When the words “Imputation Credits” appear most people’s eyes glaze over! But for business owners and investors Imputation Credits are truly your best friend!
Back in the Day…
When I first started my accounting career the top NZ tax rate was 66%. For every dollar earned personally (after paying “business” expenses) you only kept 34 cents.
In addition to those horrific income tax rates NZers also faced “double taxation”. When a company paid tax (at up to 48%) on its net profit then that same net profit was taxed a second time when distributed as a dividend to shareholders!
Mininising taxation became a popular national sport and there was little incentive for businesses to be profitable. That historical NZ tax regime encouraged loss making ventures to reduce taxation, taxpayers sought out untaxed capital gain opportunities, and personal expenditure often masqueraded as business / tax deductible expenditure.
NZ didn’t tax spending until 1 October 1986, when 10% GST was introduced.
Enter Imputation Credits to the Rescue
In 1989 NZ introduced a dividend imputation system. This meant that a shareholder receiving a dividend from a company was entitled to an “imputation credit”, being the tax already paid by the company on that portion of income paid to the shareholder, to reduce or eliminate the shareholder’s personal income tax liability on that same income.
The imputation credit regime helped remove double taxation from the NZ tax system.
Fast Forward to 2021
As at August 2021 NZ has 15% GST on expenditure and company income tax of 28%. NZ trust’s pay 33% income tax, and individuals pay income tax at variable (marginal) tax rates based on their level of net taxable income. An individual’s tax rate ranges from 10.5% if they earn under $14,000 annually, to 39% on income over $180,000.
Now, when a NZ company pays a taxable dividend it has already paid 28% income tax on that income and a further 5% withholding tax is paid when the dividend is declared, meaning the dividend is already tax paid at 33%.
If the shareholder has a marginal tax rate of less than 33% then they will receive a tax refund and possibly have a tax loss to carry forward. If the shareholder has a marginal tax rate of 39% then they will have an additional 6% tax to pay on the dividend when they file their personal income tax return.
So, What Can Go Wrong?
Many NZ companies are “Mum and Dad” businesses and the quality of tax planning can be variable. The shareholders may decide to sell shares to a family member, family trust, key employee, or a third party without thinking about the possible tax consequences.
Under existing tax rules if a company’s shareholding changes by more than 34% then the imputation credits (aka company tax already paid on income that has yet to be paid out to shareholders) will be forfeited.
Forfeited imputation credits results in double taxation when the same profit will be taxed twice, once when the company earns the profit and again when it is distributed to the shareholders. Unfortunately, there is no “fix” to recapture imputation credits if more than 34% of the company shares change ownership before dividends are paid.
Summary
Get tax advice before restructuring company shares. This blog is a very simple summary of what is often a complex tax planning exercise, especially when there have been several shareholding changes over the years.
If you don’t get good tax advice then you may end up with an effective tax rate of 67% once again, reverting back to the bad old days.
“Nothing is more responsible for the good old days
than a bad memory.”
Franklin Pierce Adams