Tax Tip 146: Contracting with Family to Divert income and Save Tax

Discussion in 'Accounting & Tax' started by Terry_w, 10th Nov, 2016.

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  1. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Contracting with Family to Divert income and Save Tax

    Last time I posted on saving tax by splitting income. This is one way to do it.

    It is possible for a person to contract with family members such as spouses, children, siblings and parents (etc).

    Why would you want to do this?

    3 main reasons
    • To benefit them rather than some stranger
    • To divert income and thereby save tax
    • To charge back to the tenant (in some cases)

    Any transaction needs to be done at arm’s length and on commercial terms – you should not be paying above market rates for example.


    Example

    You live with a spouse who is not working. You also have an investment property that is between tenants. You could potentially contract with the spouse to mow the grass, clean up the garden and to clean the property generally.



    How
    • You should be paying them market rates
    • They should have an ABN registered (consider GST registration too)
    • Get them to invoice you in writing with the invoice conforming to ATO requirements
    • Actually pay them the money
    • Assume you will be audited and keep proper records.


    Benefits
    • You claim the expense and receive a benefit at your marginal tax rate
    • The spouse declares the income and pays tax on this.
    • You may be able to charge the costs back to the tenants in some situations (but generally you cannot claim a fee for your own time)


    Example of Potential Tax Savings

    If your spouse had a taxable income of $1,000 and you were on $200,000 and the expense was $1,000

    You claim $1,000 deduction and receive a benefit of $490 in savings

    Spouse receives $1,000 in income but no tax is payable

    Family is $490 better off.

    Warning
    Naturally this sort of transaction is open to abuse so the ATO will be looking closely at this sort of thing. You need to get tax advice before implementing. Your tax advisor should also consider the anti-avoidance provisions (Part IVA).

    Legal Implications
    There are also legal implications in the areas of:
    family law
    asset protection
    estate planning
    bankruptcy
    etc
     
    Gypsyblood likes this.
  2. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Of course there are instances when paying a related party is NOT acceptable

    eg
    - Personal services income
    - Personal services business
    - A tax scheme which may have deductions denied under Part IVA
    - Payments to a partner from a common law partnership
    - Disallowed deductions under s26-35
    - Payments not made in accordance with a contract or Fair Work or similar law... Usually met with a "dog ate my homework" type excuse.

    Then there could be non-compliance with workers comp, superannuation guarantee charge and even legal liability. eg Who provided the tools etc...Having an ABN does not make a business.

    A good example is some small businesses who claim that the wife does the books. But she has NO idea about MYOB and all the work is processed externally etc. UYsually detected during record keeping audit when questions about bank recs come up. Blank look and no response ? So, what work do you do ? Who prepares the invoices ? Who marks them paid etc ....Hole gets bigger. s26-35 starts to run through ATO's mind. Best ones are when the ATO front up to the office and the staff innocently tell ATO the bosses wife is rarely ever there - Do you want us to call her ? ..Oh dear.

    Best tip I can give is to over-remunerate for work actually performed but never remunerate a lie.
     
    Last edited: 10th Nov, 2016
    Pingu1988 likes this.