Taxman warns self-employed on trusts

Inland Revenue yesterday warned self-employed people against using trading trusts to reduce their taxable income.

The IRD raised concerns that some professionals, who set themselves up as employees of trusts, were setting their incomes at levels "considerably" below what they would earn as self-employed practitioners.

Although most businesses are operated through companies, some smaller businesses, notably doctors' and dentists' practices, are run via more flexible trading trusts.

The IRD warning follows a Taxation Review Authority case in which District Court Judge Paul Barber ruled against a self-employed dentist.

The dentist sold his business into a trust and became the trust's employee.

The trust then paid him an "artificially low" annual salary of $80,000 when it should have paid him $120,000.

Judge Barber said the dentist's income was earned by the trading trust, the net income was distributed among the trust's beneficiaries by book entry, and lent back to the dentist.

This, Judge Barber said, was a tax avoidance arrangement under the 1976 Income Tax Act.

Thomas Pippos, Deloitte's senior tax partner, said it appeared that the dentist moved income that would be taxed in his name at 39 per cent into the names of minors, probably his children, meaning it was taxed at only 19.5 per cent.

Graham Tubb, the IRD's national manager of technical standards, said people considering operating a business through a trading trust should take careful advice from a tax adviser or the IRD first.

He said the IRD was investigating about 100 similar cases, some of which involved "very substantial" sums.

Potential penalties include up to 100 per cent of the tax avoided, plus interest.

Mr Pippos said the IRD's announcement would "scare" some people. But there should now be some consistency in how trading trusts are viewed.

However, the IRD's approach came under fire from the Institute of Chartered Accountants. Its tax committee chairman, John Canton, said the IRD's warning, via a press release, had not removed any of the uncertainty surrounding the use of trading trusts.

"If Inland Revenue can't say what's acceptable, they should say what's not," Mr Canton said. "They don't say how far or in what circumstances they'll chase you."