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RA 11/02

Revenue Alert

2011 Revenue Alert considers when diverting personal services income by structuring revenue earning activities through an associated entity is tax avoidance.


A Revenue Alert is issued by the Commissioner of Inland Revenue, and provides information about a significant and/or emerging tax planning issue that is of concern to Inland Revenue. At the time an Alert is issued, risk assessments will already be underway to determine the level of risk and to consider appropriate responses.

A Revenue Alert will identify:

  • the issue (which may be a scheme, arrangement, or particular transaction) which the Commissioner believes may be contrary to the law or is inconsistent with policy;
  • the common features of the issue;
  • our current view; and
  • our current approach.

An Alert should not be interpreted as being Inland Revenue's final position. Rather, an Alert outlines the Commissioner's current view on how the law should be applied. For any Alert we issue it is likely that some investigatory work has already been carried out.

If people have entered into an arrangement similar to the one described or are thinking about it, they should talk to their tax advisor and/or to Inland Revenue for advice about tax implications.

ISSUE: Diverting personal services income by structuring revenue earning activities through an associated entity such as a trading trust or a company: the circumstances when Inland Revenue will consider this arrangement is tax avoidance.


This Revenue Alert updates the Commissioner's view on this matter following the Supreme Court's decision in Penny and Hooper v CIR  [2011] NZSC 95. It replaces Revenue Alerts RA 08/01 issued in March 2008 and RA 10/01 issued in June 2010.

Key issues

  • The use of companies, trusts and other business structures do not of themselves give rise to avoidance concerns;
  • However, the use of those structures can provide the controllers of the business with an opportunity to divert income away from themselves;
  • When the business involves the provision of services, whether that diversion is legitimate or not requires a focus on two issues:
    • Is that individual controller appropriately compensated for his or her skill and exertion?  This requires an examination of the respective drivers of profit for the particular services provider and how the profits of the business are actually distributed
    • If not, are there any valid commercial reasons for the individual receiving a reduced level of remuneration?  Here the focus is on whether there are particular reasons why the individual is accepting an unreasonably low level of remuneration.
  • We will be concerned with arrangements where the compensation received by the individual is artificially low while related entities benefit (or the individual ultimately benefits), and any commercial reasons for that transaction do not justify the low level of remuneration.


Inland Revenue has always been concerned about arrangements involving taxpayers who arrange to effectively divert to an associated entity some or all of the income they earn (or could earn) from a business or activity of supplying personal services - where it has the effect of taking advantage of lower marginal income tax rates payable by that entity and/or by family members as beneficiaries or shareholders of that entity.  Other tax-linked benefits (such as certain entitlements and obligations such as Child Support) may also arise under the arrangement.

There are legitimate reasons for using entities such as trusts or companies in many business situations. Therefore the mere use of alternative business structures will not, on its own, amount to a tax avoidance arrangement.  Further, the profit generated by the business may not be wholly generated by the individual and there may also be good non-tax reasons as to why the controller of a business receives significantly less of the business' profits than would otherwise be the case.

However, where the business involves the provision of services, we are likely to examine closely any arrangement where the individual service provider (usually the real owner or owners or controllers of the business) is not receiving a significant portion of the profits derived from the business.  This is particularly so where there is an absence of other business profit drivers and other non-tax reasons do not justify the level of remuneration received by the individual.

Inland Revenue's position in this regard has recently been confirmed by the Supreme Court's judgment in Penny & Hooper v CIR.  That decision confirms that income substantially generated by the direct personal skills, experience or labour of an individual should generally be subject to tax in the hands of that individual.  The individual's contribution to the business should be properly reflected in the income returned by that individual - either through an appropriate salary or other taxable distributions to the individual.

We consider that the Supreme Court's analysis endorses earlier cases decided in this area, and potentially applies to any type of services provided by an individual to third parties.

We will closely examine situations where an arrangement has the effect of diverting a substantial amount of that personal exertion income  but the benefit of those diverted funds are still enjoyed, directly or indirectly, by the individual or their family or associates. We will generally focus on the most serious and artificial cases - where the arrangement results in a substantial proportion of the income generated by the business being diverted away from the individual service providers.

In many cases, taxpayers entering into these types of arrangements are also benefiting from reduced child support liabilities or student loan repayment obligations. In some cases taxpayers are structuring their remuneration at a level that will allow them access (or greater access) to other non-income tax benefits that rely on income calculated for tax purposes.  


