Shareholder Issues 2 September 2014 Questions & Answers Q1: Sorry I m confused; you mentioned the 66% rule again. Does that mean if you pay a salary of $100,000 with PAYE deducted (paid regularly through year) can you pay a shareholder salary of $50,000 at the end of the year without PAYE deducted? A1. No, it s an all or nothing approach. srd 3(3) states - The person may choose to treat all amounts paid to them in the income year in their capacity as employee of the close company as income other than from a PAYE income payment. Q2. Attribution - Is it legitimate deduction to pay spouse of person providing services for admin type duties? A2. Yes, there is no problem paying a spouse a fair market salary/wage for services actually rendered. Q3. LTC - Property Investment Co, is it legitimate to pay management fee to one of shareholder for administration duties with respect to the company? A3. Yes, the working owner definition and deductibility provision supplements the general permission which means if you satisfy the general permission, you don t need to rely on sdc 3B for a deduction. sdc 3B is not designed to disallow deductions, but rather allow certain deductions which may not otherwise be available. Provided the management fee is fair and reasonable and reflects services actually provided, and those services have the necessary connection/link with the LTC business/income earning activity, they will be deductible under the general permission. Q4. But PAYE versus non PAYE is all or nothing...following earlier Q what happens if Attribution rules cause profit to a shareholder drawing PAYE salary A4. In terms of the attribution rules, the mechanism for attributing income to a service provider does not deem the amount attributed to be a PAYE income payment. It merely treats the amounts as income of the individual and not of the company for income tax purposes. Accordingly, this would not upset the ability to pay non-paye deducted salaries, nor would the attributed amount be deemed a PAYE income payment and subject to PAYE.
Q5. What happens if Attribution rules cause profit to a shareholder drawing PAYE salary A5. As per A4 above. The attribution rules apply but don t impact on PAYE/non-PAYE payments. Q6. Can we pay a PAYE salary from a trading trust, and also make an income distribution to the same person as a beneficiary? A6. Yes, there are no problems paying a PAYE salary from a trading trust a trading trust is no different than any other employer in that regard. However, you can t pay a non -PAYE shareholder salary from a trading trust. Q7. Please clarify the purpose / application of the 66% rule referred to earlier in the seminar. A7. This provision dates back to the Income Tax Act 1976 so I can t say exactly why it was introduced. However, I assume it is there to allow shareholder employees of small/close companies to opt into the provisional tax regime rather than the PAYE regime, presumably to give them the flexibility to adjust their salaries depending on the performance of the company. Q8. Re Excessive Remuneration - how should the added requirement for close company remuneration not influenced by relationship be applied? A8. Refer response to Q28 Q9. For contract services to a shareholder employee, can we pay withholding tax as opposed to PAYE? (We meant one or the other - withholding or PAYE, not both) A9. Withholding tax obligations are also contained within PAYE income payments per srd 3 and are now referred to as schedular payments. They capture payments such as director s fees, farm contract work, commercial cleaning and maintenance. As such, they are all caught by the rule in srd 3(3) all or nothing. This would mean if you deduct withholding tax from payments for contract services provided, you would be forced to deduct PAYE in relation to a shareholder salary. Q10. What happens when your PAYE salary does not reach the Penny v Hooper threshold? A10. This would be a bit like the attributions rules see A4. If IRD challenged the amount payable and decided to assess the shareholder for a larger portion of the company profits, this would not be done by way of a shareholder-salary on which PAYE may need ot be deducted. IRD would simply assess the shareholder for the additional income and remove it from the company s assessment. Page 2 of 9
Q11. What happens when you have a coy with attribution issues and a PAYE salary has been paid? What do you do with surplus profits? A11. See A4 above. Q12. What happens if a client s company accounts are not filed on time does this mean you cannot declare a shareholders salary? A12. No, you can still declare a shareholder salary nothing hinges on filing the returns on time. But, remember, you have to show the shareholder salary was incurred at balance date and paid within the time frame for filing the return. Therefore, you would need to at the very least have credited the shareholders current account with the salary amount by the due date for filing. Q13. Can we pay one shareholder a PAYE salary and another shareholder a non PAYE salary? A13. Yes, absolutely no problems with this. The issues of PAYE v non-paye applies on an individual basis. The choice is that of the shareholder-employee not the company. Q14. If we ceased PAYE payments in February and still need to do the 'top up' payment for the year, would we open PAYE registration for June to reflect the final payment to be made within the 63 days? A14. Yes, assuming we can show the salary was incurred at 31 March, we would have until 2 June to pay the salary, and this would trigger a PAYE liability in the next PAYE return (20 July for a once per month filer). Q15. If there are 2 shareholders, one can be on PAYE and another on non PAYE? A15. Yes, see A13 Q16. Can you claim GST on the reimbursing of depreciation component? A16. No, there is no GST component on a reimbursement of depreciation. Q17. If IRD don't enforce the rules what are the long term implications of us doing it wrongly- re slide on IRD picking up A17. The risk is that one day they change their focus and ping you for interest and penalties. Same consequence as continuing to drive at 109kph on the motorway when the Police start enforcing the 100kph speed limit. Page 3 of 9
