Excessive Payments for Services or Benefits
11.34. A common method of income-splitting is the payment by one relative to another of sums for services rendered or in respect of some benefit received and the amount of the payment exceeds what would normally, in an arm's length transaction, be expected to be paid for those services or that benefit. Payments of this kind are encountered in the relationship of employer and employee, hire of equipment, rent of premises and interest on money lent. Partnerships and private companies are areas frequently used for this purpose. The relationship of the person performing the services or affording the benefit to the person making the payment would, if the quantum of the payment were reasonably commensurate with the nature of the services or benefit, be an irrelevant consideration and the payment would be an allowable deduction under section 51 of the Act as an outgoing in gaining or producing the assessable income of the relative making the payment. Section 65 of the Act provides that a payment to an ‘associated person’ or a liability incurred to make such a payment shall be allowable as a deduction only to the extent to which, in the opinion of the Commissioner, it is reasonable. Section 65, broadly speaking, defines an ‘associated person’ as including relatives (as defined in section 6 (1)) of a taxpayer, partnerships in which relatives are involved, and relatives of partners in a partnership making a payment, as well as members of a company and beneficiaries in a trust, and relatives of these people, where a company or a trust is a partner. Provisions are included in the section to cover the position of the recipient of a disallowed payment and also to cover an amount not allowable as a deduction in a partnership in which a private company is a partner. These are of some unavoidable complexity.
11.35. Section 109 of the Act is designed to prevent income-splitting by a private company where excessive payments are made or credited to persons who are or have been its shareholders or directors or their relatives for services rendered or by way of an allowance, gratuity or compensation upon retirement from or termination of office or employment. The amount allowable as a deduction shall not exceed an amount which, in the opinion of the Commissioner, is reasonable.
11.36. The Committee is of the opinion that the principles of sections 65 and 109 are to be supported but that, as they now stand, these sections are not sufficiently wide in their coverage. There are basically four types of taxation entities that need to be considered in the context of income-splitting by the means envisaged in sections 65 and 109: an individual taxpayer, a partnership, a trust estate and a private company. The Committee recommends that the principles of sections 65 and 109 should apply to all payments flowing from any one of these entities to another entity in such circumstances that the payment, or part of the payment, can enure directly or indirectly for the benefit of the payer or a member or director of the payer or for the benefit of a relative of such a payer or member or director of a payer. For this purpose a settlor or deemed settlor and a beneficiary of a trust estate are to be included in the term ‘member’ in relation to a trust estate of which they are a settlor, deemed settlor or beneficiary.