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SPS 05/05
05 May 2005

Retrospective adjustments to salaries paid to shareholder-employees (May 05) (WITHDRAWN)

Withdrawn statement SPS 05/05 Retrospective adjustments to salaries paid to shareholder-employees (May 05). Statement provided for historical purposes only.


This statement has been withdrawn and is provided for historical purposes only.


  1. This Standard Practice Statement (SPS) sets out the criteria for considering whether the circumstances are appropriate for the Commissioner of Inland Revenue to recognise retrospective reductions to salaries paid to shareholder-employees, where a genuine error has been made in the preparation of the company's accounts.


  1. This SPS addresses the question of when a retrospective reduction in a shareholder-employee's salary may be made.  It does not apply to requests for retrospective amendments to PAYE deducted from shareholder-employee's salaries.  Furthermore, it does not apply to situations where a company proposes to increase a shareholder-employee's salary due to an increase in the company's income.

  3. It also does not apply to situations where other mistakes have been made in a company's accounts and the company is seeking to rectify these mistakes without involving any retrospective reduction in salaries paid to shareholder-employees.

  5. This SPS will apply from the 2005-2006 and subsequent income years.  For periods prior to the 2005-2006 income year, please refer to SPS GNL 410 - Retrospective adjustments to salaries paid to shareholder-employees.


  1. In the Tax Information Bulletin Vol 9, No 4 (April 1997) at page 9, Inland Revenue published an item entitled Retrospective adjustment to salaries paid to shareholder-employees.  Its effect was that where an error had been made in the preparation of the accounts of a company, Inland Revenue would amend the company's assessment to take account of the additional expenses that should have been included in the original return.  However, where the company and the shareholder-employee proposed to reduce the salary amount that was originally agreed to be paid by an amount equal to the additional expenses allowed, Inland Revenue would not agree to these consequential adjustments.  In that case, neither the company's nor the individual's assessments would be amended to reflect the fact that a reduced salary would be paid.

  3. Subsequent to the publication of the item, the Taxation Review Authority considered the same issue in Case U27 (1999) 19 NZTC 9,261.  Willy DJ arrived at a different conclusion to the item.  His Honour held that decisions as to the amounts of a shareholder-employee's salary for two income years that were made mistakenly could be reversed or amended.  In that case, the accountant was not fully informed of the company's financial affairs (there was, unknown to him, a tax dispute with Inland Revenue).  This led him to prepare end of year accounts that did not accurately reflect the company's true position.

  5. The company had over several years fallen behind in accounting for PAYE, GST, ACC premiums and FBT to the Commissioner.  The accumulated taxes and penalties resulted in a substantial overstatement of the resulting profit.  This was important because salaries in this company were only ever paid out of profits.  Therefore, the level of salaries was based on incorrect profit figures.  Although the resolutions authorising the salaries were prepared, these were never signed.  When the accountant discovered his mistake, new resolutions were prepared to authorise the distribution of reduced salaries.

  7. The Taxation Review Authority held that section 75 of the Income Tax Act 1976 (section EB 1 of the Income Tax Act 1994, and sections BD 3 and EI 8 of the Income Tax Act 2004), which deemed a person to have derived income when it has been dealt with in the person's interest or on their behalf in various ways (including being "credited in account"), applied, i.e. it operated on the circumstances brought about by the company resolutions correcting the error.  His Honour decided that the company was entitled to and did rectify the error when it came to its notice and the shareholder-employee was obliged to pay tax only on the reduced amounts of income for the relevant income years.

  9. In the light of Case U27and other relevant factors, such as company law, the published item in 1997 was withdrawn and replaced by SPS GNL-410 - Retrospective adjustments to salaries paid to shareholder-employees, which was published in the Tax Information Bulletin, Vol 15, No 6 (June 2003). This SPS updates and replaces SPS GNL-410.


Income Tax Act 2004

BD 3 Allocation of income to particular income years


  1. Every amount of income must be allocated to an income year under this section.

General rule

  1. An amount of income is allocated to the income year in which the amount is derived, unless a provision in any of Parts C or E to I provides for allocation on another basis.

Interpretation of derive

  1. When the time of derivation of an amount of income is being determined, regard must be had  to case law, which-
    1. requires some people to recognise income on an accrual basis; and
    2. requires other people to recognise income on a cash basis; and
    3. more generally, defines the concept of derivation.

Income credited in account

  1. Despite subsection (3), income that has not previously been derived by a person is treated as being derived when it is credited in their account or, in some other way, dealt with in their interest or on their behalf.

Role of Part E

  1. Part E (Timing and quantifying rules) contains a number of provisions that-
    1. specifically modify the allocation of income or have the effect of modifying the allocation of income; or
    2. allocate income as part of the process of quantifying it.

Single allocation

  1. An amount of income may be allocated only once.

EI 8 Matching rule for employment income of shareholder-employee

Matching if company allowed deduction

  1. If a company is allowed a deduction for expenditure on employment income that is paid or is payable to a shareholder-employee under section CE 1 (Amounts derived in connection with employment), the income is allocated in the way set out in subsections (2) and (3).

Allocation to deduction year unless unexpired

  1. The income is allocated to the income year to which the deduction allowed to the company is allocated, except for an amount equal to any unexpired portion for the income year of the company's expenditure under section EA 4 (Deferred payment of employment income).