It is often a combination of factors, such as those listed below, that concern us.  Where income is generated from the supply of services provided by individuals a combination of some or all of the following factors may result in us looking more closely at a business structure:

  1. The controllers of the business arrange for an entity, such as a trading trust or company, to operate and own the business.  The operating entity engages or employs them (or contracts for their services);
  2. Where the business has been transferred, the business operates substantially as it did before its transfer to the operating entity; 
  3. The business may not in substance be operated according to the terms of the arrangements entered into. This includes examining the agreements themselves, the manner in which they are actually implemented and also whether the overall arrangement is commercial having regard to a comparison with relevant standard business practices;
  4. The degree to which the individual service providers or their family ultimately control the entity, its economic product and cash flows from the business;
  5. Whether there is a redistribution of the underlying income from the entity to the person or to family members, usually via a trust but there are other mechanisms, for example, by way of employment of the family members perhaps at inflated salaries, or related party loans or the payment of management and other service fees to associates; and
  6. The extent to which, as a consequence of the arrangement, significant tax benefits are obtained e.g. where the entity and/or any beneficiaries or shareholders pay lower marginal tax rates than would have been payable by the taxpayer, but for the arrangement.

In certain circumstances, notwithstanding that all or most of the above factors may be present, the arrangement will still not constitute tax avoidance.  This is because there are legitimate reasons both for adopting particular business structures (such as asset protection, limited liability and business continuity).  Businesses can also legitimately make decisions about whether or not, or the extent to which, profits are to be retained or distributed, for example.

There is also nothing preventing individuals, or entities related to the individual service provider, from owning the business and receiving distributions of profit reflecting that ownership.  Further, it may be appropriate in certain circumstances for family members or associated entities to receive funds from the business as:

  • An employee or service provider; and/or
  • An owner of capital equipment used by the business.

However, in those circumstances care needs to be taken that the relevant transactions can be commercially justified.  We will be more concerned with arrangements that have non arms-length factors present, especially where the individual service providers are not adequately remunerated for their contribution to the business.  We will look at the totality of the arrangements.

Businesses need to have a valid commercial basis for the way in which profits are distributed, especially in the form of remuneration paid to individuals they employ or contract to provide services.  The profits of a service entity will generally be driven by a combination of the following:

  • The controllers of the business' personal skill, judgement and exertion:  The more specialised and marketable those attributes are, the greater the remuneration should be;
  • The use of capital assets: Where the business and not the individual owns significant assets that are used to generate business income, the owners of the business are entitled to a appropriate return on those assets;
  • Services provided by other staff: Similarly, where the business employs other skilled staff, some of the business income generated can be seen as contributing to the business' profits and not the individual business controllers.  The greater the number of specialist staff employed in the business, the more influential this will be;
  • Intangible assets: Sometimes the profits of a service business may also be improved through matters such as business know-how or other IP owned by the business. As with capital assets, an appropriate return on such assets can be expected by the business; and
  • Return on business risks: This may be influenced by factors such as who has legal liability for the business or its funding.  For example, who carries the reputational risk for the business, who is liable to the industry body for any wrongdoing, what insurance policies are in place, and who guarantees any borrowings.  Where the structure does little to remove those risks from the controller, the controller's overall remuneration should reflect those risks.

We recognise that it can sometimes be difficult to determine an appropriate remuneration for the individual. There is no exact science to weighing up the extent to which the individual is responsible for the business' profit (instead of other profit drivers).  However, we consider that in most circumstances, the main profit driver of a service business is the personal skills and exertions of the controllers of the business - particularly where the business does not require a great deal of capital.

In those circumstances, we would expect the compensation received by those individuals (whether by way of salary, service fees, distributions of profits or any combination of them) to be significantly more than the return received by entities associated with the business.  We will particularly weigh that against what happens to other forms of distribution from the business received by the associated entities (such as loans, dividends, salaries, service fees, trust distributions etc).

Given our focus on the more artificial arrangements, and the resources available to us, we are more likely to examine arrangements where the total remuneration and profit distributions received by the individual service provider is less than 80% of the total distributions received by the controller, his/her family and associated entities.

The department's approach focuses on the commercial reality of the business, and not on “market” salaries, or comparable industry averages.

