Active vs Passive Income
The test for whether or not income is 'passive' is whether the income derived by the person is
dependent on the person's 'personal exertions'.
There have been a number of cases that have considered the definition of ‘personal exertion’. The
judgements of Hadlee v CIR [1989] 2 NZLR 447 and Caverhill v ARCIC (AP93/97) confirm that
“personal exertion” is not restricted to “physical exertion”.
The interpretation of “personal exertion”, adopted by ACC, is intended to cover all possibilities where
the income of a self-employed person would cease, but for their continued personal exertion, whether
by physical or mental means. From an ‘entitlement’ perspective this is important because any form of
compensation would be based on earnings not otherwise derived by a self-employed person. From a
‘collection’ perspective the definition is important because the self-employed person would only be
liable on earnings otherwise derived.
‘Physical exertion’ can be interpreted as the exercise of ‘physical effort’ by a self-employed person
that contributes to, or otherwise maintains, their level of income. ‘Mental exertion’ on the other hand
can be considered to be the ‘mental effort’ of a self-employed person that contributes to, or otherwise
maintains, their level of income. E.g. Day to day decision making in relation to management,
administration of a business would generally be caught under the ‘metal effort’ test of personal
exertion.
Personal exertion does not necessarily involve manual or physical labour; exertion by the sweat of
the brow. Input or contribution to a business enterprise may be to management, administration,
planning, strategy, structuring, etc, are envisaged by the term. Caverhill v ARCIC.
The exercise of physical or mental effort by a self-employed person that contributes to, or otherwise
maintains, their level of income.
a. Has the self-employed person exercised ‘physical effort’?
b. Has the self-employed person exercised ‘mental effort’?
c. To what extent does the effort of ‘a’ or ‘b’ contribute to, or otherwise maintain the selfemployed persons level of income? There should be a clear connection between the effort and
income derived by the self-employed person.
d. But for the effort would the income cease?
i. Identify what effort contributes to or maintains the self-employed person’s income?
ii. Would the income continue in the absence of the effort of the self-employed person?
There is no ‘black and white’ test to determine if income is the result of personal exertions. The principles
demonstrated by the above cases show that each case must be considered on its merits. In some
circumstances a type of income will be liable and in another circumstances it will not be.
So if a self-employed person declares income from a rental property that is fully managed by a
property management company, and the only involvement the self-employed person has with the
property is to appoint the property manager, all other activities in relation to the property are carried
out by the property manager. The income from the property would continue even if the self-employed
person were incapacitated.
The nature of the income in the scenario above is ‘investment’ – in other words, other than setting up
effort no effort is required by the investor to earn the income.
However, if there is no property manager, ACC considers that rental income liable for levies.
If you believe that the income records are incorrect, you should re-file the tax return. If an individual returns
rental income correctly on their return, that income does not attract ACC levies as the rental income box
details are not transferred to ACC. The same applies with partnership income derived from rents, investments
or overseas income. If this income is declared in the partnership income box it will be levied. If it is declared in
the other income box it will not attract levies.