Tax Avoidance And The Supreme Court - Waiting For ... - SSRN papers

1

Tax Avoidance And The Supreme Court - Waiting For Godot?

CRAIG ELLIFFE Professor of Taxation Law and Policy University of Auckland, Business School and Partner, Chapman Tripp

Waiting for Godot is the play by Samuel Beckett, in which the characters wait for someone named Godot, who never arrives. Godot's absence, as well as other aspects of the play, has been interpreted in many different ways since the play's premiere. The play follows two consecutive days in the lives of a pair of men who divert themselves while they wait expectantly (and endlessly) for Godot. They claim Godot to be an acquaintance but in fact hardly know him, admitting they would not recognize him if they saw him. To occupy themselves they eat, sleep, talk, argue, sing, play games, exercise, swap hats, and contemplate suicide — anything “to hold the terrible silence at bay”.1

Last year the New Zealand Court of Appeal decided three significant2 cases concerning the application of the anti-avoidance provisions in the Income Tax Act and the Goods and Services Tax Act (the GST Act). These were Ch’elle Properties (NZ) Ltd v Commissioner of Inland Revenue,3 Accent Management Ltd & Ors v Commissioner of Inland Revenue,4 and Glenharrow Holdings Ltd v Commissioner of Inland Revenue.5 In each case the Commissioner was successful in asserting that the taxpayer’s anticipated tax consequences should be overturned by the

1

See further the description in Wikipedia.

2

Noting that there were additional Court of Appeal decisions concerning tax avoidance in a series of “Russell Template” transactions in Wire Supplies Limited v Commissioner of Inland Revenue [2007] 3 NZLR 458; (2007) 23 NZTC 21,404, and Ron West Motors (Otahuhu) Ltd v Commissioner of Inland Revenue (2007) 23 NZTC 21,434.

3

Ch’elle Properties (NZ) Ltd v Commissioner of Inland Revenue [2008] 2 NZLR 342; (2007) 23 NZTC 21,442.

4

Accent Management Ltd v Commissioner of Inland Revenue (2007) 23 NZTC 21,323.

5

Glenharrow Holdings Ltd v Commissioner of Inland Revenue [2008] 1 NZLR 222; (2007) 23 NZTC 21,564.

Tax Avoidance -Waiting for Godot

Electronic copy available at: http://ssrn.com/abstract=1553446

2

general anti-avoidance rules in either section 76 of the GST Act or in section BG 1 (the section reference is the same in both the 2004 and 2007 Income Tax Acts). Various reconstruction scenarios were suggested by the Commissioner, and effected by the Courts. Both the Accent Management decision and the Glenharrow case have been appealed. The Supreme Court has heard the Accent Management appeal in June 2008, whilst Glenharrow was held in early July. Neither decision is expected for several months. The approach of the Supreme Court to the arguments advanced by the taxpayers, and indeed the Commissioner, will be of huge interest to taxpayers and their advisors alike. The purpose of this paper is to examine these cases and, in the light of the Privy Council’s decision in Peterson v Commissioner of Inland Revenue,6 speculate on the likely approach of the Supreme Court. All three cases were apparently, in the view of the Court of Appeal, as significantly across the line of tax avoidance as a particular English rugby journalist maintains is Richie McCaw’s propensity to be offside at the breakdown. Historically, the position of New Zealand Courts has broadly been to focus on transactions, and to have significant regard to their legal form. Possibly because of the absence of commerciality or the presence of non-market features, the Court in the recent cases has seemingly had little hesitation in looking closely at the substance and true commercial nature of the transaction, rather than its form. If a substance over form approach is adopted in the Supreme Court, and this is likely in the view of the writer, then quite a significant change in the approach taken to the assessment of tax avoidance by the New Zealand Courts is imminent, particularly with transactions that have significant non-commercial or non-market features.

There are of course many different types of tax provisions. There are those that are designed to convey a certain tax benefit. For example they may permit a

6

[2006] 3 NZLR 433; (2005) 22 NZTC 19,098 (PC).


