the domestic market as sectors enter the ETS and need to pay for the emissions. Power bills are expected to increase 5% and fuel at the pump 3.5c a litre. All competitors in each participant industry are on an equal footing so prices can safely be raised without loss of market share. The Government has recognised that that may not be the position for those operating in the international market and to protect those businesses the Government have agreed to provide free allocations of NZUs to cover up to 90% of the emissions of energy intensive trade exposed businesses and to phase that out at 1.3% a year.6. TAXATION OF EMISSION UNITS
The taxation of sale and purchase of emission units will depend on the purpose and industry type of the participants in the ETS.Businesses participate in the emissions trading scheme in different ways.
- Some have a legal obligation to acquire and surrender emission units to cover their direct greenhouse gas emissions or the emissions associated with their products. These participants are generally ‘upstream’ operators, for example transport fuel producers or importers bringing in products to New Zealand.
- Some have the choice to apply to opt in to the scheme if they carry out a relevant activity, for example, landowners with forests planted after 1989.
- Some receive free emission units that can be used to meet their own obligations or to sell to other firms, for example landowners with forests planted before1990.
- Some do not have to take part in the emissions trading scheme, but trade emission units in the same way that stockbrokers or real estate agents trade in their respective markets. These are secondary market traders. They may have specialist expertise in linking those who can reduce their emissions and have spare emission units with those wishing to buy these units.
Taxation
- Upstream operators. Sale and purchase of units is taxable on an accruals basis in the year of the transaction. The units will be added back at cost at year end to the extent that they are still on hand. The deduction for cost of the emission units will effectively be in the year of sale or surrender of the units. GST is zero rated.
- Post 1989 forestry related units. Sale and purchase of units is taxable on a cash basis in the year of the transaction. No deduction for additional units purchased in excess of entitlement. GST is zero rated.
- Pre 1990 forestry related units. Sale and purchase of units is not taxable where the land is held on capital account. GST is zero rated.
- Secondary market traders. Sale and purchase is taxable to the extent that the units were purchased for the purpose of resale. There are no GST obligations to those taxpayers that buy and sell in the secondary market.
CLIENT QUERIES
7. FRINGE BENEFIT TAX - VALUE OF MOTOR VEHICLE PREVIOUSLY OWNED BY THE EMPLOYER OR BY AN ASSOCIATED PERSON OF THE EMPLOYER
Question
For fringe benefit tax (FBT) purposes, in what situations will the value of a motor vehicle owned by an employer be affected by the vehicle having previously been owned by an associated person of the employer?
Answer
The value for FBT purposes of a motor vehicle owned by an employer is determined on the basis of either the cost price or the tax value of the vehicle to the employer. Generally, the starting point for both of these bases is the actual cost price of the vehicle to the employer - the cost price is the actual cost price to the employer, and the tax value is the actual cost price to the employer less the total accumulated depreciation of the vehicle. The Fringe benefit amount is 5% of the GST-inclusive cost price or 9% of the GST-inclusive tax value of the vehicle (or 5.625% of the GST-exclusive cost price or 10.125% of the GST-exclusive tax value).
The appropriate starting point to value the vehicle for FBT purposes will not necessarily be the actual cost price of the vehicle to the employer if, in the two years before the employer most recently acquired the vehicle, the vehicle was owned by:
- the employer (i.e. sold and repurchased); or
- a person associated with the employer at the time the person owned the vehicle.
The provisions are anti-avoidance provisions aimed at ensuring FBT liability is not reduced by an employer selling and repurchasing a vehicle at market value so as to take advantage of a lower cost price of the vehicle.
Previously, it was suggested that the relevant period was the two years before the vehicle was provided to the employee. That was changed in the Taxation (International Taxation, Life Insurance and Remedial Matters) Act 2009 to clarify that this interpretation is incorrect.
If the cost price method is to be used, the starting point will be the highest cost paid for the vehicle by the employer or the associated person on any acquisition.