Q18. Question regarding the GST element of reimbursements. I would have thought that one would not have been allowed to claim back the GST on 100% of a vehicle lease because (36months) there is an interest component. A18. If the lease is an operating lease, the monthly lease fee will be subject to GST. Therefore GST could be claimed back on a reimbursement but only to the extent of the business use. Only a finance lease has an interest component. Q19. Including accountancy fee and ACC (unless invoice received)? A19. The same rules regarding expenditure being incurred apply to accounting fees as they do to any other expense. With respect to ACC, sef 3 provides a specific rule in relation to timing of deductibility. It states that the deduction is allocated to the income year in which the premium is due or payable. Q20. Question regarding accrual of accountancy fee and ACC was during your discussion of allowed accrues - when committed or when not committed. A20. See A19. Q21. What about the interest component of a lease? ex GST A21. See A18 - for tax purposes there is no interest component in an operating lease despite what the commercial reality is. Q22. What do you do if PAYE salary say $150k and then find that salary is less than 80% of income in a personal services company? How do you pay out balance so not in issue re Penny and Hooper? A22. You could pay an additional salary with PAYE deducted or wait until the next year and pay a bonus in relation to the previous year and not deduct PAYE. Key point is that in the latter case, the income is deemed derived and the deduction incurred in the later income year. This may still satisfy IRD that >80-% of the prior year profits have been distributed. Q23. Re salary and Penny and Hooper. If you pay a bonus to get to the 80%, what date is it paid and when do you pay over PAYE? A23. See A22. Q24. Why is the attribution rules not excluded where you have a rental property on the basis that it has substantial equipment as part of the activity? A24. There must be personal services income before the attribution rules apply. Income from a rental property is not personal services so the rules wouldn t apply irrespective of the level of investment in assets. Page 4 of 9
Q25. Regarding non-paye salaries, section EA 4 extends the time allowed for crediting or paying shareholder salaries to the last date for filing the relevant return. If a client has provided us with their information long after the return was due, does that mean we don t have the freedom to distribute a shareholder salary for the late year? An example would be a client who has only recently given us their information for the last 3 years. There was no special agreement to extend filing with the IRD. A25. Refer answers above. It may still be possible to show the expense was incurred and the salary credited to account if the client s internal accounting system would show this. Otherwise, technically you may be out of luck. Again, this comes back to the enforcement issue with IRD. They may blindly accept the expense as being incurred and paid without questioning it, but this doesn t make is right Q26. In the LTC section there is a bullet point saying working owners can be reimbursed for expenses tax free but not owners. Does this mean that a shareholder who does not have an employment contract with the LTC can t be reimbursed for expenses they paid out of their own pocket? Likewise, in an ordinary company how about shareholders who do not have PAYE salaries? A26. What this means is that they can t be reimbursed tax free under scw 17 because they are not employees. In theory, any payment by the company to reimburse the LTC owner would be treated as 1. Tax deductible to the LTC, with GST claimable provided a GST invoice is retained, and 2. Taxable income to the owner but the owner could then offset the expenses actually incurred netting the profit down to nil. Point being the owner should disclose the income and expense in their return. We suspect the practical reality is that the owner simply wouldn t bother returning the income or claiming the expense, but that is the practical reality rather than the technically correct position. The other practical reality is that IRD probably won t care either way, but if they ever did raise the issue you would need to produce the relevant evidence (invoices etc). If the expenses were significant, we would recommend disclosing them in the owners return to ensure statute barring can be relied on. In relation to shareholder-employees in an ordinary company, they are still considered an employee for the purposes of scw 17 if they received a non-paye deducted salary. Page 5 of 9
Q27. It has been our understanding that GST cannot be claimed on a motor vehicle reimbursing allowance paid to a shareholder employee. In your presentation you suggested that GST can be claimed on a reimbursing allowance. I agree that GST can be claimed on a direct reimbursement, or an allowance paid where there has been a continuous log book. However our practice has been that you can t claim GST on motor vehicle reimbursing allowances. Could you please explain why GST is able to be claimed on a reimbursing allowance and the relevant legislative backing? A27. If the reimbursing allowance is based on actual expenses and the relevant GST invoices are retained, there is no problem with claiming the GST component. If the allowance is based on a fair and reasonable estimate or mileage rates, then there is no GST component that could be claimed. In terms of a statutory reference, there is none. The GST Act does not contain the equivalent of the Income Tax Act 2007 s scw 17. However, there is a long standing IRD policy contained in TIB Vol 4, No 8 (April 1993) relating to reimbursements of home telephone costs. It is widely accepted that the principles underlying this policy apply to all forms of expense reimbursements not just telephones. Q28. With respect to shareholder salaries your slides state that if a NZ tax resident is an adult working 30 plus hours a week in the company you can pay whatever salary you want. Is this suggesting that if we have a husband and wife who are both shareholder employees of a company, both working in excess of 30 plus hours a