Shareholder salary, dividend and LTC election
Rimu Engineering Ltd has two 50/50 shareholders. Aroha works 45 hours a week as general manager and runs operations. Ben is a passive investor and does not work in the business. Profit before shareholder salary and tax is $260,000. Aroha proposes a shareholder salary of $110,000 to herself and no salary to Ben; Ben wants the remaining profit paid as a dividend. The company has no losses to carry forward. Both brothers are on the top 39% marginal rate. They are considering electing into the look-through company (LTC) regime next year. The company has three employees and pays ACC levies on their salaries. Aroha's market salary for a general manager is about $105,000–$120,000. Ben has no intention of working in the business.
1. Is the proposed $110,000 shareholder salary deductible? What constraints apply?
Read the worked answer
The salary is deductible if it is paid or payable for services actually provided by Aroha and is reasonable in amount. Aroha works full-time as general manager, and $110,000 is within the market range of $105,000–$120,000, so the amount is likely reasonable. The company must actually record the salary, account for PAYE and ACC, and treat it as a shareholder-employee salary. The main risk is an excessive salary: if Inland Revenue considers part of the salary is not commensurate with Aroha's services, it can recharacterise the excess as a dividend. The company should document Aroha's duties, hours and the market benchmark. Ben cannot receive a deductible salary for no services.
2. Compare the company tax, dividend and LTC outcomes, and advise whether the LTC election solves the brothers' problem.
Read the worked answer
With Aroha's salary, company profit is $260,000 − $110,000 = $150,000. Company tax at 28% is $42,000, leaving $108,000. If that is distributed as a dividend, it carries imputation credits. Because both shareholders are on 39%, they face a 5% top-up on the grossed-up dividend. The salary itself is taxed at Aroha's marginal rates and attracts ACC. Without a salary, company tax would be $260,000 × 28% = $72,800, leaving $187,200 for dividends, with the same 39% top-up. An LTC election means the company's income is allocated to owners in proportion to their ownership interests, generally 50/50, regardless of who works in the business. That would give Ben 50% of the income even though he is passive. The LTC removes company-level tax but not the 39% personal rate, and it may not match the commercial arrangement. The LTC is therefore not a complete solution.
3. What PAYE and ACC issues should the company manage?
Read the worked answer
Aroha's shareholder salary must be processed through the payroll. The company should deduct PAYE using the appropriate tax code, account for ACC earners' levy, and include the salary in the company's ACC liable earnings. If the salary is paid regularly, the company must withhold PAYE. If it is not regular, shareholder-employee rules may allow an election not to withhold, but the company should confirm the position and still return the income. Ben receives no salary, so no PAYE or ACC applies to him. The company should keep employment records and ensure the salary is actually paid or credited before year-end.