Penny and Hooper open Pandora’s Box

Inland Revenue argued that the salary paid to the surgeons was artificially low, compared to the incomes they received as sole practitioners and hence this was a case of tax avoidance.

The Supreme Court agreed, but indicated that the arrangement would not be tax avoidance if the surgeons had been paid a ‘commercially realistic salary.’

The decision has prompted business owners and their advisors to seek clarification from IRD on the application of the findings in Penny & Hooper.

In response, the Department has released a ‘Revenue Alert,’ saying that it will “focus on the more artificial arrangements.”

It will examine cases where the total remuneration received by shareholder employees is less than 80% of the total distribution made by the company to associated interests.

IRD insists that using a company, trust or another business structure including partnerships and look-through companies should not be for avoiding tax.

The Department is concerned about what lies beneath these structures.

Business owners employed in their companies need to review their exposure by answering the following initial questions: 1. Is there salary from the company commercially realistic, i.e. appropriate compensation for their skill and exertion? 2. Are there legitimate commercial reasons for a low remuneration compared to the income of the company? 3. Is their appropriate documentation setting out the commercial reasons for using the structure and supporting the arrangements within the structure?

If the answer to any of these questions is ‘No’ or ‘Maybe,’ it is time to consult your advisor!

Ravi Shailen Mehta is a Director at PricewaterhouseCoopers in Auckland. A similar article on the subject (‘Black letter of the law hard to fathom,’ written by tax expert Vijay Talekar) appeared in our September 15, 2011 issue.

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