New Zealanders have enjoyed relative freedom to make gifts without tax consequences since the abolition of gift duty in 2011.
This, combined with the abolition of estate duty in 1992, has meant it has been possible to make gifts of cash or other assets without a tax cost for the past 12 years. Of course, this lack of tax cost is subject to some exceptions, of which perhaps the most well-known is the bright-line test, which taxes certain (deemed or actual) capital gains derived in relation to real estate.
However, there are lesser-known provisions of the Income Tax Act 2007 (ITA) that can apply to tax gifts in certain circumstances. Inland Revenue (IR) has released its view on when these provisions apply in a draft interpretation statement Income tax: Income – when gifts are assessable income. The statement is accompanied by a fact sheet that summarises the statement. Both are open for feedback until 18 September 2023.
As the introduction to the statement acknowledges, “[a] gift is not usually subject to income tax”. However, the statement sets out the view of the Commissioner of Inland Revenue as to when a gift will be assessable income (and therefore taxable), under Part C of the ITA. The statement provides that a gift may be assessable income where it is:
- received in connection with employment;
- from a business or profit-making activity;
- received in undertaking a voluntary activity (if it is not a reimbursement of expenditure); and
- income under ordinary concepts.
The statement applies to monetary gifts and to non-monetary gifts that are convertible to money. However, it does not apply to gifts that may be subject to fringe benefit tax or that are not subject to income tax but may be family scheme income under the Working for Families regime.
Gifts in connection with employment
The statement notes that an amount received by a person will be employment income if it comes within section CE 1(1) of the ITA. That section sets out various types of income commonly received in connection with employment or service.
An employment relationship relevant to the person receiving the gift, whether it is a past, present or future relationship, will raise a question as to whether the gift is assessable income. However, such a relationship will not always in and of itself indicate that the gift is assessable income.
The statement summarises the main themes that indicate a gift is employment income as follows:
- The amount of the payment reflects the extent of the services the taxpayer has provided to which the payment can be related.
- The payment is made as a quid pro quo in the hope of future services from the employee or to encourage further efforts.
- The payment is a product of, or contemplated by, the terms or implied terms of the recipient’s employment agreement. However, a payment made under the terms of an agreement separate from the employment agreement may still be treated as employment income.
- The payment had recurred or has a foreseeable element of recurrence, rather than being a one-off payment.
- The employee’s services to which the payment can be related are commonly within the range of duties expected of the employee or the range of activities the employer carries out. However, if an employee willingly does something beyond his or her usual duties and is paid for that, their employment duties are enlarged to encompass it.
- Such payments (including tips or gratuities) are expected or asked for or are commonplace as a matter of practice in the occupation, profession or industry.
- The payment is one commonly provided to the recipient, not as a personal gift but because he or she is the employee who is the current holder of an office.
The statement also lists factors that indicate a gift is not employment income and factors that are not necessarily relevant (being that the employment is unpaid, and the recipient had to be an employee to receive the payment).
Gifts to businesses and profit-making activities
It is probably more intuitive that gifts made to businesses and other forms of profit-making activity are considered taxable income.
The statement confirms that gifts are considered business income or income from a profit-making activity when they are a financial product of the business or profit-making activity.
In other words, if the gift is intended to support or enhance the business activity being carried on it will be taxable. This is consistent with fundamental principles in the ITA that tax income is derived from a business (section CB 1) and from carrying on a profit-making undertaking or scheme (section CB 3).
It is also consistent with relevant case law which has held that gifts and other voluntary payments can be income for taxation purposes, despite the voluntary nature of the payment.
What is key for a gift received by a business is the reason it was made. If the payer of the gift has an interest in the continuity of the business in question and wants to assist it, then this will lead to a conclusion that the gift is taxable as there is a direct link between the reason the gift is being made and the continuance of the business activity.
Businesses and income-earning activities inherently exist to make a taxable profit. This differs from charitable organisations or activities carried on for personal or other non-income-earning purposes.
So, it stands to reason that gifts received by a business will often be made to further its profit-making activity and therefore it is appropriate to tax them.
