Top tax rate increase needs attention

In the turmoil of temporary lockdowns and excitement of the America’s Cup racing, many people have lost sight of the fact that the promised lift of the top marginal tax rate for individuals earning over $180,000 will apply from April 1, 2021.

It is fair to say that for those affected by this change, it remains front and centre of their thoughts.

You may recall that at the time this policy was announced by the Labour Party before the election in 2020, there was a lot of discussion around how narrow it was in terms of truly addressing tax system equity (only affecting 2% of the population) but also how vulnerable it was to circumvention by people who were not solely salaried employees (e.g. business owners trading through other structures).

This criticism lead to several comments by the Government that it would be watching the taxpayer response carefully and would consider further “integrity measures” if it concluded that these rules were actively “avoided” by a large number of taxpayers.

One potential solution was raising the trust tax rate to 39c in the future.

The difficulty for taxpayers is determining what actions are OK to do to mitigate future tax costs, and what actions would be considered crossing the “avoidance” line so as to be ineffective at law and subject to challenge, penalties and interest.

It is also important to reflect on the last time that New Zealand had a 39c tax rate, and how it became perceived by those affected as relatively unreasonable/unfair in their minds, and the huge distraction it created in the business ecosystem as people became focused on it. It is important to note that this time around, the income threshold is much higher.

Those taxpayers on arm’s-length salaries from corporates and the public sector can probably do very little to mitigate this extra tax burden.

While there is chatter around the potentiality of changing their contractual terms or interposing “new” entities into the existing arrangements, there would be a fairly high threshold of commercial drivers required to demonstrate such is not simply tax avoidance (and thus able to be disregarded by the IRD).

Further still, the IRD has already confirmed that it will be monitoring both new entity (companies/trusts) formation, and changes in payment patterns through the payroll/PAYE system, and will be actively asking questions on a pre-emptive basis.

However, for those “in business” already, there is much greater scope to potentially mitigate the impost of this extra tax on personal income for the foreseeable future.

However, the most logical mechanisms to do so, in a valid and commercially acceptable way, probably do require some actions before March 31, 2021.

Accordingly, business owners should be talking to their advisers about what can be done on a reasonable basis, and what activities are plainly crossing a line towards tax avoidance.

For example, if a company has significant built-up reserves, directors could consider a fully imputed dividend payment before March 31, 2021, ideally of cash but potentially by way of credit to shareholder current accounts, reflecting a distribution of income derived in a time whereby marginal tax rates were lower.

In some ways, this is actually a positive for the Government, as it brings forward a 5c RWT obligation but holistically ensures these funds are not accidentally taxed at 39c in the future.

Another matter that companies/trusts should reflect on is the level of salaries paid to associated employees, with a view to determining whether they are appropriate (there are risks around them being too high and too low).

There are a raft of matters/actions that should be considered at this time, albeit an eye needs to be kept firmly on whether potential actions are commercially sensible and/or do not cross a line into tax avoidance.

Something to remember when considering potential actions is that the IRD will have the benefit of hindsight when assessing the overall effect of a series of activities over a period of time, and that while, when considered individually, certain actions make absolute sense in isolation, when they are combined with other actions, there seems to be an overall accumulated picture of tax avoidance.

Tax mitigation v tax avoidance is a vexed area of tax law and involves a significant amount of judgement as to where one ends and the other starts.

There is quite a lot of published material from IRD to provide some guidance, but it is likely there are more integrity measures to come as part of Budget 2021 and beyond.

Examples may include what information the IRD ultimately seeks under its new powers in respect of information collection from family trusts or focused review activities around overall reductions in historical income levels at a personal level.

In summary, there are things that can legitimately be done now to mitigate the impost of the higher tax rate on some income, but “let’s be careful out there”.

 - Scott Mason is a senior tax partner at Findex in Dunedin.