Electronic copy available at: http://ssrn.com/abstract=1553446

3 7

deduction for the unsuccessful exploration for a “specified mineral” when such expenditure would ordinarily be a capital expense and non-deductible. In this case to claim a deduction for such exploration is consistent with the legislative intent. As William Young P said in the Court of Appeal’s decision in Accent Management:8

“Behaviour of that type (being the sort of behaviour which was within the contemplation

of

the

legislature)

cannot

be

within

the

general

anti-avoidance provisions because the overall legislative purpose is that such behaviour should attract the tax consequences provided for by Parliament”.

There are also times when the specific tax rules relied upon are not intended to convey the tax benefit that the taxpayer seeks. The case may be able to be decided by construing the specific tax rules so as to accord with legislative intent and without the need to resort to the general anti-avoidance provisions.9 There are many examples of such cases.10

The general anti-avoidance rules are required to be kept in mind when construing specific tax rules and looking for their scheme and purpose.11 In particular when looking at the relationship between the general anti-avoidance rule and specific tax rules, there are three key assumptions12:

7

Section YA 1 and section CU 28 of the Income Tax Act 2007.

8

Accent Management Ltd v Commissioner of Inland Revenue (2007) 23 NZTC 21,323, at [125].

9

Ibid, at [125].

10

For instance, the Deed of Assignment by a partner of part of his share in the partnership was ineffective to transfer the tax liability in respect of the income earned to the assignee. Hadlee and Sydney Bridge Nominees Ltd v Commissioner of Inland Revenue [1993] 2 NZLR 385; (1993) 15 NZTC 10,106 (PC).

11

Accent Management Ltd v Commissioner of Inland Revenue (2007) 23 NZTC 21,323, at [126].

12

Ibid, at [126].


4

(a)

Deductibility rules should only be invoked by those who engage in business for the purpose of making a profit13;

(b)

Specific tax rules on deductibility should be invoked only in relation to the incurring of real economic consequences; and

(c)

Deductions should not come within the specific tax rules by means of contrivance or pretence.

Establishing the Business Purpose Before looking at the central theme of this paper, which is how the absence of commerciality (or the existence of non-market transactions) influenced the Court of Appeal in its examination of economic burden and the legal purpose of expenditure (paragraph (b) above), it is worthwhile noting that an absence of business purpose can be fatal to a taxpayer’s case in an attempt to prevent the application of the anti-avoidance rules14.

In many respects the three Court of Appeal cases last year are not terribly good examples of “the line between legitimate tax planning and improper tax avoidance” that was described by Richardson P in the majority decision of Commissioner of Inland Revenue v BNZ Investments Ltd.15 This is because there was significant judicial incredulity in respect of whether the arrangements entered into by the taxpayers were for genuine business purposes.16

13

The absence of a genuine profit making purpose is likely to lead the Court to a conclusion that tax avoidance is the purpose of the arrangement.

14

What seems less clear but is certainly tenable is whether the presence of a genuine business purpose will mean that the general anti-avoidance provisions cannot be invoked unless there are features of circularity, artificiality or contrivance that frustrate the scheme and purpose of the Income Tax Act 2007.

15

Commissioner of Inland Revenue v BNZ Investments Ltd [2002] 1 NZLR 450; (2001) 20 NZTC 17,103, at [39].

16

Although it should be noted that the position in Glenharrow Holdings Ltd v Commissioner of Inland Revenue [2008] 1 NZLR 222,at [161] is different as evidenced by the dissenting (on this point) judgment of Chambers J, at [161] reflecting that Chisholm J’s finding of fact in the


5

Under section BG 1 a tax avoidance arrangement is void as against the Commissioner for income tax purposes. Within the definition of “tax avoidance arrangement17” is the requirement that if the arrangement has tax avoidance as one of its purposes or effects then such an arrangement will be caught by the provision unless that tax avoidance is a merely incidental purpose or effect.

