Government’s new top tax rate change: High earners warned over tax avoidance

High earners are being urged to be wary of restructuring their finances ahead of a higher top tax rate.

The new Labour Government is expected to introduce a new top tax rate of 39 per cent for those earning more than $180,000 from April next year.

That means there will be a substantial gap between the top tax rate and the company tax rate of 28 per cent as well as the trust tax rate of 33 per cent.

Deloitte tax partner Robyn Walker said it was an inevitable outcome of an increase in tax rates that some people would relook at how they earned their income and would consider whether there was a more “tax efficient” way to structure their affairs.

“Moving income from being earned personally to being earned through an alternative vehicle is an option for taxpayers to consider.

“The 11 per cent difference between the top personal tax rate and the 28 per cent company tax rate may be irresistible to some high earners.”

Walker said a person on $200,000 would pay $58,119 in tax under the new tax rate but under a company structure that could reduce to $56,000 a year.

But it would be higher under a trust structure at $66,000 in tax.

That was because both trust and company tax was charged at a flat rate, while individual income tax was progressive, Walker said.

Only the amount of money earned over the $180,000 threshold would be taxed at the top 39 per cent rate.

Walker said any moves to restructure to transact through companies or trusts came with a tax avoidance warning.

“Any restructuring which is undertaken for predominantly tax reasons is likely to be reviewed by Inland Revenue.”

Walker also pointed to a warning released by Labour as part of its tax policy announcement which said if it saw exploitation of the trust system it would move to crack down on it.

The warning stated: “We are not going to increase the trust rate because there are legitimate reasons for people to use trusts. But if we see exploitation of the trust system then we will move to crack down on those people who are exploiting it.

“The Government has invested more than $30 million into IRD’s capacity to go after people dodging their tax obligations, and we will continue this work.”

New Zealand has had a 39 per cent top tax rate before, from 2001 to 2010, when the Labour Government began lowering it. When National was elected it scrapped the top rate.

In 2011, the Supreme Court found two orthopaedic surgeons – Ian Penny and Gary Hooper – had avoided income tax by paying themselves low salaries through a structure of companies and trusts.

After the judgment, the IRD said those who made voluntary disclosures would need to pay extra tax only for income earned during the previous two years.

That resulted in millions of dollars in tax being paid.

Walker said the top tax rate change also had implications for fringe benefit tax and resident withholding tax, which is applied on dividends and interest from other investments such as savings in the bank.

If the fringe benefit tax did not increase to take into account the top tax rate, there would be an incentive for high-income earners to try and substitute salary for perks in order to have a lower tax cost, she said.

“It is definitely something that will need to be considered.”

Walker said withholding tax could also be increased in line with the top tax rate.

That could mean if an individual doesn’t tell their bank which withholding tax rate they should be on, they could be automatically defaulted onto 39 per cent tax on any interest they earn.

Walker said the resident withholding tax on dividends could stay the same or increase depending on what the Government decided.

Last time the top tax rate was at 39 per cent, it stayed at 33 per cent.

But she said that meant high-income earners should be prepared to put some money aside to pay tax on those dividends.

“If you are investing directly, and are earning over $180k, you just need to be prepared there will probably be a top-up to be paid at the end of year – assuming the RWT rate doesn’t move.”

She said it could also drive investment behaviour encouraging high earners to invest via a portfolio investment entity, which had a top tax rate of 28 per cent rather than direct share investment.

The Government is expected to outline the details of its new tax legislation in a bill before Christmas. The new top tax rate is due to come in from April 2021.

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