If the tax value method is used, the appropriate starting point is determined by the most recently used basis to value the vehicle and the owner of the vehicle when that basis was used. If the previous owner used cost price then the rules effectively provide for reversion to highest cost price for FBT purposes.
8. ASSOCIATION RULES - LAND TRANSACTION
Question
An individual wants to buy a residential rental property but the buyer’s parents are property developers and the buyer is concerned that the association rules may make any capital gain taxable on sale through the land taxing provisions in the Income Tax Act.
Are the parties associated for the purpose of the land tax provisions?
Answer
The buyer will not be associated with the parents under the new associated persons provisions, as the buyer is not an infant child (being over 20 years of age).
Section YB 4 (which contains the test for association between relatives) states:
YB 4 TWO RELATIVES
YB 4(1) DEGREE OF RELATIONSHIP
Two persons are associated persons if
(a) they are within two degrees of blood relationship:
(b) they are married, in a civil union, or in a de facto relationship:
(c) one person is within two degrees of blood relationship to the other person’s spouse, civil union partner, or de facto partner.
YB 4(2) EXCEPTION: BLOOD RELATIONSHIPS
For the purposes of the land provisions and sections EB 13 (Low turnover valuation) and EC 5 (Transfer of livestock because of self-assessed adverse event), subsection (1)(a) and (c) does not apply, and persons are associated persons because of a blood relationship only if one is the infant child of the other.
Under subsection (2), the “two degrees of blood relationship” test does not apply for the purposes of the land provisions.
Therefore, the buyer’s residential rental property is not tainted by the buyer’s association with his or her parents and their development activity.
RECENT TAX CASES
9. COMMISSIONER OF INLAND REVENUE v IAN DAVID PENNY AND GARY JOHN HOOPER [4 June 2010]
In a split decision by a 2-1 majority the Court of Appeal ruled in favour of the Commissioner of Inland Revenue to overturn the decision in The High Court in a landmark case on tax avoidance. The majority of judges confirmed that the adoption of legitimate legal structures or entities will not be a barrier to finding tax avoidance if the arrangements are artificial, contrived, or amount to a pretence.In the appeal, the Commissioner of Inland Revenue alleges tax avoidance by the taxpayers who practise as orthopaedic surgeons. Initially they each conducted their practice on their own account. Later, each set up a company to purchase their practice. The companies are owned substantially by the taxpayers’ family trusts. Thereafter, each taxpayer was employed by their respective companies at a salary the Commissioner considers to be artificially low. The balance of the practice income in each case was treated as company income and paid by way of shareholder dividend to the family trusts. The Commissioner formed the view that the restructuring of the taxpayers’ practices and the allocation of such low salaries was an arrangement which had the purpose or effect of tax avoidance in terms of the Income Tax Act 1994. In particular, the Commissioner considered the taxpayers improperly took advantage of the lower company tax rate of 33 cents in the dollar and should have been taxed at the higher marginal tax rate of 39 cents in the dollar applicable to their personal income. The Commissioner’s view was that the difference of six cents in the dollar between the company and personal tax rates was avoided to the extent that the salaries allocated to the respondents were set at commercially unrealistic levels. The Commissioner reassessed the taxpayers’ income for the tax years 2002 to 2004 by attributing salaries to each of them at a substantially higher level. He did so on the basis of advice as to what level of salary would be commercially realistic in the circumstances.
The matter went to The High Court where it was accepted that the formal structures adopted by the taxpayers were a legitimate choice for the conduct of their businesses. It was also found that the way in which they conducted their affairs did not constitute tax avoidance. In particular, the arrangement was not contrary to the scheme and purpose of the Act and that the allocation of a commercially realistic salary was not a concept recognised by the Act.
The central issue in the appeal was whether he High Court failed to address the Commissioner’s contention that the arrangement was contrived and artificial, and the effect of that issue on the application of the tax avoidance provisions in the Act.
