With all the publicity about international tax avoidance by America’s largest corporations it comes as no surprise that smaller businesses (and individual taxpayers) see this as being grossly unfair. The American Sustainable Business Council says that, “each of America’s small businesses on average picks up the tab for $3,067 to cover the costs of tax avoidance by U.S multinational corporations playing the offshore profit-shifting game.” 

Although New Zealand’s multinationals don’t have exactly the same tax avoidance/mitigation opportunities as their US counterparts; such practices are common here too. As with the US, the cost of the tax practices of New Zealand’s large companies is borne by everyone else in the economy.

This morning’s NZ Herald includes another home which screams possible ‘tax issues’. We don’t know the owners or their tax position; however, we note that this featured inner city home has been owned by the present owners for only 3 years. The article tells us that the owners bought the house because they “were looking for a renovation project” and that they are selling it as they are “working towards their next project.” What this wording suggests is that the reason for owning the house was not to provide a family home, but to generate a profit. There is no issue with that as long as people are aware of their potential tax liabilities.

How do you know if you might have to pay tax on the sale of a property? 

At one end of the scale is someone who owns their family home for decades, does not own any other property, and who has no close connection with anyone in the building or property industries. Such a person is highly unlikely to be exposed to having to pay tax upon the sale of the home. 

At the other end of the scale is a taxpayer that the IRD came across recently. That person had traded more than 50 properties in one year and not declared any of it for tax. Obviously there would be tax issues for that person, and the failure to declare appears so gross that tax evasion charges could be an issue. People who fall in-between should ask themselves if they may need to pay tax on the sale of their properties. Often the answer is a clear cut no, however, the answer is yes more often than many realise.

If you don’t need to pay tax don’t send red flags to the IRD through the wording of real estate articles or advertisements as this may cause you to be audited. Even if you come out squeaky clean from such an exercise, it’s better to avoid getting yourself into that position in the first place. If you’re unsure about your position it is best to seek advice before placing the property on the market as the liability to pay tax on a sale is a factor that may affect whether the property goes on the market at all, and if so, the minimum selling price that you will accept. 

Some liken taxation to theft. For these people trying their utmost to remove earnings and assets from the tax net is a no brainer. People with this view point can justify their actions as they believe they are keeping what is theirs and to which the state has no right.

Most people accept the need to pay some tax in exchange for the general benefits they receive personally, and as a society. However, those people may harbour strong disagreements in regard to the use that the state puts some of their taxes to. For example, a Catholic taxpayer may strongly object to paying tax to the state if the state allows abortion on demand. A member of the 99% Occupy movement may strongly object to paying tax if some of that tax money is used to bail out wealthy bankers. A business owner may object to his or her taxes being used to subsidise people who don’t want to work or who are otherwise economically unproductive.

One solution to this ethical dilemma is tax and asset planning that enables the taxpayer to minimise the tax they pay to the state. Any tax saving could be donated to a charity in line with the taxpayer’s ethical beliefs. As long as the taxpayer acts carefully, such a solution provides a means for the taxpayer to do what is right while not placing themselves legally in harms way.

What’s the difference between:

Tax fraud;

Tax evasion;

Tax avoidance; and

Tax  mitigation?

Why does it matter?

An example of tax fraud could include charging GST on sales when you have no intention of paying that GST to the IRD. Examples of tax evasion could include consistently selling goods on Trade Me and not declaring the income, or the failure to declare interest earned on overseas bank deposits.  Tax evasion and tax fraud can lead to jail time, as well as high penalties. Tax fraud and tax evasion involve illegality.

What about tax avoidance? Defining what is tax avoidance can be difficult but generally it does not involve illegality. Many people who have found themselves in this category probably believed that they were acting legitimately in structuring their tax affairs. In determining whether an arrangement constitutes tax avoidance the IRD will look at a  number of factors, including: whether tax minimisation is the dominant reason for the arrangement, the economic reality and economic effects of the arrangement, and whether the tax outcome is different from Parliament’s intention.

Some examples of unacceptable tax avoidance include:

Professionals diverting income from their personal work through trusts and companies in order to pay less tax.

Selling your family home to a company and then renting it back. The company deducts interest, rates and other expenses in its tax returns.

Using loans from a trust to fund your living costs, where the economic reality is that the loans are in the nature of income but no tax is being deducted from payments made.

If the IRD (or Court) deems that your arrangement constitutes tax avoidance, penalties, interest and tax will be payable. The amount due can easily become very large, especially if more than once tax year is involved or if the arrangement is an older one (so that penalties and interest have had longer to accumulate).  In one case, an employee of a multi national was unaware that he had become a New Zealand tax resident. The IRD determined that he owed $350,000 in back taxes, penalties and interest. In another case the total payable amounted to $2.3 million.

What about tax mitigation? Tax mitigation involves acceptable tax planning. It has been called “sleep at night” tax planning. Tax mitigation involves finding tax efficient ways to structure business transactions. The tax effects remain within the letter and the intent of the law. Taxpayers are entitled to take account of potential tax savings when making business decisions but this should not be the dominant purpose, nor should artificial structures be put in place.

There are many grey areas and careful advice is needed to ensure that the correct business and tax decisions are made and so that you know where you stand. Please ask if anything is unclear.

People who avoid income tax by paying themselves artificially low salaries through a company or trust have until 31 March 2013 to take advantage of an IRD amnesty. The amnesty was granted in the wake of the Supreme Court case of Penny and Hooper. In that case, two orthopedic surgeons paid themselves salaries that were a fraction of the actual earnings from their personal work. It amounted to tax avoidance.

If you are in a similar situation, making a voluntary disclosure to the IRD prior to 31 March 2013 means that you will avoid penalties and the IRD will only reassess two years. If you don’t make a voluntary disclosure you will face penalties (and these are likely to be at the higher end of the scale given the publicity about the case) and reassessment for four years (in some cases the IRD can reassess for an indefinite period of time).

If you’re not sure about your personal situation please make contact.