Inland Revenue has welcomed the Supreme Court decision in the Penny and Hooper Case.
Acting Commissioner of Inland Revenue, Mary Craig, said the decision upholds Inland Revenue's view, and a ruling by the Court of Appeal last year, that the income allocation or diversion arrangements constitutes tax avoidance.
The decision helps to clarify the law in this area, and Inland Revenue will carefully work through the implications, Ms Craig said.
Orthopaedic surgeons Mr Ian David Penny and Mr Gary John Hooper had entered into a tax avoidance arrangement, where they incorporated their businesses and drew a salary that enabled them to pay tax on the bulk of their income at a lower rate. Both men acknowledged that the salaries paid were not commercially realistic in those circumstances.
The Supreme Court upheld the earlier decision by the Court of Appeal, made in 2010.
However, while welcoming the decision, Inland Revenue will be taking a measured approach as to how it is applied.
"The decision does not mean that every incorporated business, or one that is managed through a family or trading trust, is a tax avoidance arrangement, and the Court gives clear advice on that," Ms Craig said.
The Court also confirmed that avoidance does not arise, despite a low salary being set, if particular circumstances are present - such as a business being in financial difficulty, or where there are capital investment requirements.
"The issue is really about balancing various factors, such as how such entities are managed, and the deliberate use of companies and trusts to divert income and reduce a person's tax obligations. If one person is generating the profits, but is diverting their income into other structures and declaring a reduced salary for the financial benefit to themselves or their family, then that is tax avoidance," Ms Craig said.
Inland Revenue is focusing on those who have created similar structures, and use them in a non-commercial or contrived manner to minimise tax, as part of its ongoing compliance focus programme, set out in its publication "Helping you get it right".
Inland Revenue in 2010 published a Revenue Alert on the matter, in the Revenue Alert RA 10/01. It is likely that this will now be updated.
Information on compliance with tax rules is available on the Inland Revenue website, in the "Getting it right" section, or people should contact their tax agent or advisor.