The new 39% tax rate puts tax structuring back into the spotlight – why it may be time to talk about tax avoidance
Tax Alert - March 2021
By Ian Fay, Brendan Ng and Charlotte Monis
Tax avoidance isn’t normally something most businesses are thinking about. However, with the introduction of a new top personal tax rate of 39% on annual income exceeding $180,000, ordinary business activity such as paying shareholder salaries and dividends, making trust distributions and paying bonuses may require consideration of these rules. This is particularly significant where payments are being made around the application date of 1 April 2021 (for standard March balance dates).
This article considers some questions taxpayers may be, or should be, mulling over ahead of the tax rate change. For more on the tax rate change, including your FBT obligations, see our article in this month’s Tax Alert on FBT, and our high level summary of consequential changes from the new tax rate in the December 2020 edition of Tax Alert.
What is Tax Avoidance?
A ‘tax avoidance arrangement’ is one that is entered into (either directly or indirectly), where any tax avoidance purpose or effect is more than merely incidental. Any tax avoidance arrangement will be deemed void by the Commissioner. You can read more on Inland Revenue’s recent views on tax avoidance in our article in the February 2021 edition of Tax Alert. At first glance, this may capture even the simple act of paying an amount on 31 March 2021 (as opposed to 1 April 2021) to take into account the new 39% tax rate.
Recently, Chartered Accountants Australia New Zealand hosted a webinar with a panel of Inland Revenue Officials to discuss the implications of the new 39% top personal tax rate. Officials highlighted two powerful tools at their disposal: increased disclosure obligations on taxpayers, and the capability of their new IT system to carry out data-analytics to identify behaviour changes that may be due to the increased gap between the top individual tax rate and the company and trust tax rates. Inland Revenue will be on the lookout for any restructuring carried out solely for the purpose of avoiding tax, and have made it crystal clear that they will be monitoring behaviour to ensure that the integrity of the tax system is maintained.
What do I need to consider, keeping the 39% tax rate and tax avoidance in mind?
While the differential in the trustee tax rate of 33% and the new top personal tax rate of 39% may be seen by some as an opportunity, there has been strong signalling that if the trust regime is exploited the Government will move to crack down on those who are exploiting it, potentially with consequential changes to the framework for taxing trusts.
Going forward, Inland Revenue will be more closely analysing trust activity, including the establishment of new trusts, movement of funds, and other related activity. This monitoring will be aided by increased trust disclosure requirements in relation to the financial position of the trust, settlement and distribution details, including identifying beneficiaries receiving non-taxable distributions from trusts. You can find out more about these disclosures in this article in this month’s Tax Alert. This information could then be used by Inland Revenue to review individual taxpayers or by the Government to inform decisions about whether the trustee tax rate should be amended. Minister of Revenue, Hon David Parker, has made it clear that if trusts are being used to avoid the 39% tax rate then further work will be done to shut this down, stating “If that behaviour becomes apparent, then we’ll move to increase the trust rate to avoid that being used as an avoidance loophole”.
Trusts continue to have a valuable role to play, for example in relation to asset protection and estate planning. With the Trust Act 2019 coming into force from January 2021, trustees need to ensure trusts are being managed consistently with the purpose of the trust and the obligations under the Act. The introduction of the 39% tax rate adds another dimension to the management of trusts and the making of distributions and loans to beneficiaries, so we recommend that clients consider their wider facts and circumstances before they undertake any action, and discuss with their Deloitte advisor to ensure that appropriate care is being taken.
b) Dividends, bonuses, salaries and other payments
There are a variety of commercial reasons for businesses to be paying out dividends, bonuses, salaries, etc, either before or after 31 March 2021, with payments on or before 31 March 2021 being taxed at the lower top personal tax rate of 33%. While a commercial reason will assist with an argument that an arrangement is not a ‘tax avoidance arrangement’, this may not be enough when viewed in the context of all of the relevant facts.
When making decisions that relate to the payment of bonuses, dividends and salaries, vesting of share schemes, or redundancy payments, etc, it is important to also consider the wider facts and circumstances surrounding these actions and how these arrangements are put into effect. With this in mind, we recommend seeking further advice if you are undertaking any of these actions before 31 March to ensure that all relevant considerations are taken into account.
In relation to shareholder salaries, it will also be important to ensure that there is a definitive commitment before 31 March to pay the shareholder salary. The commitment to pay a shareholder salary before 31 March cannot be satisfied by mere payment after year-end. This is an obligation which may come under greater scrutiny with the new top tax rate so appropriate steps must be taken.
IRD to tackle tax avoidance with SMART new tools
Inland Revenue still has a couple of mountains to climb to complete its technology-driven transformation, but their new START computer system is seeing more detailed data being received more frequently. This will enable Inland Revenue to monitor trends and changes in behaviour, then use this information to decide whether something should be investigated further.
Inland Revenue’s intention at this time is to undertake more real-time monitoring. Previously, under their old system, Inland Revenue would not have been able to analyse top tax rate data until 2022 tax returns filed were filed, so after 31 March 2023. However, with more data points being received more frequently, Inland Revenue can intervene earlier and have stated that their intention is to analyse any trends that emerge and to consider any significant changes from previously filed returns.
Inland Revenue will also be monitoring new company incorporations and trust registrations, as well as closing of companies and trusts, partly to determine whether there is any commonality and to ensure that there isn’t a significant change in behaviour.
The key message here is that if you are considering restructuring, using trusts or even relatively simple actions such as paying dividends or bonuses, you should be considering the wider facts and circumstances surrounding these actions. This is particularly true when considering the tools Inland Revenue now has at its disposal. What is acceptable behaviour, or not, in the context of the 39% tax rate may depend on these wider considerations and how the arrangements are put into effect. Having a clear commercial rationale for your decisions will assist, but the (heavy) caveat to this is where other factors and circumstances begin to add up and point towards a non-commercial or tax only rationale, the risk of Inland Revenue taking an interest is likely to increase.
We are currently assisting a number of clients in meeting their obligations arising from the 39% tax rate, including in relation to FBT, employee share schemes, salary setting, dividends and so on. If you would like to discuss any of these issues please contact your usual Deloitte advisor.
March 2021 Tax Alert contents
- What are the tax obligations which come with claiming COVID-19 Government support?
- The tax cost of your fringe benefits is about to increase
- The new 39% tax rate puts tax structuring back into the spotlight – why it may be time to talk about tax avoidance