In Accent Management there was an arrangement that allowed taxpayers to take large, upfront deductions for expenditure that would be paid (in a cash sense) in much later tax years (2047 and 2048). In 1998, for example, the taxpayers claimed approximately $41,000 per hectare for depreciation on the licence premium (ie 1/50th of the $2,050,518 per plantable hectare due in 2048), whilst the actual cash expenditure incurred in that tax year was $50 per plantable hectare.

In the High Court18 Venning J had come rather forcefully to the conclusion that:

“The evidence leads me to conclude that tax avoidance was more than incidental and rather, was the dominant purpose of the Trinity scheme for the following reasons.”

Venning J then set out numerous evidential and factual observations (the writer counts 17 in total in paragraphs [307] through to [323] of Venning J’s judgment)19 which are indicia of tax avoidance. In the Court of Appeal, William Young P concluded:20

High Court (2005) 22 NZTC 19,319 was that the agreement was genuine and was to be implemented according to its terms. 17

Section YA 1 of the Income Tax Act 2007.

18

(2005) 22 NZTC 19,027, at [306].

19

(2007) 23 NZTC 31,323, at [307]–[323].

20

(2007) 23 NZTC 31,323 at [141].


6

“It is clear that the real purpose of the arrangement is not the conduct of a forestry business for profit, but rather generation of rather spectacular tax benefits.

The end result (ie the profitability or otherwise of the venture)

was never seen as being material. The corollary of this statement was that there was never a “real” purpose of making a profit from the harvesting of trees.”

Additionally a statement in the business plan of CSI Insurance Group (BVI) Ltd which Venning J attributed to Dr Muir, the architect of the Trinity scheme, was hugely damaging, indicating the real purpose of the transaction.21 The business plan said:

“The real benefits of the deal are tax concessions that can be obtained now by the investors and the Foundation. One of the conditions required to gain the tax relief is that the insurance must be in place. The actual outcome of the deal in 50 years’ time is not considered material”.

The Court of Appeal placed great reliance upon this statement as it clearly demonstrated what the parties really intended to achieve as a result of the arrangements.

There is a certain irony that the highlighted “smoking gun” in the Commissioner’s evidence was a statement of subjective view attributable to Dr Muir when, as Robertson J in Ch’elle Properties Ltd in the Court of Appeal reflected:22

“It is the objective assessment of the arrangement which will provide the answer as to whether it defeats the intention and application of the Act and is therefore void”.

21

Ibid, at [142].

22

(2007) 23 NZTC 21,442, at [25].


7

The Judge

went on to cite Commissioner of Inland Revenue v Challenge

Corporation23 and said:

“I am satisfied as well that the issue … is something to be decided, not subjectively in terms of motive, but objectively by reference to the arrangement itself”.

This must have been a delightful (and somewhat rare) find for the Commissioner as it no doubt confirmed his worse suspicions. Notwithstanding the damaging evidence of subjective purpose behind the statement, it is highly likely that the other factual matters would have been viewed by the Court of Appeal as all amounting to objective evidence that a more than merely incidental purpose of tax avoidance existed in the Trinity arrangements.

Presumably it is not every day that the Commissioner finds a clear statement supporting his suspicion that the arrangement is designed for a dominant purpose of tax avoidance. It is much more likely that it will be the non-commercial aspects of the transaction which, on an objective view, will lead a Court to conclude that tax avoidance was a more than merely incidental purpose.

Analysing the non-commercial or non-market aspect of the arrangement So what is it about the recent three cases discussed in this article that caused the Court of Appeal to conclude that the schemes were across the “line” referred to by Richardson P in BNZ Investments?

24

A tax avoidance purpose was evidenced by

non-commercial or non-market features of the arrangements. aspect of the transactions could be listed as follows:

23

(1986) 8 NZTC 5,001, at p 5,006.

24

See footnote 13.


