Money: Take care when redirecting income to avoid 6c rise

By Denham Martin

Taxwise


Since the election I have followed with interest various claims that my accountant or lawyer may be able to devise "schemes" involving companies, trusts or superannuation funds to avoid the future tax rate rise. Are these "schemes" a legitimate means of avoiding the tax hike?

I.P, Warkworth


The "schemes" involving companies, trusts and superannuation funds to which you refer are no doubt mechanisms by which income is shifted from an individual to an entity to benefit from variations in tax rates.

The new Government's proposed amendments to the tax rates would see a marginal tax rate of 39c levied on personal earnings over $60,000. Assuming that the other marginal rates remain at the current levels, this would give personal rates of 19.5c for income up to $38,000, 33c for income between $38,001 and $60,000, and 39c for income above $60,000.

This contrasts with:

\EE Companies - taxed at the flat rate of 33c.

\EE Trusts - trustee income taxed at the flat rate of 33c and beneficiary income taxed at the beneficiary's marginal tax rate.

\EE Specified superannuation contributions - withholding tax deducted at the flat rate of 33c.

An individual would always have a tax advantage over a company, trustee or a specified superannuation contribution to the extent of the first $38,000 earned. In fact, an individual would have to earn approximately $150,000 before the blended marginal tax rates equalled the tax at the flat rate of 33c.

Accordingly, when reviewing various schemes bear in mind they are directed towards income above $60,000 as opposed to total income.

Structures, which at first blush appear to be tax effective, need to be considered in terms of tax avoidance.

Finance Minister Michael Cullen has indicated the IRD will be pushed towards policing tax avoidance with more vigilance.

The IRD's powers to investigate and strike down tax avoidance arrangements are extensive and the Government would not need to change any laws to allow this more vigilant policing.

Whether a scheme is legitimate or amounts to tax avoidance will ultimately depend on the purpose for which it was entered into.

Any arrangement is void against the IRD where any purpose or effect of that arrangement (whether direct or indirect) is tax avoidance, unless it is a merely incidental purpose or effect.

Tax avoidance includes directly or indirectly altering the incidence of tax, relieving any person from a liability to pay tax, and avoiding, reducing, or postponing any liability to income tax.

Therefore, if you enter into a scheme for the purpose of "avoiding the tax hike" you should be concerned.

Having said this, there may be justifiable commercial reasons for restructuring your affairs.

But you should remember that if the restructuring is examined by the IRD, the taxpayer bears the onus of proof in showing that any tax avoidance effect was merely incidental.

Further, when considering the "schemes," you should be aware that not all income streams can be transferred from an individual. Where you earn your income from provision of your personal services, you cannot simply assign that income to, for example, a trust.

Where an arrangement is void against the IRD, it can reconstruct income streams to the appropriate taxpayer, issue assessments, and impose penalties. Thus the tax benefits would be lost, but the commercial ramifications and other consequences of the scheme remain.

* Denham Martin is the principal of Denham Martin and Associates, lawyers specialising in advice on taxation and related matters.