Tax cases have historically not been a feature of even the business pages of news publications.
However, the recent spate of tax avoidance cases, which incidentally have all been held in favour of the Inland Revenue Department (IRD), have become mainstream.
The landmark case of ‘Penny and Hooper’ is one such that has sparked the interest of every one.
Mr Penny and Mr Hooper were orthopaedic surgeons who carried out their trade through a company structure (paying tax at the lower company tax rate of 33% at the time) and paying themselves a modest salary (which was not subject to the top individual marginal tax rate of 39%).
IRD asserted tax avoidance in this case on the basis that the company was not paying a ‘commercially realistic salary.’
Revenue Alert
The Supreme Court agreed and issued its verdict on September 6, 2011.
Following the Supreme Court’s decision, IRD issued a ‘Revenue Alert’ that set out the Commissioner’s expectation in relation to arrangements where income substantially generated by the direct personal skills, experience or labour of an individual should be liable for income tax by that individual.
As discussed in my article in Indian Newslink (‘Penny and Hooper open Pandora’s Box,’ October 10, 2011), IRD’ s key focus is on cases where the total remuneration received by shareholder employees is less than 80% of the total distribution made by the company to associated interests.
In such cases, the presumption is, this would be considered by the Department to be an artificial arrangement and would, therefore, constitute tax avoidance.
As a follow-up to this Revenue Alert, the Commissioner agreed that, where taxpayers make voluntary disclosures in situations that substantially replicate the structure used by taxpayers in ‘Penny and Hooper,’ the Commissioner would only amend the last two income years filed by the taxpayer (prior to the Supreme Court’s decision on September 6, 2011) and no shortfall penalty would be applied.
Uses of money interest will, however, continue to apply.
Settlement Agreement
In short, IRD will enter into a Settlement Agreement with taxpayers that tell what is wrong with their tax return, before the Department finds out by some other means.
IRD generally has four years from the end of an income year to amend the return and assess taxpayers for outstanding taxes.
As such, this is a significant concession provided by the Department.
IRD estimates that more than 170 taxpayers have made voluntary disclosures with over $4 million of additional revenue collected.
End of concession
IRD has recently confirmed that the concession will end on March 31, 2013.
Voluntary disclosures on ‘Penny and Hooper’ type structures made after this date will not qualify for the concession. As a result, the Commissioner may seek to re- assess earlier years in appropriate cases and, in addition, shortfall penalties may be applied.
The concession provides taxpayers with certainty over their tax structure going forward and, from that perspective, this is an encouraging move.
Taxpayers should consider whether to make a voluntary disclosure and take advantage of IRD’s current concessionary policy before it ends.
In doing so, they must consult the three key questions that I had posed in my Indian Newslink article last year: 1. Is the salary from the company commercially realistic (i.e. appropriate compensation for their skill and exertion)? 2. Are there legitimate commercial reasons for a low remuneration compared to the income of the company? 3. Is there appropriate documentation setting out the commercial reasons for using the structure and supporting the arrangements within the structure?
It is important to note that the Commissioner is not attacking the structures that have been put in place, but the arrangements underlying the structures.
Ravi Mehta is Director, PricewaterhouseCoopers based in Auckland.
Email: ravi.s.mehta@nz.pwc.com
