Inland Revenue Department (IRD) has warned taxpayers that breach of existing rules on diversion arrangements would bring defaulters to grief.
The Department issued a ‘Revenue Alert’ following a Court of Appeal decision on the Penny and Hooper Case.
In its verdict delivered on June 18, the Court of Appeal held that the defendants had set up companies to avoid taxes and hence were liable under the relevant law in force.
The decision reversed an earlier judgment of the High Court.
Surgeons Ian David Penny and Gary John Hooper had each set up companies to buy their individual practice. They employed themselves in the 2002, 2003 and 2004 tax years at salaries that IRD considered as artificially low.
The Department had taken the view that the defendants had structured their affairs to show that their practices were operated through companies to avoid taxes.
The Court heard that the two defendants had taken advantage of the lower company tax rate of 33% when they should have been taxed at the higher marginal tax rate of 39% on their personal income.
The Revenue Alert sets out New Zealand’s taxation rules and determines the factors that would enable IRD to identify tax avoidance cases.
The Department’s Group Tax Counsel (Assurance) Graham Tubb said the decision in the Penny and Hooper case affirmed the long-held views on tax planning.
“It is in line with recent cases dealing with forestry structures, intellectual property rights and structured finance arrangements,” he said.
However, the decision did not mean every incorporated small business or those run through trusts are now a tax avoidance arrangement.
Mr Tubb said the decision continues a long line of successful cases dating back to the 1980s and others concerning the sheltering of personal income.
“To be considered avoidance, the tax effect would need to be substantial and unusual. It is a question of degree, but as is suggested by the Court, IR should not interfere in ‘marginal circumstances.’
“The Penny and Hooper decision confirms important criteria which, in combination, are likely to be indicative of tax avoidance and we reflect these in our updated Revenue Alert,” he said.
According to Mr Tubb, neither the Government nor the Department was attempting to influence the concept of market or individual salary.
“There are often legitimate reasons to retain income in the entity for business purposes. However, where tax avoidance is found, IRD will consider if the distribution of profits is sufficient,” he said.
Read our expert’s comments (Court decision opens a new Pandora’s Box) in this section.