week, where the husband is full time contracting deriving income and the wife is doing admin, we can credit whatever salaries we like i.e. 50% husband and 50% wife. This scenario assumes the attribution rules don t apply. Or does the requirement re remuneration not influenced by relationship modify this provision? A28. sgb 25 recharacterises excessive remuneration as a dividend. However, sgb 25 does not apply if - (a) the service provider is an adult employed substantially full-time in the business of the company; and (b) the service provider participates in the [management or administration] of the company; and (c) the amount provided to the service provider was not influenced by their relationship with a shareholder or director; and (d) the service provider is a New Zealand resident. The argument/interpretation in the situation above would be that, both the husband and wife are working full time in the business and as equally hard as each other. Therefore, the reason they receive 50% each of the profits of the company as a Page 6 of 9
salary has nothing to do with the fact one is a relative of the other and everything to do with the effort put in. Q 29. Can you please provide a reference to the exclusion from FBT for the key man insurance where the benefit is payable to the employee (page 19) A29. scx 31 excludes from the FBT rules a premium for income protection insurance paid by an employer for the benefit of an employee if a payment of the insurance to the employee would be assessable income of the employee. sce 11 deems payments under such policies to be taxable income of the employee. Q30. does the upstream loan situation discussed also apply to debtor balances owing to the subsidiary from the parent? A30. No, provided the terms of trade relating to the debtor balances are the same for the shareholder or associated person, they will not give rise to a deemed dividend. In order for a deemed dividend to arise there must first be shareholder capacity. Where the terms of trade for the shareholder/associate are exactly the same as any other customer, there is no shareholder capacity. Q31. with the TBI - can it be paid to selectted shareholders only or has to be paid to all shareholders? A31. This is more a company law issues than tax but my understanding is that a bonus issue in lieu or a bonus issue elected to be a TBI under scd 8, must be offered to all shareholders of a particular class they are treated exactly the same as any other company dividend/distribution. Q32. Re RWT on Dividends. Please confirm RWT exempt on company shareholder only for the following example, Trust Shldr 1 40%, Trust Shldr 2 20%, Coy Shldr 3 40%. ie RWT applies to trust shareholders, but not coy shareholder. A32. Assuming we have understood the question correctly, RWT must be deducted on interest paid to the company shareholder because it is not in the same group as the company paying the interest (it only holds 40% of the paying company). The exclusion from RWT on interest and dividends contained in srf 2 requires the payer and payee companies to be in the same group. This depends on who the shareholders in the paying company are and we don t have that information. Q33. Page 17 first slide. Is ownership and term of lease and/or A33. These are or tests - apologies for slightly misleading slides. If the term of the lease exceeds 75% of the estimated useful life (45 months for a motor vehicle), the lease is a finance lease and it is irrelevant whether ownership passes or not. Likewise, if the lease provides for ownership to transfer under the lease, it does not matter that the lease term may be less than 45 months. Page 7 of 9
Q34. Slide 9 - Sorry, how is LCVI calculated? A34. One of our examples was as follows. Company A Company B LCVI Shares Shares % Trust 99 999 99.0% Individual 1 1 0.1% Lowest Common Voting Interest 99.1% In the above example, the Trust owns 99 out of 100 shares in Coy A being 99%. It owns 999/1,000 shares in Coy B or 99.9%. The trust s lowest common voting interest is therefore 99%. The individual owns 1/100 shares in Coy A being 1%. It owns 1/1,000 shares in Coy B or 0.1%. The trusts lowest common voting interest in both Coy A & Coy B is therefore 0.1%. Add the LCVI for the Trust and individual together and we get 99.1%. Q35. Wholly Owned Group : what happens if the group wasn't formally created, does it automatically exist? A35. Yes, it automatically exists. A wholly owned group exists as a question of fact, no elections or otherwise are required (unlike a consolidated group which is a completely different kind of beast altogether). Q36. If S/H C/A has positive balance at start of year, then Od during the year, can we offset credit interest from start of year against interest on OD c/a? A36. Yes, in my view you can offset interest to end up with a net amount payable or receivable. Q37. Regarding Pg 18 summarising preferences for Finance/operating leases- this appears to be the opposite of Pg 17 middle slide A37. Assume this question relates to my narrative to the two slides (the slides themselves are completely different and I can t see where they contradict each other). I ve listened to this part of the Webinar presentation and I can t see where the contradiction lies. With respect to the middle slide on page 17, I commented that full income tax and GST deductions but paying FBT works well when the business use is low. In relation to the slide on page 18 it states the full deductions/fbt option works well when the private use is high. Page 8 of 9
Q38. Facts: Company A has shareholder 1 is an individual (1%) and shareholder 2 is a trust (99%). Shareholder 1 current account was overdrawn, but shareholder 2 current account is in credit. Shareholder 1 is the beneficiary and trustee of shareholder 2. Question: Should the company charge interest to shareholder 1? Can shareholder 1 & 2 be treated as 1 because of shareholder being a beneficiary and trustee of shareholder 2? A38. Yes, shareholder 1 s current account is overdrawn and therefore interest needs to be charged. The trust and individual cannot be treated as a single shareholder to overcome the need to charge interest. However, you could consider setting the debts off against each other. Page 9 of 9