Tax Bites #13

About the Author:

MURRAY McCLENNAN

Director at Tax Central
A chartered accountant and a member of the International Fiscal Association and the Society of Trust and Estate Practitioners, Murray has over 30 years experience in tax.

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Inland Revenue Audit Focus

Management Fees

I confess that I invariably regard management fees between associated persons or related parties with some skepticism, even though I have not worked for Inland Revenue for nearly 24 years. Are the fees legitimate payment for services provided, a legitimate tax planning tool, or a mechanism to transfer funds as there are no viable alternatives?

While there is no legal requirement for a written agreement that details the services provided, such an agreement adds credibility. A written agreement would include:

1. Details of the services provided;

2. Cost of these services;

3. When payment is due; and

4. Whether additional services may be requested and the relevant procedure.

Where management fees are paid between associated persons and the supplier is GST- registered, the time of supply is when the services are provided and not at, or beyond, yearend when a tax invoice is raised. I recommend regular payments with the ability to add “balloon payments”.

Trading Trusts

Short and simple, Inland Revenue dislikes trading trusts. In my view Inland Revenue’s stance is not entirely warranted.

Trading trusts provide considerable scope for both income splitting and diverting income to persons or entities with losses.

If the trust derives income through the services of a key employee that employee must receive a market salary. In Case W33 the TRA held that while the structure itself was okay the salary paid was artificially low. In addition, the attribution rules could apply. 

Resident Withholding Tax

Resident withholding tax (RWT) must be deducted from interest payments, unless:

1. The total interest paid in the income year is less than $500;

2. The payee holds a valid certificate of exemption; or

3. The payer and payee are members of the same wholly-owned group of companies. A wholly- owned group is where there is 100% common ownership.

I recently dealt with an audit that was triggered by the failure to deduct RWT from interest paid to a company with losses. The company did not have a certificate of exemption.

Loans and Bad Debts

A lender does not get an automatic deduction for a bad debt in respect of unpaid loans. The lender must be a dealer in financial arrangements. The taxpayer in Hong v CIR was unable to prove that he was in the business of dealing in or holding financial arrangements.

In addition, no deduction is available for capital bad debts on loans between associated persons.

Losses from LTCs

Losses flowing through to shareholders is limited to each shareholder’s economic interest in the LTC in that income year. Economic interest includes:

1. Shareholder loans or advances;

2. Loans or advances from trusts where the shareholder is a trustee; and

3. Where the shareholder guarantees third party loans (e.g. bank loans). The value of such loans is divided by the number of guarantors.

Murray McClennan
Director
Tax Central Ltd
027   244-5365
www.taxcentral.co.nz

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