Artificially low salaries having the effect of diverting taxable income to other taxpayers on a lower marginal tax rate will be hit as tax avoidance following strong words from the Supreme Court. If the salary is not commercially realistic or not supported by any commercially legitimate reason it is open to attack as tax avoidance.
These comments followed an unsuccessful appeal by two Christchurch orthopaedic surgeons who made use of company structures owned by family trusts to divert income from their medical practice to other family members. At the time, the company marginal tax rate was well below the rate imposed on personal income earned by the surgeons.
The two surgeons worked as salaried employees of their companies. The salaries paid were well below market rates payable to orthopaedic surgeons in private practice.
This re-arrangement of their business affairs resulted in tax savings of some $65,000 over three years for one surgeon, and $103,000 for the other.
The Supreme Court did highlight commercial circumstances where a company’s payment of a lower than market salary could be seen as legitimate and not tax avoidance: In a one-person company where an annual salary amounted to the company’s annual profit; where a company was looking to expand and retained earnings were necessary to support proposed capital expenditure; and in circumstances where a company was facing a liquidity crisis and cash was needed to pay creditors.
Penny & Hooper v. CIR – Supreme Court (24.08.11)
11.11.001