Allocation otherwise when ceases being unexpired

  1. The remaining income is allocated to the income year or years in which the corresponding amount of the company's expenditure on the income is no longer treated as an unexpired portion.

Standard Practice

  1. Where
    • a genuine error has been made in the accounts as a result of which a deduction has not been claimed for legitimate expenditure incurred, or a receipt has been incorrectly categorised, and
    • the company as a result decides to reduce the amount of salary previously allocated, and
    • the company has passed a resolution reflecting the reduction in light of the relationship between the company and the shareholder-employee, and
    • a request for correction has been filed with Inland Revenue with a copy of the resolution,

    Inland Revenue will consider the request to amend assessments in accordance with the principles set out in a separate SPS (currently this is SPS INV-510 Requests to amend assessments), provided full disclosure is made and the relevant financial statements have been amended and lodged.
  1. It is expected that requests of this nature will be made in a timely fashion.  What is timely involves an exercise of judgment.  There are two aspects to consider:
    • Once a mistake has been discovered then the parties should set about attending to it promptly.
    • As to how long a mistake may go undetected, the answer is less certain. Timeliness requires that a mistake is discovered when in the course of events and in the circumstances of the taxpayer company, one would have expected it to have been discovered.  It could be that many months may go by before the error is detected.  For example, in Case U27, there was a lack of communication between the accountant and principal shareholder and director. The latter kept certain information about the arrears of taxes to himself.
  1. Inland Revenue considers the presence of a "genuine error" in the sense of oversight to be a crucial requirement for accepting the taxpayer's application.  It is considered that the shareholder-employee salaries are generally irrevocable, unless a genuine error has been made.

  3. Whether something is a genuine error is determined by the Commissioner.  If, after considering all relevant information, the Commissioner is not satisfied that a genuine error was made, the Commissioner will not amend an assessment.


  1. The following examples provide some guidance on what will not be regarded as "a genuine error" for the purpose of this SPS:
    1. Fraud committed by a shareholder-employee

      Where a shareholder-employee has committed fraud in relation to their salaries or other shareholder-employees' salaries in the company, no genuine error has been made.  Inland Revenue will not amend the company's and shareholder-employees' assessments.

    3. Retrospective reduction of a shareholder-employee's salary with the intention to reduce the shareholder-employee's child support liabilities or to increase their entitlement to family assistance

      Inland Revenue will not amend the company's and shareholder-employee's assessments in the above case.  This is because no genuine error exists, merely a changed decision motivated by additional benefit to the employee.

    5. Retrospective reduction of a shareholder-employee's salary with the intention to assist with the company's cash flow

      Inland Revenue will not amend the company's and shareholder-employee's assessments in the above case.  This is because no genuine error exists.

  3. Where Inland Revenue agrees to a retrospective adjustment on the shareholder-employees' salaries, sections BD 3 and EI 8 of the Income Tax Act 2004 will deem the shareholder-employee's salary to be the amount as determined by the amending resolution and under section 113 of the Tax Administration Act 1994, Inland Revenue will adjust the company's and employee's assessments accordingly. 


  1. The following examples may give some guidance as to when Inland Revenue will permit adjustments to be made.
    1. Incorrect treatment of receipt

      Where there is an error in the categorisation of a capital receipt (e.g. a loan repayment) as revenue and this results in an overstatement of income, an adjustment may be made. 

    3. Omission of expenditure

      Where an error arises from the omission of deductible expenditure incurred in the current year, an adjustment may be made. 

    5. Company still in profit despite the error made

      Although an error has been made in the accounts, that error is not sufficient to produce an overall loss and the company still has sufficient profit after the accounts have been corrected to cover the salary originally agreed to be paid.  In this situation, Inland Revenue is less likely to exercise the discretion, but will consider each application for an adjustment on its merits.  For example, the Commissioner will need to consider the nature of the contract between the parties and past practice.  While in this circumstance, there would not be the same pressing need to amend or rescind the salary declaration, nevertheless the company could find the situation inconvenient and desire that the amount credited to the shareholder-employee at least be reduced to some extent.  Past company practices of retaining profits may be taken into account.  If the genuine error causes non-compliance with these practices (e.g. the excessive shareholder-employee's salary reduces the percentage of company profits normally retained), the Commissioner may allow the adjustment.

    7. Accrual expenditure

      A company has committed itself to certain expenditure in one year although it has not had to discharge or bear that expense until the following year.  If such an item has been overlooked and the accounts need revision, it would be less likely for the shareholder-employee's salary to be revised.  There may still be funds available to pay them.  This is a matter where circumstances will vary.  Where there is accrual expenditure, the answer will depend on the amount of the unexpired portion of that expenditure relating to future income years.  The Commissioner will consider each application for an adjustment on its merits.

    9. Change of shareholding in the company

      Genuine errors were made by the company before the original shareholder-employees sold their shares to the current shareholders of the company.  The current shareholders passed a resolution to retrospectively reduce the original shareholder-employees' salaries in prior income years. 

      Provided that the original shareholder-employees were fully informed and agreed to such reductions, the Commissioner may agree to adjust the company's and the original shareholder-employees' assessments.

      However, if the original shareholder-employees disagree with the resolution to reduce their salaries in prior income years, the Commissioner will usually not adjust the company's and the original shareholder-employees' assessments in these cases until the dispute between the original shareholder-employees and the current shareholders is resolved.


This Standard Practice Statement is signed on 5 May 2005.





Graham Tubb
National Manager (Technical Standards)