Credit: Peter Speakman, Principal – Speakman Law

Transfers of land often invoke consideration whether or not the Brightline test is re-started. Inland Revenue has recently issued an Interpretation Statement (IS /22/03) that is most helpful in this regard.

IS 22/03 highlights that there must first be a disposal for the land tax rules to apply. In turn, in order for there to be a disposal:

• Land must be “got rid of” by the disposer; and
• One person must lose ownership of the land and another must gain it.

Various instances of co-ownership changes invite the question whether there has been a disposal. These are noted below.

Is there a “disposal” when the form of co-ownership changes, but the proportional shares do not change?

This may occur where, for example, joint tenancy ownership is substituted with a tenancy in common, or vice versa. This will not be a disposal. That is because there is no alienation of the land and at no point do the parties lose control of the property. Also, there is no “dealing with” the land, in the sense that the land does not move from one party to another.

Is there a “disposal” when the parties proportional shares change?

An example might be where co-owners hold the land as 50-50 tenants in common and then move to holding it as 75-25 tenants in common. Notable in this example is that no ownership interest is fully alienated, and it is instead reduced. This will amount to a disposal to the extent of the reduction. The Brightline period will restart with respect to the proportionate interest in the land that has transferred but not with respect to the balance of the land.

Is there a “disposal” when a co-owner is added or removed?

Yes, to the extent of the diluted ownership share.

Is there a “disposal” when land is transferred on a change of trustees of a trust?

No. Tax legislation essentially treats all of the trustees of a trust as a single person. Consequently, a change in title reflecting a change of trustees is merely a disposal to one-self and is disregarded. It does not restart the Brightline period. Note, however, the opposite is the case if land is resettled on a new trust notwithstanding that the resettled trust may have identical trustees to those of the old trust. Resettlement is a taxable event and amongst other things, will restart the Brightline period.

Whilst some of these conclusions are perfectly obvious and are as one would expect, it is nonetheless helpful to have any doubt about them removed.

Credit: Peter Speakman, Principal – Speakman Law

The loss carry forward rules were recently eased (actually it was over a year ago now, somehow it doesn’t feel that way), by permitting companies to carry forward losses where their business is unchanged, notwithstanding a significant change in shareholding. Prior to this ‘easing’, a 49% change in shareholding in a company was enough to cause the company to forfeit its tax losses.

This was particularly problematic for start-ups, which invariably are reliant for that growth on multiple capital raising rounds, with each one sometimes cancelling out the benefit of prior tax losses.

The continuity of business test permits a company in respect of which there has been a shareholder continuity breach provided there has been no ‘major change’ to its business, or if there has been, it is a ‘permitted change’.

In determining whether a major change has occurred, a key factor will be the extent to which the assets used in deriving the company’s assessable income have remained the same or similar over the relevant period. Obviously, assets of a company may need to be replaced due to wear and tear, obsolescence, or to keep up with new improvements. Provided the replacement assets are of the same character as the assets they are replacing and are similar in size and number, the change in those assets will not represent a major change.

Other relevant factors that are to be taken into account include changes in business processes, suppliers, personnel, scale and the type of product or service offered.

Inland Revenue has issued an Interpretation Statement that is most helpful in determining whether a major change has occurred, and more broadly in applying the business continuity test. Nonetheless, Inland Revenue conclude that this remains a difficult thing to determine and it may be easier to start with identifying where there has been a permitted change. If a change is permitted, then it is no longer necessary to establish whether the change is major. Permitted changes are those

a) Made to increase the efficiency of a business activity that the company carried on immediately before the beginning of the business continuity period;

b) Made to keep up to date with advances in technology relating to a business activity that the company carried on immediately before the beginning of the business continuity period;

c) Caused by an increase in the scale of a business activity that the company carried on immediately before the beginning of the business continuity period, including as a result of the company entering a new market for a product or service that it produced or provided at that time;

d) Caused by a change in the type of products or services the company produces or provides that involves the company starting to produce or provide a product or service using the same, or mainly the same, assets as, or that is otherwise closely connected with, a product or service that the company produced or providing immediately before the beginning of the business continuity period.

