The Government has quietly delayed changes to the tax system designed to stop people using companies to avoid paying the top rate of income tax, after outcry at the proposals put forward by IRD.
The Government feared the new top income tax rate of 39 per cent on income earned over $180,000 creates a greater incentive for people to use companies to avoid having income taxed at that rate.
In March, Revenue Minister David Parker, Finance Minister Grant Robertson and IRD put proposals to tighten tax rules to block people from using this route to minimise their tax burden. The changes were included in the "dividend integrity and personal services income attribution discussion document".
That consultation finished in April. IRD said if it were to adopt any of the proposals it would be in "the second half of 2022", meaning they would apply "from the 2023-24 income year".
IRD now says it will not proceed with the proposals at this stage following "a number of concerns" raised by submitters. This prompted ministers to instruct officials to do further work on the proposals. A common concern was the proposals would unfairly capture people who were not using structures to avoid tax.
Instead, IRD will likely put new proposals out to another round of consultation this year. This means the changes will not be included in tax legislation currently set to come to Parliament in August.
A spokesperson for IRD said, "Officials have reported back to the Ministers of Revenue and Finance on the submissions received in response to the dividend integrity and personal services income attribution discussion document.
"Submitters raised a number of concerns and Ministers have asked officials to do further work on the proposals.
"There is likely to be further consultation later in the year. The proposals therefore will not be included in the Tax Bill that is likely to be introduced in August," the spokesperson said.
National's small business and revenue spokesman Andrew Bayly said the backtrack was "great news for small business owners".
"The proposed changes would have been another slap in the face for the thousands of small business owners who employ one person or who work on their own," he said.
Deloitte Tax Partner Robyn Walker said it was "a relief to see that the original proposals are going to be reconsidered and toned down".
"While there is likely agreement that something could be done to ensure that people aren't manipulating their affairs to avoid the 39 per cent tax rate, the original discussion document never presented clear evidence that there was a problem to be fixed or that the application of laws and Inland Revenue's existing audit powers couldn't deal with the problem," she said.
Walker said IRD's proposals were "hugely complicated rules which would have a chilling effect on all business transactions, particularly New Zealand's SMEs".
The Government's concern was that shareholders could avoid tax by retaining profits in a company rather than paying dividends.
Those people would then sell the shares in the company for an increased price that reflects the value of the undistributed profits. The increased sale proceeds are not subject to tax for the shareholder. Because a dividend paid prior to sale would have been taxable at that person's marginal tax rate, they likely saved paying a considerable amount of tax.
The difference between the company tax rate of 28 per cent and the top income tax rate of 39 per cent means there is a greater incentive for people to structure their affairs to minimise their tax burden.
IRD proposed three major changes.
The first would reclassify the sale of shares in a company by its controlling shareholder as giving rise to a dividend for that shareholder, to the extent the company has retained earnings.
The second change was to beef-up record-keeping requirements, and the third was to remove the "80 per cent one buyer rule", which is designed to capture companies that have a single main client. IRD wanted to broaden these rules.
In the discussion document released with the proposals, IRD said it had calculated that 350 high wealth individuals - and families with more than $50 million in net assets - controlled 8468 companies and 1867 trusts.
In the 2018 tax year, those 350 individuals paid $26 million in tax, while their companies and trusts paid $639m and $102m respectively.
IRD argued this showed "a significant amount of income earned through lower tax rate entities".