The Court of Appeal identified two defining features of the arrangements adopted by both taxpayers. The first is that each had been conducting their respective practices as orthopaedic surgeons on their own account and then chose to incorporate their practices. In Mr Hooper’s case, that occurred in 2000, coinciding with the increase in the top personal tax rate. Mr Penny’s company was incorporated earlier in 1997. And secondly, the net income before tax to each taxpayer reduced from the year 2000 onwards – in Mr Hooper’s case from about $650,000 to $120,000 per annum and in Mr Penny’s case from $302,000 to $125,000 and then to $100,000 thereafter. Their reduced salaries in the company structure represented approximately 18 per cent and 33 per cent respectively of the net pre-tax income they previously enjoyed. The Court ruled there was no commercial reason for what was considered to be an artificially low salary received by each surgeon, and there was no reason to suggest that there is any other purpose for awarding the salary at those levels other than to minimise tax.
The Court did not rule that the company/trust structure in itself is necessarily tax avoidance. Rather it was the use of
that structure by the surgeons to reduce their personal tax that crossed the line into tax avoidance. The taxpayers had the ability to effectively control the relevant salary levels and cash flows in their capacities as directors of their companies and through their control of the family trusts.The Court also accepted that non-market salaries paid by family companies or trusts may be justified in some circumstances including:
- diminution of hours of work or degree of effort or not fulltime in business;
- material reduction in gross income before expenses or insufficient profit to pay market salaries; and
- need to apply cashflow from profit to purchase capital assets or other expenditure.
The dissenting Judge ruled that the taxpayers were entitled to choose their own business structure and were not required to pay any particular salary especially if they wish to take a reduced salary to benefit their family trusts. The structure is so widely used it should not constitute tax avoidance. The judge concluded that the taxpayers had not gained benefits in tax provisions in an artificial or contrived way. Rather they had taken advantage of the difference in tax rates in a way within acceptable commercial practice.
The Court’s split decision leaves uncertainty for the taxpayer and it is likely that the taxpayers will not appeal the case to the Supreme Court, so the issues may remain unresolved in the foreseeable future.
In applying the finding it will be a matter of assessing all facts including the extent and nature of any element of artificiality or contrivance in order to determine whether any particular arrangement is within or outside the contemplation of Parliament in enacting the tax legislation to determine whether there is an arrangement that could be deemed to be tax avoidance. The Court in this case indicated the artificiality or contrivance should be obvious and the Commissioner should not interfere with marginal circumstances.
The change in tax rates in the Budget 2010 to align company, trustee and top individual rates to within 5% may lessen the impact of this decision on tax planning options and identification of prospective taxpayers for IRD audit.
10. NEWS ABOUT THE OFFICE
Michelle Oldfield recently qualified as an Associated Chartered Accountant (ACA) of the New Zealand Institute of Chartered Accountants following a period of hard work and study. She has also recently returned from an extended trip overseas.Sharon Brodie has also been progressing her studies and is very close to completing her Chartered Accounting qualifications.
Wood Walton is actively implementing XERO online accounting software for a number of clients with very good reception to date. We strongly encourage you to find out more at www.xero.com and contact us if you wish to proceed. There are many advantages which we would be happy to discuss with you.
11. SEMINARS COMING UP
Wood Walton is presenting on taxation issues at an ETS seminar to forest owners on 10 July 2010 at Summerhill Farm Woolshed, 340 Reid Road, Welcome Bay, Tauranga. Other presenters include MAF and BOP Farm Forestry, Fenton McFadden for legal implications and Westpac for carbon trading.Wood Walton is also hosting an evening seminar on 15 July on Budget 2010 issues and opportunities and taxation implications of charitable giving.
Everyone is welcome to these seminars. Invitations have been sent out and if you have received yours and you are interested in attending either of the above we ask that you contact Trish by email (trish@woodwalton.co.nz) or telephone 07 578 0174 to register.
Scan of news article featured in the Bay Of Plenty Times Tuesday 22 June 2010.
