1 March 2026
In situations where PAYE has been deducted from wages but not paid to Inland Revenue, directors and associated persons of close companies may face unexpected personal tax consequences. Inland Revenue has the ability under Section LB 1(3) of the Income Tax Act 2007 to reassess an individual’s tax return and limit their PAYE tax credits to the amount actually received by the Commissioner. Given the number of liquidations we manage where PAYE arrears are present, it is important that directors understand this rule. The article below explains how the section operates and why Inland Revenue may invoke it.
Section LB 1(3) — Income Tax Act 2007
We want to take this opportunity to draw your attention to a lesser‑known or used section of the Income Tax Act 2007 (ITA 2007) that we have seen applied by the Inland Revenue (IRD) in some recent liquidations. The section, however, can be used in other situations when PAYE has not been paid to the IRD by an employer.
We think it is important that directors and advisors are aware of this section where directors and/or associated persons are being paid on the payroll of a close company(1) (all or part of their remuneration) and having PAYE deducted, that when the employer does not pay (or is contemplating not paying) the PAYE to the IRD.
Section LB 1(2) of the ITA 2007 allows a tax credit for the tax year equal to the amount of tax withheld from a PAYE income payment of a person who is an employee.
Section LB 1(3) of the ITA 2007 limits this credit to the amount of tax paid by the employer to the Inland Revenue if certain conditions are met.
This section allows the IRD to reassess the income tax return of a director or shareholder if the amount of the tax credit is more than the amount of tax paid to the Commissioner if
(a) the employer is a close company(1); and
(b) the employer and the person are associated persons, or the employer and the spouse, civil union partner, or de facto partner of the person are associated persons; and
(c) the employer withheld the amount of tax for the PAYE income payment shown in their employment income information.
In a liquidation, this section is not something the Liquidator has any control over as it impacts the individual taxpayer and relates to events before the Liquidation. This is a section the IRD can apply at its discretion to the individual taxpayer.
A Simple Example
A is a director/employee who has been paid $150,000 during a tax year and $42,414 tax had been reported as PAYE deducted at source through Payday filing.
The company still owes $20,000 of this amount in unpaid PAYE.
The IRD can reassess A’s tax return to reflect only the $20,000 having been paid against their earnings, making them personally liable for the shortfall in tax due.
While Section LB 1(3) is technical in nature, its impact can be significant for directors and associated persons when PAYE has been withheld but not paid. Importantly, this is a matter that Inland Revenue deals with directly with the taxpayer and sits outside the liquidator’s control. Directors and advisors should therefore be mindful of PAYE arrears as they arise, as the consequences can extend beyond the company and into an individual’s personal tax obligations.
Definition
(1) Close company:
A company that has five or fewer natural persons (associated persons counted as one) who either hold voting interests, or hold market value interests in the company of more than 50%.
Reference
Section LB1 of the Income Tax Act 2007 can be found at:
https://www.legislation.govt.nz/act/public/2007/0097/latest/DLM1517915.html