IRD PUBLISHES VIEW ON PENNY AND HOOPER DECISION
Following the Supreme Court’s unanimous decision in the Penny and Hooper litigation, the Inland Revenue Department (IRD) has published its current view on how the law should be applied in Revenue Alert RA 11/02.
The Revenue Alert notes that the use of companies, trusts, and other business structures do not of themselves give rise to avoidance concerns. However, where those structures allow the personal services provider to divert income away from themselves that arises from their personal exertion there could be an avoidance issue.
When the business involves the provision of services, whether that diversion is legitimate or not, requires the focus on two issues:
- Is the individual appropriately compensated for his or her skill and exertion? This requires an examination of the respective drivers of profit for the particular services provider, and how the profits of the business are actually distributed;
- If not, are there any valid commercial reasons for the individual receiving a reduced level of remuneration? The focus is on whether there are particular reasons why the individual is accepting an unreasonably low level of remuneration.
The IRD will be concerned with arrangements where the compensation received by the individual is artificially low, while related entities benefit (or the individual ultimately benefits), and any commercial reasons for that transaction do not justify the low level of remuneration.
The Revenue Alert states that the IRD will focus on situations where an arrangement has the effect of diverting a substantial amount of personal exertion income, but the benefit of those diverted funds are still enjoyed directly or indirectly by the individual or their family, or associates.
Given this focus, the IRD have noted that they are more likely to examine arrangements where the total remuneration and profit distributions received by the individual service provider is less than 80% of the total income derived by the business.
How it affects you
It is pleasing that the IRD’s focus will be on the most artificial cases. However it remains to be seen whether the 80% threshold indicated in the Revenue Alert provides a rule of thumb for businesses providing personal services in the future. If so, this would allow the business entity to retain 20% of the profits for distribution. If you have taken a position substantially different to the 80% threshold above we suggest you contact your tax advisor immediately to discuss your options.
CONSEQUENCES OF GIFT DUTY ABOLITION
We have commented a number of times this year that the repeal of gift duty does not trigger a “free for all” in terms of gifting outstanding loan balances, nor does it mean that the usual documentation required for a valid gift will no longer be required.
The IRD has released a Special Report which addresses a number of concerns that people have had in relation to the abolition of gift duty and sets out some of the reasons why gift duty has been abolished. The Special Report notes that whilst gift statements will no longer be required, the other usual documentation required for a gift to be made will still be required, for example, Deeds of Gift. Land transfer records will still be required for the transfer of real property. Registration details will show the transfer of motor vehicles, and banking records will show the transfer of cash.
A concern raised by many was that the removal of gift duty would enable debtors to defeat their creditors by gifting away their assets. However, there are three existing statutory regimes which allow for the claw-back of gifted assets. The Insolvency Act provides the official assignee with the power to cancel gifts made within two years before adjudication, or within five years if the bankrupt cannot demonstrate solvency at the time the gift was made.
The Companies Act provides the official assignee with similar powers but over shorter time frames (6 months and 2 years respectively), and the Property Law Act enables the Court to set aside property dispositions where there was an intention to prejudice the interests of a creditor. This provision has no time limit.
From a relationship property perspective, the Property (Relationships) Act provides the Courts with the power to set aside transfers of property to trusts where there has been an intention to defeat a spouse’s or partner’s claim at the time the disposition was made. Further, if the disposition was not intended to defeat a claim, but had that effect, the Courts are able to grant compensation, including other non-trust assets or income of the trust. Finally, s 182 of the Family Proceedings Act allows the Court to vary the terms of an agreement or settlement made before or after a marriage or civil union, and this includes the ability for the Courts to vest part of a trust to an affected partner for their benefit.
How it affects you
The Special Report highlights the fact that the abolition of gift duty will not give rise to a ‘free for all’, nor will it allow claims by creditors, spouses and partners to easily be defeated as existing legislation provides ample relief in those circumstances.