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Is your Family Trust really safe?

By Catherine Atchison - 15 Sep 2011

Your Family Trust may be vulnerable to the tax man

What's the real purpose of your company or family trust? If it is primarily for minimising tax, the IRD may still come after you.

In a recent case - Penny and Hooper v Commissioner of Inland Revenue - the Supreme Court looked closely  at the use of companies and family trusts in relation to tax avoidance.

The Inland Revenue won its case, with the Court ruling that the arrangements constituted tax avoidance under the Income Tax Act.

Overview of the case

The case involved two surgeons whose practice was earning in excess of $500,000. The surgeons formed companies to buy their surgical practices, which then paid the surgeons salaries of $120,000 or less.

The salaries were taxed at 39 cents in the dollar (the highest marginal tax rate at the time). But the balance of each practice's income was taxed at 33 cents and distributed to the doctors via their family trusts.

Court found tax reduction was real purpose of arrangements.

The surgeons' arrangements were definitely lawful uses of the corporate structure under company law.

However, the artificially low salaries were not justified for commercial or family reasons, and tax reduction was not merely an incidental feature of the arrangements. The Court found that tax reduction was the main reason for the arrangement.

The Lesson

When you are considering arrangements that have a tax minimising effect, you must consider whether the purpose of an arrangement is supported by solid non-tax reasons. These include avoiding liability in a hazardous business or raising bank finance.

In short, any tax advantages should be incidental and not the original purpose behind your arrangements. Tax benefits which are not merely incidental to commercial or family purposes may leave your tax minimising arrangement open to attack by the Inland Revenue.

For information and advice about structuring your affairs, contact Catherine Atchison.


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