The non-market

8

A. Accent Management: the structure “made no commercial sense at all”:

25

(a)

the taxpayers effectively provided all the funding to acquire the land;

(b)

they then paid an additional $2 million per plantable hectare to use the land, the purchase of which they had funded;

(c)

the option to acquire the land in 50 years’ time for half its value did not “balance the ledger”;

(d)

the prospects of profit were remote;

(e)

given the interrelationships between the parties, and the circularity of funds, the insurance arrangements offered no substantial risk reduction and so “the insurance arrangements likewise make no commercial sense26”;

(f)

the “apparent obligation” incurred by the taxpayers is “of no real significance to those who have incurred them27”. The individuals behind the companies could simply walk away from the liabilities.

B. Glenharrow: tax avoidance was found to have existed on the basis of “a grossly inflated valuation28” in circumstances where an unregistered vendor sold to a registered purchaser (who sought to claim the input tax as a credit) with the purchase price lent to the purchaser by the vendor with only a conditional obligation to repay the loan.

The Court found:

25

(2007) 23 NZTC 31,323, at [143].

26

Ibid, at [143].

27

Ibid, at [143].

28

[2008] 1 NZLR 222.


9

(a)

A special rule for non-market transactions implies that such transactions can frustrate the scheme of the GST Act.29

(b)

The Judge in the High Court was entitled to conclude that although Mark Meates (the vendor) was not involved in any sham, his valuation of $45 million for the mining licence was grossly inflated30, particularly as it had been acquired by Mr Meates for $10,000 on a handshake.

(c)

The remaining term of the licence was 3.3 years although it was not clear whether this could be extended.

C. Ch’elle Properties Ld: the case is similar to Glenharrow; a mismatch in GST resulting in substantial GST refunds arising from a scheme where 114 special purpose companies were incorporated to purchase land (on a payments basis) and on-sold to a single purchaser (Ch’elle Properties Ld) whichwas registered for GST on an invoice basis. The shareholder of Ch’elle Properties was a person who had a “social … relationship” with the beneficial owner of the vendor companies, but she had no “relevant business experience and no resources capable of meeting the financial obligations undertaken31”.

The Court held:

(a)

“The invoices issued by the 114 companies were not going to be repaid for 10 to 20 years”32 (and consequently no output tax was payable) where the taxpayer was immediately entitled to input tax;

29

Ibid, at [78].

30

Ibid, at [80].

31

[2004] 3 NZLR 274; (2004) 21 NZTC 18,618, at [24] (HC).

32

[2008] 1 NZLR 222, at[1] (CA).


10

(b)

The proliferation of companies had no rationale or utility beyond the mechanism to exploit a tax advantage by coming under the $1 million threshold.

In each instance in the above decisions, the Commissioner has been able to look at normal or traditional commercial practice and to point to features in these arrangements

which

he

would

regard

as

commercially

unnecessary

and

inexplicable from a business perspective.

In such circumstances he has then been able to assert successfully that the reason why these non-market features were present in the case was because of the artificial nature of the transaction and the way in which it was designed to ensure a tax advantage was available to one or other of the taxpayers.

In the absence of a clear statement of a purpose to avoid tax, the artificiality or non-commercial nature of the transactions are most likely to be the indicia of the “more than merely incidental tax avoidance purposes” for which the arrangements are entered into.

Economic burden and the legal purpose of the expenditure In the Court of Appeal in Accent Management William Young P, O’Regan and Robertson JJ provide a significant examination of both the Privy Council’s majority and minority’s judgments in Peterson in both a qualitative and quantitative sense. It is beyond the scope of this paper to fully explain the role of the principle in Cecil Bros Pty Ltd v Federal Commissioner of Taxation,33 and Europa Oil (NZ) Ltd v Commissioner of Inland Revenue.34

However, these authorities stand for the

proposition that if a taxpayer makes a payment, even if it is more than the market price, then the consideration actually paid should be ascribed as the legal benefit

33

(1964) 111 CLR 430.

34

[1976] 1 NZLR 546.


