A key proposal relates to the tax treatment of gains derived by a shareholder on the sale of their shares in a company. Under current law, for most shareholders, those gains are considered to be capital in nature and are not subject to tax. However, the IRD argues that in many cases, the gain derived on sale reflects the value of retained earnings within the company (including retained earnings that have been invested in new assets). If those retained earnings were distributed to the shareholder directly, this would give rise to a taxable dividend. The IRD therefore proposes that a sale of shares in a company by a controlling shareholder would trigger a deemed taxable dividend for the shareholder. The amount of the deemed dividend would equal the higher of the retained earnings balance of the company (and its subsidiaries) at the time of sale (grossed up to a pre-tax amount) and the company’s imputation credit balance divided by 28%. Any sale proceeds received by the shareholder over and above the deemed dividend amount would continue to be a tax-free capital gain.
The IRD also proposes that the personal services attribution (PSA) rule be amended to apply more broadly. The PSA rule is aimed at situations where personal services of a person (the working person) are provided through a company or trust structure. This has the effect that income from the services is taxed within the entity rather than in the hands of the working person at their personal marginal tax rate. Where the PSA rule applies, the income of the entity is attributed to the working person and is taxed at their marginal tax rate.
At present, the PSA rule can only apply where at least 80% of the entity’s income is from services supplied to a single customer (and/or any persons associated with the customer). The IRD proposes to remove this requirement so that the PSA rule could apply even where the entity in question had a diverse customer base. Another requirement for the PSA rule under current law is that 80% or more of the income of the entity must be attributable to the services of the working person. The IRD is consulting on whether this threshold should be reduced, so that the PSA rule could apply where the working person’s services produce just 50% or more of the income of the entity. Changes to the exception for entities with substantial business assets are also under consideration – the dollar threshold for what qualifies as substantial business assets could be increased significantly and vehicles may be excluded when valuing these assets.
The closing date for submissions on these proposals is 29 April 2022.
If you have any questions about the matters raised in this article please get in touch with the contacts listed or your usual Bell Gully advisor.