Another Blow by the Government Targeting the 39% Tax Avoidance

One would think that the Government has caused enough damage through tax measures targeting the residential property market such as the loss ring fencing rules, increased brightline period from 5 to 10 years, restriction on interest deductions and introduction of the 39% top marginal tax rate for individuals. In that case think again. Not only are some of these rules extremely iniquitous, but they add significantly to taxpayer’s compliance costs.

The Government has decided that further measures need to be introduced to prevent people avoiding the 39% top marginal tax rate. The latest round of proposals were released in the Governments Consultation document “Dividend Integrity and personal services income attribution”. The Government is consulting on these proposals and has invited submissions, which are due by 29^th April. What are these proposals?

Introduction of Capital Gains Tax on sale of shares

Sale of shares in a company that an individual and/ or their associates have controlled, where the retained earnings have not been paid out prior to the sale (and therefore avoiding 33% now 39% tax rate) will be subject to the deemed dividend rules. Such a sale would have historically given rise to a tax-free capital gain, but it is proposed that proceeds are taxable to the extent of the vendors share of retained earnings in the company. This is unlikely to raise much in the way of revenue for the Government because those earnings would, to the extent that they could be imputed, have been distributed to avoid the loss of imputation credits.
This will apply to groups of companies as well as where the shares are sold in a holding company as opposed to the operating company.

Maintaining ASC (available subscribed capital) and ACDA (Available capital distribution amount) records

Whilst most of us do this as a matter of good practice, Government feels that there is a need for this to be mandated by law.
This will enable the IRD to easily verify the non-taxable amount that arises when shares are repurchased by the company or the company is liquidated. Under the current rules
The consultation document suggests that the reporting should be done on an annual basis.
An amount paid to a shareholder upon liquidation is also tax free to the extent that it consists of ASC or ACDA (in essence third party capital gains).An amount paid to a shareholder on repurchase of shares by the Company is tax free to the extent that the repurchase amount does not exceed the ASC.

Changing the personal services attribution rules

To remove the 80% single customer rule. Currently when a person provides personal services through a company, where 80% of the income is received from a single customer or is performed/ generated by a single person, income needs to be attributed to the individual. Government is proposing to remove this threshold entirely.
The Government is also proposing to reduce the working person threshold from 80% to 50% and to increase the substantial business asset threshold from $ 75,000 to either $ 150,000 or $ 200,000 and excluding luxury vehicles, unless the business in question is that of transportation. This will have a significant impact upon the likes of incorporated real estate salesperson. The increase in threshold will not affect taxpayers whose business assets cost more than 25% of their income. Consequently, the threshold of $ 75,000 will be greater where the income from personal services is greater than $ 300,000.

Other Measures

Government also noted in this document that as part of stage 2 of its review, it will focus on Trusts and retention of company profits as well as a review of taxation of PIE income ( tax rates) .
One can only assume that the trustee rate and top personal rate are likely to be aligned in the near future to 39%.

What are the consequences

The main consequence is that these rules, if in fact enacted, will force companies to pay larger dividends more frequently.
In terms of changes to the personal services rules, the application of the attribution rule will be much wider. Companies providing services where the majority of the work is done by working owners will have the income attributed to the owners as if the company was a partnership.

March 2022