Attribution of personal services income
Many people aren’t aware that specific tax rules exist that can deem income derived by a company or trust to be derived by them personally. The rules were first introduced when the 39% tax rate was introduced to stop people getting a tax advantage by trading through a company or trust to access the lower 33% tax rate. Although the top personal marginal tax rate has been reduced to 33%, the company rate is lower at 28%, and hence the rules are still active and need to be kept in mind.
Income is attributed when:
- 80% or more of the entity’s income from personal services is derived from services personally performed by an associated person or a relative,
- 80% or more of the entity’s income from personal services is derived from the sale of services to a customer or a person associated with the customer,
- the person’s net income for the income year exceeds $70,000, including any amounts available for attribution, and
- substantial business assets (as defined below) are not a necessary part of the business structure used to derive the entity’s assessable income.
“Substantial business assets” are depreciable property that cost more than $75,000 or, make up at least 25% of the associated entity’s total assessable income from services for the income year and are not for private use.
When a person first sets up business, it may be that the rules don’t apply. But experience has shown that circumstances change over time and those changes can mean someone drops into the ambit of the rules, without rea
lising it. For example, Jenny and Harry are a brother and sister team that went into business together. Jenny is an interior designer and Harry is an architect. They are employed by a company in which they each own 50% of the shares. The Company receives income from the services they perform.
Jenny decides she wants a change of scenery and sells up and moves to New York to become an actress. Harry buys Jenny’s 50% share in the Company.
Harry subsequently wins a large contract with Fletcher Construction that provides more than 80% of the company’s income for the following six months and the contract is later extended.
In this scenario, the income derived by the company from personal services performed by Harry is likely to be subject to the ‘attribution rules’. Under the attribution rules, the net personal services income derived by the Company will be attributed to Harry. If net income of $180,000 were attributed directly to Harry and subject to tax at the top marginal tax rate (33% as opposed to the 28% company tax rate), additional tax of $9,000 would be payable.
The IRD’s intention is to ensure that taxpayers like Harry cannot avoid the highest personal tax rate (currently 33%). Increasingly more resources are being put into this area to ensure taxpayers are returning the appropriate amount of tax, so if you think the attribution rules may apply to you, please seek professional advice.