Tax officials are proposing changes which would increase the tax burden on a lot of small businesses.
They would greatly expand the scope of a relatively obscure part of the tax laws — the personal services income attribution rule.
It was introduced 20 years ago to deal with cases where people who are in substance employees, set up a company to sell their services to a single client — often the Government — so as to be taxed at the company rate rather than their personal marginal rate.
This was after the previous Labour Government introduced a new top personal income tax rate of 39 per cent, increasing the incentive to arbitrage off the difference between it and the company rate. It is an issue which has arisen again, with the reintroduction of a top rate of 39 per cent on income above $180,000.
But the proposed changes would catch the working proprietors of genuine businesses, warns Robin Oliver, director of tax advisers OliverShaw. For 16 years he was deputy commissioner of Inland Revenue in change of tax policy.
"It is likely to catch tradies — a plumber, say, or a landscape contractor — with a van and some equipment and just themselves or one employee doing the work," says Oliver.
The proposals are to be found in chapters six and seven of an IRD discussion document out for consultation with the catchy title Dividend Integrity and Personal Services Income Attribution.
It says the current rule applies in certain circumstances when income from personal services performed by an individual is earned through an entity such as a company or trust. The rule attributes the income from personal services to the individual who performs the services, thereby ensuring the income is taxed at the individual's marginal rate of personal income tax, rather than at the company rate of 28 per cent or the trustee rate of 33 per cent.
For the rule to apply, several threshold tests must be satisfied:
• The "80 per cent one buyer" rule. At least 80 per cent of the company's income must come from one buyer of its services.
• The "80 per cent one natural person supplier" rule. At least 80 per cent of the company's income is earned by services performed by one person.
• "Substantial business assets" are not required to generate the income, with "substantial" currently defined as assets which cost more than $75,000 or more than 25 per cent of the company's annual income.
• If those tests are met, the rule would still apply only if the net income involved exceeds $70,000.
The discussion document proposes scrapping the "80 per cent one buyer" rule altogether. It gives as an example an accountant, Bill, who is the sole employee and shareholder of his company. It pays the 28 per cent corporate rate on the income from accounting services he provides to clients and pays him a salary of $70,000, retaining any residual profit in the company or lending it to him.
For reasons that are entirely unclear, officials regard this as unacceptable.
Oliver does not. Why, he asks, should one of the big four accounting firms with thousands of partners be able to access the corporate tax rate but an accountant in practice on his or her own cannot, just because they have multiple clients?
"It is no longer looking at people who are really employees. The [original] focus was definitely on that. Suddenly it is something that applies to actual, real businesses," he says.
Officials also propose to lower the threshold for the "80 per cent one natural person supplier'" rule to 50 per cent, so it would catch a company whose income is "mostly" from the services of one person.
The chances are that a tradie with an offsider sitting next to him in the van would be caught.
As for the "substantial business assets" test, the discussion document says, "There is a question as to whether the $75,000 threshold in this test should be revised upward so that it is set at a level that more accurately reflects the cost of business assets today". It suggests $150,000 or $200,000, although the alternative test of assets less than 25 per cent of income from personal services would remain.
Finally, officials propose keeping the net income threshold, below which the rule would not apply, at $70,000.
"Given the main purpose of a possible expansion of the personal services attribution rule is to ensure the integrity of the top personal rate of 39 per cent, some parties may see a rationale for increasing the $70,000 threshold," the document says.
That is putting it mildly. Since the new top personal rate of 39 per cent only kicks in at $180,000, it is absurd to pretend this is about preventing avoidance of that rate if the threshold stays at $70,000. Really, they don't even try: "However, it is noted that a 5 per cent differential still exists between the 33 per cent personal tax rate (which applies to each dollar of income earned between $70,001 and $180,000) and the company tax rate (currently 28 per cent). As such there may be a tax deferral benefit or incentive in relation to income earned between $70,001 and $180,000," the document says.
Feedback on this point is invited.
As indeed it is on the proposal to drop the "80 per cent one buyer" test, so that businesses with multiple clients could be caught.
And to lower the "80 per cent one natural person supplier test" so that what is more than a one-man-band could be caught.
Submissions on these proposals close on April 29. Anyone appalled by the prospect of a tax grab from small enterprises should get their views in quick.