The new 39% rate

As flagged during the election campaign, the Government has pushed ahead with introducing a new 39% top tax rate. As with any tax changes, this has knock-on effects that need to be considered.

The new top rate applies from 1 April 2021 to income earned by individuals (including bonus payments, back pays and redundancies) on amounts over $180,000 in an income year, and the PAYE, RWT and other withholding rules are being updated to account for this. It will only apply when the total income is more than $180,000 so there is no change for those earning less than that.

Other employment related tax rates have been modified effective from 1 April to remove any planning opportunities for employers, including:

• A new top rate for FBT will be added, being 63.93% for fringe benefits (such as cars) provided to employees earning an all-inclusive pay of more than $129,681 (this is consistent with other FBT bands).
• Changes to Employer Superannuation Contribution Withholding Tax (ESCT) deducted from employer contributions to Kiwisaver or Superannuation schemes. A new top rate of 39% will apply when a person’s income from employment plus from employer Kiwisaver contributions is over $216,000 per annum.

Pre 31 March 2021 actions

For income that is going to be earned and taxed in the hand of individuals with income over $180,000 per annum, you should consider the following:

• Employment income is taxed at the date the cash is actually paid, or credited to an account. If any bonuses are accrued at 31 March but are not usually paid until shortly after, these could be paid prior to 1 April and taxed at 33% rather than the 39% that applies if paid after that date.
• If a company has retained earnings and imputation credits available, dividends could be paid prior to 1 April. The additional tax payable would be 5%, compared to the 11% that will apply on or after 1 April 2021. Any effects on provisional tax should be considered.
• If salary is less than $205,000, consider sacrificing salary in exchange for increased employer Kiwisaver contributions, to take advantage of the $216,000 band above.
• Reviewing how motor vehicles are provided to high earning employees and whether there is scope to take vehicles off balance-sheet and reduce the FBT bill by paying vehicle allowances instead of providing motor vehicles.

Active income vs investment income

Because the new higher tax rate only applies to individuals, the obvious solution is to redirect taxable income so it is earned by non-individuals. However, this opportunity is limited where the income is derived from providing personal services. There are already a number of rules, court decisions, and Inland Revenue pronouncements limiting when personal services income can be earned by non-individuals.

The last time the individual tax rate was 39% most of the loopholes re-directing personal services income were closed, by use of the attribution rules, and using the general tax avoidance rule in the case of Penny & Hooper. Inland Revenue will be on the lookout for any new loopholes, and move quickly to shut these down.

Investment income

While the comments below discuss investment options, this is not intended as investment advice and should not be relied upon in making investment decisions.

If you have funds to invest it pays to make sure your investment strategy aligns with your tax profile and goals. For individuals affected by the new 39% tax rate the general recommendation is that “passive” income sources should, where possible, not be held individually or, if held individually, invested via Portfolio Investment Entities (PIEs), to cap the top tax rate at 28%. A new RWT rate on interest (but not dividends) of 39% is being introduced effective 1 October 2021.

Alternative investment vehicles for investments are:

• Trusts trustee rate of 33% and ability to distribute to beneficiaries on lower tax rates (subject to “minor beneficiary rule”). See comments below about Inland Revenue keeping an eye on trusts.
• Companies tax rate of 28% but if the funds are used by shareholders interest needs to be charged. If the profits need to be paid to individual shareholders as a dividend “top up tax” of up to 11% will be payable if they have income of more than $180,000. There can be also be other restrictions arising with companies, such as less discretion in how to tax foreign investment fund (FIF) income.
• PIE investments top tax rate of 28%, but PIEs can be restrictive, lack flexibility and limit diversification.

As always, any restructuring should not be driven by tax reduction reasons, but should be done for genuine commercial reasons (e.g. asset protection, ease of operation) otherwise there is the risk of unwinding due to tax avoidance rules.

Trust disclosure

Although the trustee tax rate will remain unchanged at 33% for the time being, there are increased disclosure requirements in relation to trusts that will apply from 1 April 2021, including financial information and details of settlors and those with power to appoint. Inland Revenue states that this information will be collected to assess compliance with the new 39% rate and whether there are any structuring issues involving trusts.

Baker Tilly Staples Rodway advice

The new 39% tax rate will be a major cost to those who derive high income from providing their own labour. Those with investments deriving passive income will have more options and should carefully review the real benefit of making any changes and make sure that they do not fall foul of anti-avoidance rules if they restructure, especially if the amounts are significant. We recommend speaking with your usual Baker Tilly Staples Rodway advisor for guidance.