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Income Attribution Rules: Will You Get Caught Out?

September 7, 2016


Many Taxpayers, particularly contractors, are not aware that income derived by their company or trust may actually be deemed to have been derived by them personally, with considerable tax implications as a result.


The little known Personal Services Attribution rules are a anti-tax-avoidance measure enforced by the IRD to make sure that certain taxpayers are paying their fair share of tax. The rules impact people, such as contractors, who derive 80% or more of their income from a single source. The effect of the rules is such that the income derived by a company or trust can be deemed to instead be the income of the individual shareholder or beneficiary who provided the services.


The rules for the attribution of income apply when:

  • 80% or more of the trading entity's (company or trust) income is derived from services performed by an associate or relative,

  • 80% or more of the entity's income from personal services is derived from the sale of services to a customer or individual associated with a customer,

  • Your net income exceeds $70,000 for the year (including any attributable income), and

  • Substantial business assets are not a necessary part of the business structure.

These rules are of greatest concern to contractors such as builders and other tradesmen. Contractors such as these often trade through a limited liability company, with themselves holding most if not all of the shares, and derive up to 100% of their income from a single source throughout a tax year. If they have a single lucrative contract or one that makes for more than 80% of the total income, then they will be caught by the attribution rules. In this situation, the income generated by the trading entity must be attributed between the entity and the individual providing the services accordingly.


The purpose of such attributions is so that the IRD can ensure that taxpayers can not avoid paying the top marginal rate of individual tax at 33% by holding profit earned by them in a company that would pay it at 28%. It also helps to minimise tax avoidance by income spreading to other shareholders or beneficiaries (that are on lower incomes than the contractor) of the entity that have not provided the services that have generated the income.


The attribution of income can mean larger than expected tax bills, especially if the trading entity has had a more profitable year than expected. However, failing to properly attribute income can be even more expensive as the IRD will likely add on penalties and interest for failing to properly follow the rules.


The IRD is not the only government body to be wary of in these situations. The ACC may also reassess the levies they have charged or provisionally assessed based on allocated income, especially if it has greatly increased. This can lead to a sharp increase in ACC levies at the same time as increased Terminal and Provisional Income Tax obligations. You should consult your accountant as soon as possible to allow for proper tax planning ahead of time and to establish a payment plan with the appropriate agencies to smooth out the payment of your obligations when they become due.


No matter the scale of your operation, it is smart business to save for your taxes as you earn the income. Knowing just how much income you are liable to pay tax on is important, so discuss this with your accountant regularly, not just at year end.


Of course, if a contracting entity has a number of different sources of income so that none are more than 80% of the total income generated, the attribution rules will not apply.


This advice is general in nature. Every situation is unique and requires tailored advice. MBP has the expertise to guide taxpayers through the attribution process. If you think you may be at risk of falling into the scope of the attribution rules, talk to our team today by calling 07 378 6655 or email chris@mercerbp.co.nz  



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