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Aggressive tax planning under scrutiny

Aggressive tax planning under scrutiny

by Anthony Davies | Friday, 20 April 2007

If you're using a trading trust to minimise clients' taxable income through income-splitting or paying under-market salaries, a recent IRD victory highlights that you need to ensure it's run within the rules and paperwork is kept in order.

That's the warning from Kensington Swan in its latest Tax Talk publication.

It highlights a recently reported IRD victory at the Taxation Review Authority (Y1 (TRA No. 094/03)) which illustrates how IRD is actively targeting this area.

"This case serves as a reminder that although taxpayers are entitled to use a trading trust structure to order their affairs, the trust must not be run in an artificial or contrived manner. It is useful to note that running a trading trust improperly does not necessarily mean there is tax avoidance but it will probably indicate artificiality. As always, it is important that minutes and accounts are properly kept and any loans have at least interest payable 'on demand'. Inland Revenue has been unwilling to set down any guidelines for trading trusts and this case represents their recent testing through litigation of trading trust structures that sit on the edge of what may or may not be tax avoidance. More can be expected and it is understood that audits are continuing of medical specialists and the like, particularly where salary paid to the specialist for private practice services is set by reference to salary paid by DHBs for public hospital attendances," Kensington Swan comments.

The case in question involved a Mr and Mrs H, who were in a partnership and established a trading trust. The beneficiaries were themselves and their four children. The trustee company entered into a distribution agreement with a bakery company and the partnership was paid a management fee. While net trust profits were supposedly distributed to the children each year, no money ever reached them. Instead, this was only a paper transaction and the money was used by their parents. These amounts were then recorded as loans in the trust's "advances account".

The Authority held the trading trust was a tax avoidance arrangement under section BG 1 of the Income Tax Act 1994 (the version of the Act in force at the time the arrangement was set up) as the income-splitting reduced the amount of tax payable. The Authority ruled the 50/50 partnership arrangement was inappropriate and assessed it at 70/30 due to Mr H making a greater contribution.
� 2007 financialalert Limited.

First published in financialalert www.financialalert.co.nz
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Dunne defends fair dividend rate compromise

Dunne Defends Fair Dividend Rate Compromise

by Anthony Davies | Wednesday, 11 October 2006

Revenue Minister Peter Dunne has gone on the front foot to defend his and Finance Minister Michael Cullen's proposed "fair dividend rate" compromise for taxing offshore shares holdings against accusations it will disadvantage managed funds.

"Once enacted, the new legislation will remove several tax disadvantages that discourage saving through funds," he said in a speech delivered yesterday at the Association of Superannuation Funds of NZ (ASFONZ) conference. He continued that there are no easy answers and any solution will necessarily involve trade-offs. "The new tax rules will have the potential to change the landscape significantly for managed funds in New Zealand. A portfolio investment entity will, in many situations, become the favoured vehicle for people to invest through."

He then went on to list four ways in which the proposed new tax regime will mean some investors will get tax breaks through investing in offshore shares via managed funds instead of investing direct.
"The tax rate on income from offshore shares earned by managed funds on behalf of their 39% rate investors is capped at 33%. In contrast, income from offshore shares earned by individuals investing directly in them is not capped at 33% and can be subject to a 39% tax rate.

"Some people have also conveniently forgotten that the cornerstone of the investment tax proposals is that low-income earners will now be taxed at their personal marginal tax rate, making an investment in a managed fund unambiguously more attractive.

"Managed funds also have a complete exemption from income tax on their Australasian share gains, regardless of how often they trade. Individuals who regularly trade in Australasian shares will be deemed to be traders and taxed on all their share gains.

"Funds have an additional advantage over individuals in that the proposed exemption from SSCWT for employer contributions to KiwiSaver funds would make investing in funds particularly attractive."

Dunne also seemed to suggest that the Finance and Expenditure Select Committee should hear further submissions on the issue before reporting back to Parliament.

"The whole issue of the fair dividend rate is likely to be a key one for the Finance and Expenditure Committee and one that the Committee will no doubt consider carefully," he said, adding that "What happens to the proposed legislation at this stage is in the hands of the Committee, and not up to Ministers."