As is often the case with tax relieving provisions, the business continuity test comes with its own anti-avoidance rule. This targets arrangements by which:

a) A company pre-emptively changes the nature of its business activities in the 2 years prior to an ownership continuity breach in order to enable the business continuity test to be satisfied after the breach;

b) A company that carries forward losses under the business continuity test derives income that would otherwise have been derived by an associated person; or

c) An associated person of the company that carries forward losses under the business continuity test incurs expenditure or loss that would otherwise have been incurred by the loss company.

When it comes to due dates and business tax debt, the IRD don’t mess around. Business owners who shirk their tax obligations can quickly find themselves in trouble.

If you know your tax bill is going to be bigger than you can handle, it’s important to deal with that as soon as possible – ideally long before it’s due. If you can’t pay your tax bill, you should look at the following steps:

CONTACT THE IRD AS SOON AS POSSIBLE

The IRD want to help you meet your tax obligations, so if you contact them as soon as you know there’s a problem, they can help you find a solution. It’s best to contact the IRD before the due date, if at all possible, as it increases your chances of being able to get favourable terms.

You should also file your tax returns on time, even if you’re unable to pay the tax owing. If you’re tax compliant or seeking to be, the IRD will most likely be happy to negotiate a payment arrangement for you to pay your debt off in instalments over time. This can help you with cash flow management while you try to turnaround the business.

If you are suffering from serious ill health then you may qualify for relief under the hardship provisions.

If your business has been adversely affected by Covid-19 then IRD will consider financial relief and instalment arrangements. IRD can remit penalties and UOMI in these circumstances. You may be asked to provide a 12 month cash flow forecast (IR591) in support, bank statements, credit card statements and accounting information including debtors and creditors. To apply for financial relief you will be asked to complete an application. You will need to provide the current value of the company’s assets, liabilities and the position of your shareholder current account. The current account will record your net drawings from the company.

Call the IRD on 0800 377 771, fill out an instalment arrangement form online, or see their website page on instalment arrangements for more details.

IF YOU’RE EXPERIENCING SERIOUS FINANCIAL HARDSHIP

In some circumstances, the IRD will write off an agreed amount of your debt if they determine – based on their criteria – you are in serious financial hardship. They will take into account your payment history, your current situation, and your ability to meet future obligations. You’ll need to fill in the Disclosure of financial position IR590 form and a 12 month cash flow forecast IR591 form.

Bear in mind the IRD will look carefully into your company expenditure and your shareholder current account and the viability of the business. If it is determined the company is not viable, it may be recommended that the company is placed into liquidation or the IRD may initiate steps for that to occur.

WILL YOU BE PERSONALLY LIABLE FOR BUSINESS TAX DEBT?

In theory, your company structure is designed to protect your personal assets in the event of company insolvency or other financial difficulties. However, there are legal means to ensure you’re held liable.

Under a HD 15 of the Income Tax Act 2007, the Commissioner is able to go after personally-held assets of company directors and shareholders in order to recover tax debt. However, this only applies when director and stakeholders have entered into an agreement to purposefully deplete a company of its assets (an asset-stripping arrangement). Such an arrangement is also a breach of Director’s Duties. This clause is rarely utilised to recover debts.

Another Act, the Tax Administration Act 1994, makes provisions for non-compliance with tax laws. Under this Act penalties for a company’s non-compliance can be placed upon an officer of the company. A conviction under this Act could see a company director facing both a significant fine and time in prison. This same Act allows the commissioner to pursue a director personally for unpaid PAYE. The IRD has successfully brought many of these cases against company directors – in these cases the directors have been complicit in breaching their tax obligations.

