Tax Bites #21

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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Given that the company tax rate is 28% and the top personal tax rate is 33% (on income above $70,000 per annum) there is a temptation for many small to medium business owners to leave profits in the company once their personal income is $70,000.

The shareholder salary or salaries paid are less than drawings. Similarly, a company sells a capital asset and the shareholders want the sales proceeds (and invariably take the sale proceeds as drawings). The result is:

1. Overdrawn shareholder current accounts;

2. Company loans to shareholders; or

3. A combination of both.

Andrea Black, economist at the New Zealand Council of Trade Unions recently published an article that highlighted a massive increase in loans from closely held companies to their shareholders, particularly since the company tax rate was reduced from 30% to 28% in 2010. During that period the value of loans to shareholders from standard companies has increased from approximately $9 billion to $24 billion. See https://www.interest.co.nz/opinion/103599/council-trade-unions-andrea-black-how-employed-people-can-end-paying.

Many shareholders don’t believe that there is an issue as its “our money anyway”. However, there is an issue for standard companies (i.e. not look-through or qualifying companies), as unless capital is introduced, or increased shareholder salaries are declared. The three main consequences are:

1. Interest is charged on the overdrawn shareholder current accounts and/or loans at the prescribed rate for fringe benefit purposes, currently 5.26%. Typically that interest will be non-deductible for shareholders;

2. FBT is paid by the company if interest is not paid or the rate of interest paid is less than the prescribed rate; or

3. In the absence of interest or FBT being paid, a deemed (non-cash) dividend is derived by the shareholders concerned.

There are limited options other the three identified above, involving share buybacks by companies, shareholders selling assets, share sales by the shareholders to family trusts or spouses/partners, or selling personal assets to the company. In my experience many advisers do not correctly deal with share buybacks.

I strongly suspect that there is widespread non-compliance in respect of loans to shareholders. Consequently, this is a prime area for audit risk review by Inland Revenue.

Although it is purely speculation on my part, I believe that the May Budget will announce changes in personal tax rates, which will reduce tax rates on income below $70,000, possibly increase the threshold for the 33% marginal rate to $80,000, and introduce a new top marginal rate of say 38% on income above $150,000. Such changes could not be implemented before 1 October 2020 and would of course require the re-election of the current coalition government, or a government of Labour and either New Zealand First or the Greens. If implemented, such changes may increase the temptation to make interest-free loans to shareholders and not deal with the tax consequences.

Remember if a company forgives debt owed by a shareholder, the shareholder derives taxable income. That is, there is no exclusion for debt forgiveness by a non-individual.

Murray McClennan

Director
Tax Central Ltd
027        244-5365

www.taxcentral.co.nz

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