Only pay your family what they’re worth
Tax Alert - December 2018
By Robyn Walker and James Rigter
As we approach Christmas you’re probably thinking about family; well if you’re thinking of paying a Christmas bonus to your spouse or hiring your children to work as “interns” over the Christmas holidays, you should be aware that Inland Revenue (“IR”) have recently released a draft Question We’ve Been Asked (“draft QWBA”) entitled “What are the requirements for claiming tax deductions for payments to family members for services?”
We’ve given the answer away with the title of this article, as any excessive remuneration will be treated as non-deductible. The IR also have strict documentation requirements, and depending on whether your business is run through a company it is necessary to seek explicit IR approval in order to claim any deductions.
The draft QWBA states that a family member is your spouse or partner, parent, sibling, child or other relative such as a sister-in-law or father-in-law.
The draft QWBA highlights three requirements that must be met before a business can claim a deduction for payments to family members for services:
• the family member must provide services to the business;
• the amount paid must not be excessive; and
• if the family member is the spouse or partner of the business owner, the prior approval of the Commissioner of Inland Revenue must have been received before claiming the deduction; unless the business is run through a company.
The consequence of not meeting the above requirements is that a deduction is denied for the amounts paid to the family member. While not explicitly stated by the draft QWBA, the family member will still be expected to return all amounts received as taxable income. When the payer of the remuneration is a company, any excessive amounts paid to a spouse or partner are treated as a dividend.
The draft QWBA makes reference to specific legislation that applies to these scenarios. If you’re not aware of the rules, sections DC 5, GB 23 and GB 25 of the Income Tax Act 2007 are the relevant rules.
Section DC 5 states that a person is denied a deduction for a payment to their spouse, civil union partner, or de facto partner for services if the Commissioner has not given approval. The Commissioner may approve deductions only if:
• the Commissioner considers that the payment is for services rendered; and
• the services are not domestic services or otherwise services connected with the home; and
• the payment is incurred by the person exclusively in deriving their assessable income; and
• the approval is granted before the deduction is claimed.
This last limb is important, as the Commissioner will not retrospectively grant approval, so application must be made and approval received before filing a tax return.
In addition to requiring prior approval, the Commissioner also requires detailed record keeping to provide evidence of the services provided by the family members. The draft QWBA recommends wage books, diaries recording the dates, hours worked, and nature of the services provided, along with other evidence. However, even if approval is received and detailed records are kept, if the Commissioner considers the rate of pay is excessive, deductions will be denied (QWBA 14/09 “Income tax – meaning of ‘excessive remunerations’ and ‘excessive profits or losses’ paid or allocated to relatives, partners, shareholders or directors” is a useful reference point for determining whether an amount paid is excessive).
A good idea, to prevent the Commissioner turning up as the Christmas Grinch, is to ensure payments to any family members are made at a similar rate to what you would pay a third party to carry out the same service.
For more information, contact your usual Deloitte advisor.