Usually when a licensed insolvency practitioner is appointed to liquidate the company and following the liquidation process and payment of the realisations to creditors, any shortfalls including to IRD are written off. Directors may face pursuit from company creditors who held personal guarantees and on the occasion by IRD for unpaid PAYE.

ARE YOU IN TROUBLE WITH THE IRD?

If you’re having problems meeting your company tax obligations, or you are trying to make arrangements with the IRD to pay arrears, it’s best to be proactive, before you find yourself in even deeper trouble.

If you think your business is in financial trouble contact us to see how we can help. If you have received a statutory demand from IRD, do not delay or next your company will be served with a winding up proceeding to place your company into liquidation. If you want to understand your options you need to make enquiry promptly.

The reinstatement of the 39% tax rate for an individual’s income greater than $180,000 has resulted in the government proposing new measures to address matters that the IRD perceives as tax avoidance.

The attribution rule prevents an individual from avoiding the top personal tax rate (39%) by diverting income to an associated company or trust. It is common for an individual, a builder, for example, to incorporate a company and provide their services through this structure. The company allocates the builder a shareholder salary, and any profits retained in the company will be taxed at 28% (corporate tax rate). However, that salary may be below market rates. To this extent, the difference between the allocated salary and the market value of that salary creates a tax advantage.

This practice gained notoriety due to the 2011 decision in Penny and Hooper v Commissioner of Inland Revenue that went to the Supreme Court. That case involved two Christchurch orthopaedic surgeons who used company structures and family trusts to avoid higher personal income tax rates by artificially lowering their salaries. 50% below what was perceived to be market value by the Inland Revenue Department. Both individuals were found to have had a tax avoidance purpose.

This case creates a precedent which further supports the government’s motivation behind the personal services income attribution rules and the proposed amendments.

The existing personal services income attribution rule is subject to three principal criteria. These are:

1. The 80% Single Source Rule – at least 80% of the associated company (or trust’s) income from personal services during the income year is derived from the supply of services to a single third-party customer;
2. The 80% Single Supplier Rule – at least 80% of the associated company (or trust’s) income from personal services during the income year is derived from services that are performed by the individual;
3. Substantial business assets (property with a cost of more than $75,000 or 25% of the company – or trust’s – total income from services for the income year) are not a necessary part of the business structure that is used to derive the business income.

Note that the attribution rule only applies where a minimum threshold of $70,000 annual earnings is reached.

So what are the proposed changes up for discussion? The proposal suggests a number of options for broadening the scope of the personal services attribution rule. If implemented, the changes suggested in this proposal would represent a shift in the focus of the rule from narrowly targeting taxpayers who are similar to employees to capture a wider array of scenarios where an individual may use an associated entity as a channel for selling their personal services to one or more customers.

It is proposed that the 80% single source rule be removed altogether. Inland Revenue is also considering lowering the threshold for the single supplier rule from 80% to 50% and increasing the threshold for the substantial business assets to either $150,000 or $200,000 (or 25% of the company or trust’s annual income).

What does this mean? Take our builder example, a sole employee and shareholder of their company working on multiple projects for various clients. Currently, the company pays the 28% corporate tax rate on the income from building services provided to clients and pays a salary of $70,000 to the sole shareholder. Any residual profits are retained in the company. If these proposed changes were to pass, the personal services attribution rule would apply so that all the income of the builder’s company (the associated entity) is attributed to the sole shareholder (the working person).

The IRD’s intention is to ensure that taxpayers cannot avoid the highest personal tax rate. The IRD are putting more resources into this area to ensure taxpayers are returning the appropriate amount of tax. If you think the attribution rules may apply to you, please seek professional advice.

As some readers may be aware, in December 2020, the Government enacted new disclosure requirements for domestic trusts, effective from the 2022 tax year onwards. The purpose of this is so the Government can gain insight into the effectiveness of the new highest individual tax rate, being 39% for individual who earn $180,000 or more. As well as this it will enable the Government to better understand and monitor the use of structures and entities by trustees.

