Opinion & Analysis
It is not just the wealthy who use trusts and companies - most people reading this would have a friend or family member who trades a business through a company or trust. Whether plumber, farmer, investor or manufacturer, businesspeople usually use the appropriate vehicle and are well advised to do so.
Some years ago, I had a client whose aim was to be the biggest taxpayer in New Zealand. This goal was inspired by the idea that if the client was paying that much tax, he had to be making a lot of money - after all, he reasoned, the IRD does not take it all.
I have to agree: you are far better to be making money and paying tax than paying no tax because you have no income.
It was with interest, therefore, that I read the report in last week's Sunday Star Times that high-worth individuals (defined as those who have a net worth of more than $50 million) do not pay much tax - at least, not in their own names. The report talks about assets that are owned in trusts, but companies are also a very common vehicle for asset ownership for the rich.
This makes a lot of people's blood boil - average New Zealanders are taxed at source through the PAYE system and have no scope to reduce tax. These people take their salaries (already taxed), buy what they need (with GST on most of it) and pay their mortgages (which, unlike some countries, give no tax relief). However, the wealthy appear to be paying next to nothing.
So, what is going on here - how do the wealthy seemingly get away with paying so little? The answer is that they do not own assets in their own names. These wealthy people (and a lot who are not so wealthy) may pay very little tax themselves but their companies and trusts certainly do - it would be a mistake to think that they avoid tax altogether. Although it may be at a somewhat lower rate, their companies and trusts will probably pay a great deal of tax.
Company tax has been set by government at lower than the top personal rate to maintain this country's competitive position. The use of companies and trusts means that although there is tax to pay - the tax is not in the hands of the individual but instead taxed at a lower rate in the company or in the hands of the trust's beneficiaries.
Assets which are in a family trust will be taxed at a flat rate of 33 cents which, because it is the same rate as the top marginal rate does not seem much of a benefit. However, owning assets through a Family Trust means there can be tax benefits for some as trusts are good for income splitting - trusts can distribute income to partners, children and other family members who have lower tax rates.
Companies are also tax efficient ownership vehicles. The company tax rate is 28 cents (lower than the top marginal personal rate and the trust rate by 5 cents). The Company can pay out a smallish salary to the wealthy owner (under $70,000 so it does not attract the top personal tax rate) but retain the rest of the profit to be taxed at the lower company rate.
However, tax minimisation using companies and trusts is no longer straightforward - the Penny and Hooper case has dealt to the tax shelter afforded by a company for some people. This case involving two Christchurch surgeons went all the way to the Supreme Court.
Penny and Hooper had been declaring relatively modest salaries for themselves (well below a reasonable market level for orthopaedic surgeons). This left the bulk of their incomes in their companies (which were owned by their family trusts) to be taxed at the lower company rate. The Court found that such artificial arrangements were effectively tax avoidance and Messrs Penny and Hooper have had to pay back taxes.
The use of Companies and Trusts as ownership vehicles for businesses and investments is widespread - far beyond high worth individuals - and would be mostly regarded as good commercial practice by those who own businesses. My aforementioned client does not really want to be New Zealand's biggest taxpayer: he wants his company to have that honour.
Martin Hawes is an Authorised Financial Adviser and his disclosure statement is available free of charge at www.martinhawes.com. This article is of a general nature and no substitute for personalised financial advice.
- Sunday Star Times