Budget 2022 - our analysis
Our tax experts summarise and give their opinion on the main points of the Labour Government’s 2022...
The reintroduction of the 39% tax rate for individual income of more than $180,000 has resulted in the government proposing new measures to address matters that are perceived by Inland Revenue to essentially be tax avoidance. Those measures attack long-established principles and will have a wide application.
Time to read: 6 mins
The proposals are to tax some of the proceeds from the sale of shares held on capital account and greatly expand the attribution of income from personal services. The government also aims to look at the income retention rules for companies and trusts.
These measures are being proposed to prevent taxpayers from what Inland Revenue perceive as exploiting the lack of a general capital gains tax, and also from diverting personal income to companies and trusts with tax rates of 28% and 33% respectively. The biggest area of concern for the government is the use of closely held companies and trusts by taxpayers who fall into the 39% personal tax bracket.
The government is proposing the following:
The government believes the difference between the top personal tax rate and the company tax rate that first occurred in 2000 has encouraged businesses to retain earnings instead of paying them out as a dividend.
The wealth could then potentially be realised from an eventual sale of the company. While there are anti-avoidance rules which prevent the conversion of taxable retained earnings into untaxed capital gains, these are largely limited to related party transactions and are not applicable on a third-party sale, and require Inland Revenue to obtain evidence and go through time-consuming procedures.
To expand Inland Revenue’s arsenal the government proposes a portion of the proceeds, for the sale of shares by a shareholder of a controlling company be taxed as a dividend. The deemed dividend would equal the higher of the retained earnings of the company (grossed up to a pre-tax amount) and the imputation credit balance being divided by 28%.
Sales proceeds exceeding this deemed dividend would be recognised as a tax-free capital gain. The treatment will apply to companies that are controlled more than 50% by an individual or an individual and their associates. It will apply to partial share sales as well as disposals of 100% of the shares.
The rule is intended to apply to New Zealand tax resident individuals and is not intended to apply to non-resident companies or shareholders.
The details of the regime and calculations will be complex and a minefield for taxpayers and their advisors.
The personal services attribution rules are being considered for considerable expansion by the government. The personal services attribution rules ensure income earned by a closely held company or trust for work done by a person (personal services), will be recognised as income of the person responsible for doing that work. The rule prevents a person from having their income from individual effort taxed at 28% or 33%, especially if, the person falls into the 39% tax rate.
The current personal services attribution rules apply when the following thresholds are met:
There is a further rule that came out of the famous Penny & Hooper case, in which Christchurch orthopaedic surgeons Ian Penny and Gary Hooper used company structures and family trusts to avoid a higher personal income tax rate by artificially lowering their salaries. The rule states that if a trust or closely held company derives its income from the personal services provided by an owner, the person performing the work must receive a market value salary.
In Penny & Hooper the doctors carried out work for many patients and therefore the 80% buyer test was not met. The government is proposing to remove the 80% limit − the first threshold to capture an entity with a diverse customer base. The second threshold is proposed to be lowered to 50% of a working person’s services producing income for an entity, with the aim of capturing more taxpayers under the personal services attribution rule. This will significantly expand the attribution rules to smaller building companies, medical practices etc. Under the proposals, in a Penny & Hooper situation, all the income less expenses would be required to be attributed to the person providing the service, not just a market value salary.
The threshold for substantial business assets rule is also proposed to increase to $200,000.
These changes are a significant expansion of the attribution rules and are clearly intended to make life much easier for Inland Revenue while removing legitimate structuring options that have always been available. There are different risks for those performing services and for those owning companies that contract to provide those services, and being able to retain income in a company or trust as security or for working capital is common practice that Inland Revenue wants to ignore.;
An issue government has identified is the poor level of record keeping when it comes to Available Subscribed Capital (ASC) and tracking historic capital gains. These amounts are important as they dictate what can be distributed from companies tax-free (usually on liquidation) as a return of capital or distribution of capital gains. Often businesses are not aware of their level of available subscribed capital as the relevant transactions happened many years ago and the relevant records have been subsequently destroyed. The government is proposing to overcome this issue by one of these proposals:
This would ensure accurate records of ASC are retained, but the up-front compliance costs to identify these figures will be significant.
It is concerning the government is looking at this degree of tinkering after their promise in 2019 that a capital gains tax would not be on the agenda. Indeed, in combination with the ten-year bright line test, the general land taxing provisions, the financial arrangements rules and the foreign investment fund rules, it is increasingly looking like New Zealand has a capital gains tax in all but name and it might be better to simply revisit a broad-based capital gains tax than have a complex series of regimes which add unnecessary compliance costs to businesses and run the risk of inadvertent non-compliance.
Negative comments in the discussion paper about smaller or fewer dividends being paid to shareholders since 2000 are also concerning. Commentators in the 1990s frequently despaired at businesses paying out dividends to shareholders instead of reinvesting those funds into their business and allowing it to grow. From a New Zealand Inc approach, we would rather see government encourage business owners to reinvest in their business than force the payment of dividends that will not serve New Zealand Inc well in the long run.
The closing date for submissions on these proposals is 29 April 2022.
If you have any queries or would like our assistance in relation to this matter, then please contact your Baker Tilly Staples Rodway advisor.
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