Currently, income retained in a trust is taxed at 33%, with no further income tax imposed if this income is subsequently distributed to a beneficiary who might be on the new highest marginal tax rate of 39%. Under these new disclosure rules, Inland Revenue will have complete visibility over how trusts are being used to fund annual capital distributions from income taxed at the lower trust tax rate. The Government will be using this information collected to decide on whether the trustee tax rate should also be increased to 39%.

What are the implications of these new requirements?

For most trusts, there is now a legislative requirement to prepare financial statements for tax purposes to a minimum standard. It is also necessary to disclose a lot of detailed information about settlements, settlors, and distributions to Inland Revenue as part of filing the annual trust tax return. It sounds simple in theory, but there is no doubt these measures will increase compliance costs for most trusts. We note in the regulatory impact statement, officials admit they “have limited understanding of the compliance costs that trusts will face with the increased disclosure requirements and how large the costs will be”.

After a period of public consultation, there has been some improvements to the minimum financial statement proposals, but in our view, this does not significantly reduce the amount of information that all trusts need to disclose when filing their tax returns. Currently, we are still waiting for Inland Revenue to release its final operational guidance on how to apply the rules.

Is your trust excluded from the new rules?

First, it is important to note that not all trusts are caught by these rules. Trustees should first check if they qualify to be excluded from these rules, as this will save considerably angst. The largest category that will be exempt are non-active trusts. Typically trusts holding the family home, with no income and expenditure will be considered non-active. All trustees in this situation should review whether their trust is non-active and speak to their accounting advisor about filing an IR633 (non-active) declaration if not already done.

The other trusts that are excluded from these rules include foreign trusts, charitable trusts, trusts that choose to be a Maori Authority, trusts that are widely held superannuation funds and lines trusts.

Filing the trust tax return and making disclosures

The next task for trustees is to file various disclosures of all settlements, settlors, distributions, and those with the power of appointment via the IR6 and IR6B forms, which we understand have been redesigned to collect all the new information now required. Unfortunately, at the time of writing this article, the final guidance on the specific information required has not been released. However, what we do know is that accountants will be asking for a lot more information from their trustee clients this year!

When you think about the way that you pay for your personal or business expenses (eg insurance, rates, rent, power, software subscriptions, apps such as Spotify and Netflix, etc) you will notice a trend over the last decade. There has been a natural progression to payment via Direct Debit. Direct Debits are now easy to set up, low cost and best of all, flexible.

We are in the process of changing the way we collect payment of our invoices. Over the next 12 months we are looking to shift to this Direct Debit model of payment. Some key benefits to you are:

Choice of payment option – choose in advance if you would prefer to pay from your bank account or a credit card.

Set and forget – You set up payments once, and after that, payment is automatically transferred on the invoice due date. No need to set diary reminders or log into your internet banking to make a payment.

Better budgeting – Paying this way makes your cash flow more predictable, which will mean it is easier to budget for our services.

Never get “chased” again – Since payments are automated, you won’t get chased if you forget and there’s no risk of incurring late payment fees or interest.

Retain 100% control – You’ll still receive notifications of invoices due and payment dates well before funds are collected. If for any reason you wish to delay making a payment or query an invoice you simply contact us to discuss it.

More efficient means lower cost – A Direct Debit system operates at a lower cost for our firm, which means we can offer you more competitive fees.

Our terms of trade are currently on our website https://www.jacal.co.nz/wp-content/uploads/2019/05/JACAL_Terms_of_Trade_Short_2015.06.pdf, this will remain unchanged.

If you have any questions regarding this please don’t hesitate to reach out to Laki Machee on 09 3612796 or Traccie Tuese on 09 2220745 who are managing the change process.

Johnston Associates has decided to provide more regular information via social media channels – namely Facebook and LinkedIn. We will continue to publish our quarterly newsletter, but you will find more regular and timely information through these channels.

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