Let’s talk about (the recent Greens’ press statement on) tax.

Recent data has shown there is a spike around $70,000 of reported taxable income for individuals – convienently the point where the top marginal tax rate of 33% starts. And according to the Greens this shows evidence of tax avoidance by rich people which can be fixed by – among other things – increasing Inland Revenue’s investigation budget. Mmm maybe.

Before I go on, I am working on the assumption that when the Greens talk about tax avoidance it is in the colloquial ‘not paying as much tax as I think you should’ kinda way rather than tax avoidance according to the actual law. All cool but unfortunately (or fortunately) the department is constrained by what Parliament has enacted and how the Courts have interpreted it.

Now in the mid 2000s – it is true – similar spikes were evidence of widespread tax avoidance among self-employed professionals. The wheeze was that they were employed by trusts which were taxed at 33% on the income the individuals earned – not the top individual’s rate of 39%. And then the trust paid the individuals a below market salary for their services to the trust.

Only the below market salary was taxed at 39% and the rest of the income at the lower trust rate. And then any tax paid income of the trust could then be distributed tax free to beneficiaries. Too easy and too good to be true. Hence tax avoidance according to the actual law.

Moving to 2017. The trust and top personal rate are the same so that particular wheeze won’t work. But now we just have misalignment between the company rate at 28% and the top personal rate of 33%.

Except that under a misalignment with the company rate there is no distributing the income tax free. When income is distributed from the company to the shareholder – a dividend – it is subject to another 5% tax. Now any ‘tax avoidance’ – in theory anyway – is just timing until the shareholder needs the money. There should be no ultimate reduction in tax. Although timing advantages can be a big deal and can also make something tax avoidance under the actual law.

But the only way I can see of moving this from tax avoidance – not paying as much tax as I think you should  – to tax avoidance under the actual law is if the department can show that the $70k is not a market salary – as they did with the self employed professionals.

And while that wasn’t simple for the department last time – now all tax advisors know about the need for a market salary – possibly from painful personal experience. So anyone giving advice that $70k is an acceptable salary – when the market rate is higher – does so knowing it could be attacked by the department and will have all the supporting arguments ready. 

But the Greens are right the spike is still there. Last time the spike was widespread tax avoidance according to the actual law – so why wouldn’t it be this time too? Not the first time I have lacked imagination.

Just in case tho I am right –  I am also all about the solutions. And there is at least one way of getting rid of the spike without increasing anyone’s budget. Think of all that extra money Greens you could spend on cleaning up the rivers instead of tax inspectors. 

One way is to increase the company tax rate to the top marginal rate.

Another way is to make the look-through company (LTC) rules compulsory.

Currently any company with five or fewer shareholders can choose not to be taxed as a company. Instead income and losses are taxed as if the shareholders had earned the money  themselves. Except currently those rules are optional. Make them compulsory and the spike goes. No more income in more lowly taxed closely held companies as no more closely held companies for tax purposes. Simple.

And the really good news for the Greens is that there is currently a bill in the House making changes to the LTC rules; so a Supplementary Order Paper doing just that would be totes in scope. Oh and it is an ‘annual rates’ bill too so they could also have a go at the company tax rate at the same time. Awesome.

Now lots of people who haven’t made an LTC  election may not like that and say so quite loudly. Coz that’s what you get when you are strong on policing tax avoidance – lots of upset people all with lots of incentive to write to you and come and tell you how upset they are.

But unless the current law with closely held companies – or company tax rate  – changes I can’t see any level of increased funding will get rid of that nasty spike.

Namaste.