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How to ease the tax burden

Friday 24th March 2000

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It is possible to escape higher tax by rearranging your financial affairs, writes SIMON WEIL in the first of two articles

It is a long-established principle that people are entitled to plan their affairs in the most efficient and tax-effective manner.

But this has to be balanced against the anti-avoidance provisions contained in the income tax legislation intended to render a structure ineffective if the main purpose of the structure is to avoid tax.

It is important therefore any arrangements have bona fide commercial and/or family objectives as the motivation for their implementation. Many of the acceptable objectives for asset planning are well established.

They include isolating family assets from business risks; protecting assets from potential matrimonial claims (and possibly de facto claims), planning for retirement, protecting inheritances; assisting with the cost of children's and grandchildren's educational expenses; and preserving residual assets for future generations.

That incidental tax benefits may also be available as a result of a structure implemented for any of those reasons should not prejudice the integrity of the structure.

Provided such reasons clearly exist, it remains to determine which of the legitimate planning mechanisms will be best suited to obtain maximum benefit. That will depend in part on the nature of the income involved - that is, whether it is passive income (derived from investments such as rental properties, shares or term deposits) or business income (earned as a result of personal efforts).

For those considering their position in respect of business income, a number of options are available. In some cases, it might be appropriate to carry on the business in partnership with a spouse.

This could present the opportunity to split business income so income is taxed at the spouses' respective marg-
inal tax rates rather than have one spouse derive all the income and carry the tax burden alone.

Alternatively, some circumstances may lend themselves to running the business through a company. While this may give rise to short-term tax benefits (in essence, the tax will be deferred until dividends are distributed to shareholders and taxed in their hands at their marginal rates), the asset protection available from running a business through a company should not be underestimated.

A variation to the corporate model is the trading trust where the business is carried on by a trust which has a company as its sole trustee. The advantage this structure offers is that income will be trust income so that the business can avail itself of the significant benefits that trusts can offer.

For salary earners, the potential for any planning is likely to be limited to remuneration packaging such as forsaking cash-in-the-hand income for employer contributions to superannuation schemes.

It needs to be borne in mind, though, that any benefits may be affected by any change to the tax treatment applicable to such schemes and, in particular, whether funds paid into the scheme would be locked up until retirement. The suitability of such planning will depend on whether the tax-saving benefits outweigh the inability to withdraw funds as and when required.

There are again a number of options available for passive income depending on the circumstances. But it is likely trusts and companies will offer the greatest benefits. The ability to derive both asset protection and tax-saving advantages makes trusts an appealing vehicle in which to hold investment assets.

However, when the asset is negatively geared, and the losses are required to be offset against other income, a company is often an appropriate vehicle. In that case, a loss attributing qualifying company can be effective to maintain tax effectiveness as well as asset protection.

While care always needs to be taken with the implementation of any asset planning structure, this is particularly so at present in light of the caveat from Finance Minister Michael Cullen that the government is looking to introduce legislation to plug any loopholes that allow the tax increase to be avoided.

Bear in mind, though, the integrity of a structure depends on worthy business or family objectives; the loss of any incidental tax benefits as a result of any new anti-avoidance legislation should not be a major concern. But if tax benefits can legitimately be gained from a restructure of your affairs, it is timely to do it sooner rather than later.

Next week: Asset planning and directors' liability

Simon Weil is a solicitor practising in the field of trusts and asset-protection planning with the Auckland office of national law firm Morrison Kent

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