But IR recognises this will not always be the case and has listed in the statement several factors that will be indicative of a gift not being taxable to a business. These include:
- the gift being unexpected or unsolicited;
- the gift being made in respect of past services that have been fully remunerated already;
- the business had ended at the time of the gift;
- the calculation of the gift is not linked to trading between the parties; and
- the parties undertake no correspondence, bargaining or negotiations with each other.
So, for a gift to be non-taxable to a business, it needs to be unexpected, unsolicited and have no clear connection with the business activity being carried on.
An example might be an unexpected gift from a philanthropic donor who has an interest in the nature of the business but who otherwise has no relationship with it.
Also relevant is whether the business or income-making activity is carried on by an individual. Where this is the case, it may be easier to establish that the gift is being made out of natural love and affection, or perhaps esteem or respect for that individual, as compared to a gift made to a company owned by a number of shareholders.
All of this means that businesses in the fortunate position of receiving a gift must carefully consider all the facts surrounding receipt of the gift to establish why it was made and whether this will cause it to be treated as taxable.
It is more surprising that gifts made in connection with voluntary activities can also be taxable. This is, however, clearly contemplated in section CO 1 of the ITA which deems an amount derived by a person to be taxable income unless the payment is reimbursing a volunteer for expenditure incurred by him or her in undertaking the activity.
Under section CO 1, a gift is taxable to the recipient if the gift and the recipient have a sufficient connection. In Inland Revenue’s view, factors such as the following will indicate this sufficient connection exists:
- the amount of the gift is commensurate with the recipient’s personal exertions in undertaking the voluntary activity;
- the gift is made in the hope that the recipient will undertake future activities;
- the gift has recurred or is likely to recur; and
- gifts are commonplace and/or expected in undertaking the type of voluntary activity in question.
So, if there are factors that indicate that the payment is not in substance a gift, but more in the nature of compensation for effort or an attempt to encourage future effort, it is treated as income. This is on the basis that it is compensating a person for their activities and therefore has an income flavour to it.
Conversely, if a gift is clearly made on the basis of personal goodwill and is received when the voluntary activity is not being undertaken, then this will be indicative that it is not taxable as it is not linked to the performance of any activity.
New Zealand has a strong culture of volunteering and numerous organisations exist that rely on the efforts of volunteers to function. While small gifts to volunteers to express appreciation and thanks are not taxable, care must be taken if they become regular and linked to the amount of effort that a volunteer has put in, to ensure such payments are not viewed as taxable compensation for services.
Gifts that are income under ordinary concepts
The final category of taxable gifts covered by the statement is gifts that are income under ordinary concepts, under section CA 1(2) of the ITA. This sub-section is a catch-all that generally applies only if another specific section of Part C does not apply to deem an amount as income.
“Income under ordinary concepts” is not defined in the ITA and is interpreted in accordance with case law. The statement notes the following features will indicate a gift is income under ordinary concepts:
- The series of gifts fulfils the notion of an “income”. That is, the gifts have the necessary periodicity and the payer makes them for the recipient to rely upon or intends the recipient to rely on them for regular living expenses and they are so relied upon by the recipient.
- The necessary periodicity of the payments refers to payments made with such regularity, recurrence, amount and frequency that they amount to an “income”.
- The payments are periodic and made with the intention of providing an income when they began (or this has been established over time) to the extent that the recipient could reasonably have expected to rely on the payments for his or her living costs.
- The recipient relies on the payments for financial support.
- The payments are connected with some activity or personal exertion of the recipient, even though that exertion or activity does not necessarily arise in the context of an employment relationship (past, present or future) and does not amount to a business or a profit-making activity.
The statement is 59 pages long and contains comprehensive legislative and case law analysis.
While the taxation of gifts might seem straightforward, there can clearly be many pitfalls if a gift extends beyond a true voluntary payment into something that may be construed as a reward for service (either as an employee or volunteer) or is intended to assist the income-earning activities of a business.
As with any tax issue, the devil is always in the detail and a clear understanding of all facts and circumstances is needed to determine the correct tax treatment.
Bruce Bernacchi is a partner and Daniel McLaughlin is a senior associate at Dentons Kensington Swan