"We of course would like to see as much consultation as possible on suggested changes to the proposals in the bill � keeping in mind however, the constraints imposed by the need for the bill to be reported back to Parliament by 24 November, without leave of the House to report later, and for the legislation to be enacted by 1 April next year," he said.

In response to financialalert's enquiries, a spokesperson for the Committee's chair, Shane Jones, said whether or not further submissions on the Bill will be heard is one of the items the Committee will be discussing at its scheduled meeting today.
� 2006 financialalert Limited.

First published in financialalert www.financialalert.co.nz
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International Share Tax Proposal

International Share Tax Proposal Cops More Criticism

by Anthony Davies | Friday, 6 October 2006

The government's proposed change to the tax treatment of international share investments (financialalert.co.nz 4 October 2006) has copped further flak from the funds management industry. This time it's AMP Capital's head of investment strategy Leo Krippner, who says the proposal disadvantages managed funds by making it appear more attractive for investors to manage their investments themselves...

"We have nothing against people managing their own money, but it shouldn't be a decision that's based on a tax differential," he told financialalert.

Under the government's proposal, endorsed last week by Parliament's Finance and Expenditure Select Committee in its Interim Report of the Finance and Expenditure Select Committee, managed funds will be taxed on a flat 5% of the value of the portfolio, while DIY investors will be taxed up to 5% but only to the extent that their investments are profitable.

Krippner doesn't believe that's consistent with the creating a level playing field between direct and indirect investors � one of the government's stated aims for its proposed new investment tax regime.

"Applying the recent proposal to historical international share returns shows that an individual would on average be taxed around 3.5% of the value of their overseas shares. Conversely, managed funds would be taxed at a flat 5%. Hence, the proposal falls short of the intention to place individuals and managed funds on an equal footing. Or put another way, individuals will effectively be penalised for choosing to invest in the diversified portfolios offered by managed fund," he says.

His counter-proposal is that both individuals and managed funds be taxed at a flat 3.5%. "This will level the playing field, and individuals can make their choice to invest directly or through managed funds based on their merits, rather than on tax considerations."

While a further option could be for both individuals and managed funds to be taxed using the "up to 5%" approach, Krippner says this is a "second-best solution" as having a variable rather than a flat rate for managed funds would mean they would need to calculate tax payable at an individual investor level rather than a fund level.
� 2006 financialalert Limited.

First published in financialalert www.financialalert.co.nz
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Proposed investment tax a "Trojan horse"

Proposed investment tax a "Trojan horse"

by Anthony Davies | Tuesday, 31 October 2006

The government's compromise investment tax proposal, the fair dividend rate method, has stirred up strong opposition from Ernst & Young tax directors Jo Doolan and Geof Nightingale. They describe it as a "fundamental threat to taxpayers" and view it as some kind of Trojan horse.

"All Kiwi taxpayers � whether or not they have offshore investments � should be paying close attention to these proposals and the implications if they are rushed through. It's like an inheritance tax while you're still breathing," says Doolan. "Implicitly, you will be taxed on part of the capital gains. It's a complete leap from any system of taxation that currently exists in New Zealand. The proposals represent a fundamental change to our whole basis of taxation. If this goes through, what's to stop the government applying the same method of tax to the housing market and domestic investments?"

Because the proposal would result in most investors being taxed on 5% of the market value of their share portfolios, regardless of what they actually earn on their offshore portfolio shares, they say it is a tax on notional gains, not actual gains. They further point out that because the gains are not realised, then cash flow difficulties could be faced when having to pay the actual tax.

"On the face of it, the latest proposals appear to be a workable compromise on the previous proposals. But with smooth words, the government is actually trying to slide through something that represents a fundamental change to the whole basis of New Zealand's taxation," says Doolan.

Nightingale also draws attention to the government's timeframe.

"Of equal concern is the speed with which this new proposal is being pushed through and with limited consultation. It's a big risk to take for the government. Particularly, as the proposals remain complex in compliance terms and will still leave distortions between investing directly and via managed funds," he says.

Doolan and Nightingale urge taxpayers to write to their MPs and the Finance and Expenditure Select Committee to express their opposition to the proposal. The deadline for getting submissions to the Select Committee is 9 November.
� 2006 financialalert Limited.

First published in financialalert www.financialalert.co.nz
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