It is not often that a tax case can strike fear into the hearts of both tax advisers and business owners alike, but the Supreme Court decision regarding Penny and Hooper has been one such case.

The court case was about two orthopaedic surgeons (Messrs Penny and Hooper) who independently of each other transferred their respective businesses to companies (which in turn were owned by their family trusts).  They then set their salaries at artificially low levels, meaning that the significant difference was taxed at 33%, rather than 39%.  The question at hand was whether these actions and/or structures constituted tax avoidance.

The Supreme Court found that the Penny and Hooper arrangements were tantamount to tax avoidance, and therefore void against the IRD.

The Supreme Court did helpfully note that the structure the taxpayers had each adopted when they transferred their businesses to companies owned by their family trusts was, as a structure, entirely lawful and unremarkable. The Court also noted that there was nothing unusual or artificial in the fact the taxpayers caused a company under their control to employ them on a salaried basis, and the adoption of a familiar trading structure could not in itself be said to involve tax avoidance.  This statement is very important for the many closely held businesses around New Zealand as it validates these types of structures for trading purposes.

However, the Supreme Court ruled that the fixing of salaries at artificially low levels so that the incidence of tax at the highest personal tax rate was avoided did amount to tax avoidance, and found, in this case, that tax avoidance was a primary or fundamental purpose of the arrangement. The Supreme Court has made it clear that tax avoidance can be found in an individual step (e.g. artificially low salary in the Penny and Hooper case) in a wider arrangement, and that that step when taken can make the wider arrangement a tax avoidance arrangement.  This is technical gobbledegook for one small bad thing can make the whole picture bad.

How does this impact you?

The court decision sends a strong message that if you put in place artificial and contrived arrangements (such as artificially low salaries) where there are not overt and defendable reasons for such arrangements or actions, then the Courts will likely find tax avoidance, and then will allow the IRD to ignore the wider arrangements/structures in place (at least to some degree).

It’s important for business owners to understand how the Penny and Hooper court decision may apply to their own circumstances - talk to your WHK adviser today regarding asset planning and business structures.  The Supreme Court decision may not provide certainty around where the tax avoidance boundary lies, but it does give us a clearer picture of that boundary without opening the floodgates.

Contact your nearest WHK tax advisers:

Dunedin - Scott Mason, Jarod Chisholm, Tony Marshall

Invercargill - Aneesha Varghese

Queenstown/Wanaka - Wendy Duncan