For that reason, we agree with both the Court of Appeal and the Supreme Court on this point, that there may be particular reasons as to why the controllers of the business may not be adequately remunerated in a particular year. Examples of this include:

  • Adverse business conditions mean that the business' profits are down but most of those profits are still paid out to the individual service providers;
  • It is financially prudent to retain some profits in the business because it is anticipated that the business may experience financial difficulties in the near future;
  • The profits are set aside to acquire business assets in the next financial year; or
  • The business relates to a charity and the individual receives less to ensure the charity's return is maximised.

There may be other non-tax reasons why a business may pay the individual less than an arm's-length party would receive over the short-term.  However, in those circumstances, we would accordingly expect to see no significant distributions being made to entities associated with the individual.

Current view

Inland Revenue considers that arrangements that exhibit a combination of the above features may constitute an avoidance arrangement in terms of sections BG 1 or GB 44 of the Income Tax Act 2007.  Such cases fall outside the contemplation of Parliament.

To determine whether or not there has been tax avoidance we will look at all aspects of these arrangements including all documentation, and the actual behaviours of the persons involved.

In summary, whether or not the arrangement under consideration is a tax avoidance arrangement in relation to the tax payable on the entity's distributed profits in any given income year will depend on an examination of:

  • The reality of the service provider's business structure and how it operates commercially;
  • Whether and how the profits of the business have been distributed in substance - including whether the individual and their family continue to receive the benefit of all profit distributions from the business;
  • Whether the remuneration received by the individual service provider appropriately reflects the individual's contribution to the business' profit; and
  • Whether there are particular non-tax reasons justifying a departure from that standard. 

Options available to Inland Revenue on reconstruction include deeming all of the income to have been derived by the individual (in appropriate circumstances), or deeming that individual to have received some other amount of remuneration personally (e.g an amount that more properly reflects the individual's contribution to the business' profits). 

Current status

Inland Revenue has investigated a number of these arrangements over recent years.  Where we still consider, after initiating the tax disputes process, that the arrangement is tax avoidance, amended assessments will be issued which attribute some or all of the diverted income to the taxpayer, to counteract the tax benefit resulting from the use of this arrangement.  Some of those investigations and disputes were deferred awaiting the Supreme Court's decision in Penny & Hooper.

We will also continue to investigate similar arrangements where there are significant tax benefits.  Many other arrangements involving service providers share some features of the arrangements considered in Penny & Hooper but have their own particular characteristics.  We will take those factors into account in any investigation but the Revenue Alert seeks to highlight the general issues we consider relevant to such arrangements. Where the tax avoidance rules apply, we will take steps to counteract the tax benefits obtained.

Late payment penalties and use of money interest may be applied to people entering into the type of arrangement described in this Revenue Alert.

Shortfall penalties may also apply, although these may be reduced where a voluntary disclosure is made.

If you consider that our concerns may apply to your situation, we recommend you discuss the matter with your tax advisor or with us, and consider making a voluntary disclosure.

Any voluntary disclosures or case-specific queries can be sent to our specialist team at [email protected]

References to consider

The following related references will assist taxpayers with determining whether their arrangement is subject to the avoidance provisions in the Revenue Acts.

Subject references: Tax avoidance
Legislative references: BG 1 ITA 2004 and ITA 2007
GB 1 ITA 2004 and GA 1 ITA 2007
GC 14B ITA 2004 and GB 27 ITA 2007
GC 28 ITA 2004 and GB 44 ITA 2007
Standard practice statements: SPS 09/02 Voluntary Disclosures (see also booklet IR281)
Revenue Alerts items: RA 08/01
RA 10/01
Case Law: Penny and Hooper v CIR [2011] NZSC 95
Krukzeiner v CIR (No. 3) (2010) 24 NZTC 24,563
Ben Nevis Forestry Ventures Limited v CIR [2009] 2 NZLR 289
Peate v FCT (1962) 9 AITR 3
CIR v Penny and Hooper [2010] NZCA 231
Hadlee & Sydney Bridge Nominees Ltd v CIR (1993) 15 NZTC 10,106
Case Z24 (2010) 24 NZTC 14,354
Case W33 (2004) 23 NZTC 11,321
Case Y1 (2007) NZTC 13,001
Wells v CIR (1973) 1 NZTC 61,094
Halliwell v CIR (1977) 3 NZTC 61,208
Shine and Laird v CIR (1981) 5 NZTC 61,058
FCT v Gulland, Watson (1985) 17 ATR 1
Date issued: 1 September 2011
Authorised by Graham Tubb
Group Tax Counsel
Legal & Technical Services
Contact for comment (via email): [email protected]
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(04) 890 1743
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