Are you an individual providing personal services through an associated entity? If so, it is crucial to understand the implications of the attribution rule and whether it applies to your circumstances.

The attribution rule is designed to prevent high-income individuals from diverting personal services income to associated entities, such as companies, trusts, look-through companies, or partnerships. This article aims to shed light on the attribution rule, its exemptions, and the importance of compliance to avoid potential tax avoidance risks.

Understanding the attribution rule:

The attribution rule should be carefully considered by individuals who provide personal services through an associated entity. If the working person earns more than $70,000 in net income, including income derived from the associated entity, and certain conditions are met, the attribution rule comes into effect. Where all the attribution rule criteria are met, the income derived by the associated entity would need to be attributed to the individual working person.

Exemptions to the attribution rule:

While the attribution rule is intended to ensure fair taxation, there are exemptions that allow for specific situations to be excluded from its application. These exemptions include:

• Non-tax residency. If both the associated entity and the person providing personal services are non-tax residents of New Zealand for the entire income year, the attribution rule does not apply.
• Controlled Foreign Company (CFC). If the associated entity is classified as a Controlled Foreign Company, it is exempt from the attribution rule.
• Substantial business assets. The attribution rule does not apply if the associated entity possesses substantial business assets that are essential to its operations and income generation.
• Threshold amount. If the total amount to be attributed to the working person is less than $5,000, the attribution rule is not applicable.
• Essential support services: If the services being provided are deemed essential support for a product supplied by the associated entity, the attribution rule does not apply.

Tax avoidance risks and Inland Revenue's guidelines

While the exemptions provide clarity, taxpayers should be cautious about structuring entities or arrangements solely to exploit lower tax rates and circumvent their tax obligations.  Inland Revenue has issued a revenue alert to guide taxpayers on circumstances that may be deemed as tax avoidance.

Taxpayers should exercise caution, particularly when the service provider receives less than 80% of the income generated from the services provided or when significant benefits arise from the chosen business structure and remuneration levels.

Paying your spouse or relative and the attribution rule

It is important to understand that the attribution rule may also apply to arrangements where an individual pays their spouse or relative a salary from the personal services they provide.

Under the attribution rule, if the associated entity pays a spouse or relative for services they provide, the income derived from those services may be attributed back to the individual who is the main earner or provider of personal services. This means that the income will be treated as if it were earned directly by the main earner, and they will be liable for the tax on that income.

Inland Revenue's enhanced measures

To address potential tax avoidance, Inland Revenue has implemented additional reporting obligations for trusts and introduced new information gathering rules, effective from 1 April 2021. These measures enable Inland Revenue to identify any changes or increased use of trust structures aimed at mitigating the impact of the new tax rate.

Understanding the attribution rule and its exemptions is vital for personal service providers associated with entities. By complying with the attribution rule, individuals can ensure their tax obligations are met appropriately. If you require assistance in determining whether the attribution rule applies to your situation, the tax team at Bellingham Wallace is available to provide expert guidance.