Income Splitting - Why Is It Closely Scrutinised?

A question arises about the nature of a payment made to a business for personal services rendered by an employee. This is especially when the arrangement is viewed as income splitting to avoid higher taxes. Splitting income is a practice aimed at avoiding higher income tax rates by sharing the income paid for the personal efforts and skills of a taxpayer with another associate or family member.

Income splitting is a tactic used to avoid high income tax rates by distributing the income paid for the personal efforts and skills of a taxpayer with another person who did not contribute reasonable effort to earn that income. The concept usually applies to personal services income.

Income splitting is prohibited under the general anti-avoidance provisions of Part IVA of the Income Tax Law. In many instances, the ATO and courts considered an arrangement as income splitting when the scheme is entered into for the primary purpose of receiving a tax benefit. If your business structure is found using this scheme, you may have to pay all of the back taxes and face heavy penalties.

Examples:

Arrangements where personal services income is paid to your business and taxed at a lower rate than if you had received the income yourself.
If you split personal services income with an associated person or with another entity associated with you, and your associate did not perform genuine services to earn it.
When you use a family trust or company to split personal services income with family members like your spouse.

To avoid penalties for income splitting, if you want to operate a partnership or pay salaries to family members, your arrangements should have commercial basis and not be intended primarily to obtain a tax advantage.