39% - Should you, could you, would you?

With the new 39% tax rate looming, there is a hive of activity. 

We outline below some of the things we are seeing and what you may wish to do.  Note that while you can do anything, this article does also contain a lot of “howevers”.  So with this in mind we also highlight where we see potential tax risk (the “bad behaviour” or tax avoidance). 

We refer throughout to 1 April 2021, however this is a reference to standard balance date taxpayers.  Dates may alter for non-standard balance date operators.

Should you pay a dividend before 1 April 2021?

For companies with individual ownership, absolutely a dividend should be considered before 1 April 2021. 

We don’t believe that, at face value, the payment of a dividend and creating a current account (i.e. a loan to the shareholder) is “bad behaviour” and avoidance.  We would, however, have greater concerns if you were (for example):

  1. Accelerating payment of tax to pay a greater dividend;
  2. Paying a dividend creating a loan to the shareholder, but also implementing a policy to make reduced dividend payments in the future.

Behaviours outside of the norm are more likely to attract Inland Revenue attention and be challenged as avoidance.  We can’t say anyone of the above iterations would be avoidance, but anything exceeding, what you would consider, a normal and common-sense dividend could be looked at.   We are not advocating an approach to do nothing, more rather be considered before you do something.

Should you consider how you are calculating FBT?

Yes. The single rate of FBT will increase from 49.25% to 63.93% for benefits provided on or after 1 April 2021. Further, the alternate rate (i.e. the rate that can be used for the first three FBT quarters) has also increased from 43% to 49.25%.

Given the top tax rate will only impact individuals who earn more than $180k per year, you should revisit your FBT options.  This could include pooling benefits and/or performing the attribution calculation in the fourth quarter next year (being of relevance where individuals would not be subject to the top marginal tax rate).

Further, you may also need to implement policies/procedures on the collection of information required to allow fringe benefit attribution to be undertaken.  These policies/procedures should be in place by 1 April 2021. 

Should you start paying your spouse a salary?

If it is bona fide payment for services provided that have not been adequately remunerated in the past, then it’s an option to consider and you’d perhaps avail of lower marginal tax rates.  However, consequences can arise if the amount is deemed excessive and not commensurate with market rates.  

Could you reduce your salary?

For example, you are paid a salary from the company (you control) of $300,000.  From 1 April 2021 the salary is reduced to $180,000.

 A reduction in salary should only be considered where there are commercial circumstances that justify any such reduction (i.e. a change in role and/or reduced hours) .

The decision in the Penny and Hooper case must always be considered if providing personal services through an intermediary (such as a company) that you control; if you roll your sleeves up, then you should be rewarded for your exertion. 

How much depends on a number of factors, which can include:

  • The level of involvement you have with the business (skill and exertion);
  • Use of capital assets (an inverse relationship to your reward, the more profits are generated by capital assets, then the less is earned from your personal exertion);
  • Employee leverage (a similar argument to the above);
  • Use of intangibles;
  • The need to retain profits in the business for future investment needs;
  • Losses, paying yourself shouldn’t result in the business incurring an overall tax loss position.

As a default, for personal service providers, Inland Revenue will place greater risk and are more likely to examine situations where the personal service provider receives less than 80% of the net personal services profit (before their salary).

Could you revoke LTC status for your company?

Absolutely, you certainly could.  LTCs offer transparency for income tax purposes and the tax position flows through to the members.  It’s concessionary treatment and transparency may no longer be desired.  However, you need to be cognisant of the potential downsides:

  • There is a deemed disposal of all the assets of the LTC on revocation.  Depending on the asset type this may give rise to taxable income and a tax liability.  For example, taxable income arising from the “sale” of depreciable property (depreciation recovery income) and stock.

  • If you retain all the profits in the company in the future, is there a risk of a Penny and Hooper argument (i.e. are you being paid properly, for tax purposes, for your personal exertion)?

If you are seeking revocation, note that it takes place from the beginning of the income year after the year of revocation, i.e. 1 April 2021 for standard balance dates, providing revocation occurs on or before 31 March 2021.

Would you change ownership structure?

There are many situations to explore here from sole trader operations to company, to personal company ownership transferring to trustee ownership.  With respect to the latter, at this stage, the trustee tax rate is not signalled for an increase (unless behaviours change such that it is warranted for discussion).  Accordingly, there is a clear advantage as dividends received by a trust are taxed at 33% (the trustee rate), in contrast to a maximum 39% in the individual’s hands.

Therefore, you certainly would consider a change.  However:

  • Shareholder continuity must be considered.  Changes in shareholders can result in the forfeiture of imputation credits (and tax losses, noting potential changes in the future in this regard for same or similar business continuation).  We would normally advise of a dividend in advance of a change that would upset continuity.
  • The reasons for the change must be considered.  In this case Trust ownership typically makes for sound estate management and succession planning, and the proposed change may have been on the ‘to do’ list for some time.  However, we cannot say with any degree of certainty how Inland Revenue would view a shareholding change and each case would need to be considered based on its own merits. 

Could you, should you, would you worry?

In this environment, yes, but it does also depend upon what you do.  If you are doing something that you wouldn’t normally do and do not have sufficient commercial reasons for change (or the tax effect is more than incidental), then it would be correct to acknowledge that there is a risk of challenge from Inland Revenue.

It’s a matter of degree and we are far more comfortable with some changes than others (for example, being smart with your FBT choices, in contrast to reducing your salary from a company you control). 

Please assume that Inland Revenue is omnipresent and that they will know what you are doing.  They have sophisticated computer systems and new disclosures that will highlight and identify:

  • New trusts and companies; and
  • Changes to salaries (salaries of $180,000 or near to will be of interest).

Inland Revenue also has the benefit of hindsight, which is an excellent tool in considering tax avoidance.  Anything out of the norm, or going above and beyond, is likely to be viewed with scepticism by Inland Revenue.  If you want to talk tax risk and 39%, we are ready to listen and offer advice.

If you have any questions or are looking for more information, you can watch our Eye on Tax discussing the 39% tax rate, or alternatively please refer to your friendly BDO Adviser.