In-work tax credit and major shareholder employees of a close company
(Clauses 65(2) and (3) and 66)
Summary of proposed amendment
The bill amends the requirements for the in-work tax credit to allow a major shareholder employed by their close company to meet the requirement of a full-time earner, regardless of whether they receive wages or a shareholder salary. A major shareholder employed full-time in a close company will qualify for the in-work tax credit if:
- they meet all other requirements for the in-work tax credit such as age, residence and care of a dependent child;
- they meet the work hours requirement of the definition of a full-time earner in relation to the close company; and
- the company derives gross income in the income year.
The amendment will apply from 1 April 2012.
Section MD 9 of the Income Tax Act 2007 is being amended to allow a major shareholder employed in a close company to meet the full-time earner requirement for the in-work tax credit. A major shareholder who is a full-time earner in relation to a close company will not have to meet the requirement to derive income as set out in section MD 9(2). Instead, the close company they are a major shareholder in and work for must derive gross income in the income year.
The person will still be required to meet all the other requirements for the in-work tax credit as set out in sections MD 5 to MD 8 relating to age, care of a dependent child, residence and not receiving a benefit. The person will also be required to meet the required hours of full-time earner as set out in section MA 7. A full-time earner is a person who is normally employed for at least 20 hours a week, if they are a sole parent, or at least 30 hours a week in combination with a spouse, civil union or de facto partner.
The terms “major shareholder” and “close company” are defined in section YA 1. A major shareholder is a person who owns, or has the right to acquire, or power to control, at least 10 percent of the ordinary shares or voting rights, or control of the company. A close company means a company in which five or fewer natural persons hold more than 50 percent of the interests; or if a market value circumstance exists, five or fewer natural persons hold more than 50 percent of the market value interests. All natural persons associated at the time are treated as one natural person.
Consequential amendments are being made to section MD 10, which relates to the calculation of the in-work tax credit.
Some shareholder-employees work full-time for their company but are unpaid for their work effort because, for example, the company has made a loss for that year and has restricted cashflow. This could occur in start-up companies, for example. Under the current full-time earner requirements, the shareholder employee would not qualify for the in-work tax credit as they did not derive income as set out in subsection MD 9(2). Other business owners, such as partners in a partnership or a sole trader, in the same situation do qualify for the in-work tax credit as they earn income from a business, even if the business makes an overall loss, as long as the business derives gross income.
The Income Tax Act 2007 contains a provision to restrict opportunities for major shareholders in a close company to inflate their entitlement to Working for Families tax credits. The net income of the close company (less any dividends paid to the major shareholder) is attributed to a major shareholder in proportion to their interest in the close company under section MB 4. This attributed income counts towards the person’s family scheme income used for abating any Working for Family tax credits. In contrast, the attributed income does not apply for the purposes of the full-time earner requirement for the in-work tax credit under section MD 9.