Read more information about some of the tax avoidance and voluntary disclosure processing issues arising from the 2011 Penny and Hooper court case.
Voluntary disclosures post Penny and Hooper - amount of income to be returned
Revenue Alert RA 11/02 sets out the Commissioner's expectation that where income is substantially generated by the direct personal skills, experience or labour of an individual, that income should generally be liable for tax in the hands of that individual.
Each case is considered on its own facts. However, the Revenue Alert sets out as a guideline that we are unlikely to investigate a tax position where 80% or more of the services-related earnings have been returned by the individual.
Relevant factors for determining amount of income to be returned
A number of factors can be relevant, including:
- the business environment the taxpayer is operating in
- future plans to purchase capital assets
- whether there are income streams received by the business from non-service related activities (for example sub-leasing of office space)
- where the business risk lies
- the extent to which there is leveraging off employees' personal exertions
- future plans to purchase capital assets.
These factors are not exhaustive, and different factors and/or a combination of factors may be relevant depending on the particular case.
Also they will be examined in the context of what benefit the individual and their family actually receive in substance from the profit distributions.
Voluntary disclosures - how much information is needed
Standard Practice Statement 09/02 - Voluntary Disclosures provides guidelines on how to make a voluntary disclosure and what constitutes a full voluntary disclosure.
Adequate information must be provided to enable a correct assessment of the tax shortfall to be made.
Where it is considered that a full disclosure has not been made, we will allow reasonable time for the taxpayer to provide the further information considered necessary.
Where further information is provided within an agreed period and we consider a full disclosure has been made, the taxpayer will be treated as having made a full disclosure.
Voluntary disclosures - the income years subject to adjustment
Where the Commissioner accepts a voluntary disclosure of a tax position which substantially replicates the structure used by the taxpayers in the Supreme Court decision of Penny and Hooper, the Commissioner will amend only the last two income years filed (prior to the Supreme Court's decision and Inland Revenue's letter from Graham Tubb to NZICA, 24 November 2011) PDF | 2 pages | 27kb
Market salary concept does not apply in Penny and Hooper scenarios
The Supreme Court in Penny and Hooper rejected the proposition that the Income Tax Act included a concept of market salary.
The Commissioner does not consider that the level of salary paid determines whether or not there is a tax avoidance arrangement. However, it is clearly a factor to be taken into account. The outcome depends on the profits actually generated, the control of the proceeds, and other factors, rather than any market comparable.
When shortfall penalties and/or use-of-money interest will apply to Penny and Hooper voluntary disclosures
Generally no shortfall penalties will be applied where the Commissioner accepts a voluntary disclosure of a tax position which substantially replicates the structure used by the taxpayers in the Supreme Court decision of Penny and Hooper, where the tax position was taken prior to the Supreme Court decision issued on 24 August 2011.
Use-of-money interest will be payable however.
Sending us a voluntary disclosure
Please send voluntary disclosures as a result of the Supreme Court decision in Penny and Hooper to firstname.lastname@example.org
We will ensure that they are dealt with in a consistent and timely manner.
Commissioner planning to increase investigations activity in this area
The Commissioner has started some further activity in this area. We are presently undertaking candidate reviews based on the data held.
Whether the concessionary approach to voluntary disclosures applies even though enquiries are undertaken
Not all enquiries from the Commissioner are audits or investigations.Where we contact a taxpayer as part of a risk review, the voluntary disclosure concessions will still be available to the taxpayer.
However, where we have commenced (or commence) an investigation into a taxpayer's affairs, the concessions are not available. This means that more than two income tax periods may be subject to adjustment and shortfall penalties may apply. SPS 07/02: Notification of a pending audit or investigation (also published in Tax Information Bulletin (TIB) Vol 19 No 3 (April 2007) sets out when an audit commences.
The Commissioner encourages voluntary compliance. Where a taxpayer considers that their tax position is inconsistent with the principles in Penny and Hooper you are encouraged to make a voluntary disclosure.
Types of income referred to in Revenue Alert RA 11/02 in reference to the 80% received by the service provider
The reference to 80% is to the level of reward received by the service provider. The 80% could be made up of income from a number of different forms of distribution from the business, including for example salary, dividends and trust distributions. We will look at the overall substantive position in deciding whether further compliance action is warranted.
Credits for tax paid by a company or by trustees
The Commissioner is taking a pragmatic approach and allowing credits for tax paid in associated entities when reallocating the income to the individual. Tax paid by the associated entity is credited against the additional tax assessed against the individual, so the only additional tax payable will be the difference in the marginal rates.
The new taxable income - whether calculated on a total profit or distribution basis
This largely depends on the taxpayer's circumstances. The 80% referred to in Revenue Alert RA 11/02 is a case selection criteria. However, when it comes to reconstructing the income it can be either the distribution or the profit. In the majority of cases we have seen to date, the bulk of the profit is distributed to the family of the service provider (either directly or indirectly). In the cases where the amount of distribution is less than the profit, the other criteria referred to in the Revenue Alert, such as retaining earnings to purchase assets can be applicable. The final re-assessment will take these matters into account.
Commissioner's approach to future years where the trustee and top individual rates are 33%
Where a taxpayer has a structure that diverts personal services income to a trust, technically there has been an alteration in the incidence of tax. Although practically there might not be income tax savings overall, there could still be gains to social benefit entitlements. Such cases might not be targeted for audit, however we still expect the person who substantially generated the income by their direct personal skills, experience or labour to return the majority of that income.
They can be remunerated by salary, wages, shareholder salary, directors' fees, dividends or through beneficiary distributions or any combination of these, so long as they return in their own name the appropriate level of income from the business.
Date published: 26 Jun 2012