11

obtained. This is neatly captured in the oft cited statement that “it is not for the Court or for the Commissioner to say how much a taxpayer ought to spend in obtaining his income”. 35

The Peterson case concerned investors who put their own funds (say $10,000) into the film (called amount X) as well as funds they borrowed (again say $10,000) (called amount Y) under non-recourse loans. These combined amounts X and Y were used to acquire the film. In the Peterson decision, the Privy Council decided that the taxpayer must win because the Commissioner had conceded that the taxpayers had paid the full amount (X + Y) for the making of the film.36 The Commissioner argued that of the taxpayer’s total payment (the combined X + Y amount), only the amount they contributed (the X) was actually suffered as an economic cost of payment for the purchase of the film. But, in the process of arguing the case, the Commissioner conceded that it was the full amount (X + Y) that was paid as consideration for the making of the film.

Commentators such as Professor Prebble in his article “The Peterson Case and its impact on the Rules in BNZ Investments Ltd and Cecil Bros”37 would say that this concession by the Commissioner was in fact a Trojan horse to the whole tax avoidance battlefield in that case. Their Lordships went on to comment as follows:38

”If the Commissioner had shown that the features upon which he relied, singly or in combination, had the effect that the investors, while purporting to incur a liability to pay X + Y to acquire the film, had not suffered the economic burden of such expenditure before tax which Parliament intended

35

Ronpibon Tin NL and Tongka Compound NL v Federal Comissioner of Taxation (1949) 78 CLR 47,60, per Dixon J.

36

[2006] 3 NZLR 433,at [46].

37

Taxation Issues in the Twenty-First Century (2006) at page 117 Sawyer (Editor).

38

[2006] 3 NZLR 433, at [42].


12

them to qualify for a depreciation allowance, then he could invoke section 99 to disallow the deduction.”

Had the Commissioner put forward evidence to show that the Y component of this purchase price was not actually economically being borne by the investors in the purchase of the film, then he would have been successful in his attempt to use the anti-avoidance rules.

Their Lordships spelt it out for the Commissioner. He needed to obtain a finding that the loans made under the non-recourse basis were made on uncommercial terms such that no commercial lender would advance money unless it received some additional consideration for doing so.

Additionally, their Lordships suggested that the Y component received by the production company needed to be examined with greater scrutiny:39

“The production company paid the money away immediately it was received. The payment is not recorded in the production company’s books, has never been explained and appears to have been made without consideration.

Such a payment would normally be improper.

It is more

likely that it was properly made but for a consideration which was considered impolitic to disclose.

The Commissioner could plausibly invite

the TRA to infer that the production company agreed to recycle the money to the lender in order to procure it to make the loan to the taxpayers. But he never did so and the TRA made no such finding in either case”.

Had the Commissioner had this finding of fact, their Lordships would have been happy to conclude that the taxpayer could not rely on the legal benefit test in Cecil Bros but that instead it would have concluded:40

39

Ibid, at [49].


13

“that the investors paid the production company X + Y not merely as consideration for the acquisition of the film but also for its services in procuring the lender to make the loan to them”.

Has the Peterson Decision Influenced the Court of Appeal? In Accent Management the Court of Appeal, applying the Privy Council’s pre-tax economic burden test, concluded that:41

“the licence fee which is payable is not a cost of the kind contemplated by the depreciation provisions relied on; this is because of the essentially voluntary nature of the apparent [sic] obligation to pay the fee. The taxpayers have not suffered the pre-tax economic burden (as opposed to a technical legal liability) which Parliament intended as a pre-condition of deductibility, cf Peterson at [43] and the remarks of Lord Nolan in Willoughby

42

”.

Earlier when setting out the broad approach on section BG 1 of the Court of Appeal, William Young P stated:43

“When construing such specific rules and looking for their scheme and purpose, it is necessary to keep general anti-avoidance provisions steadily in mind. On this basis, it will usually be safer to infer that specific tax rules as to deductibility are premised on the assumption that they should only be invoked in relation to the incurring of real economic consequences of the type contemplated by the legislature when the rules were enacted”.

40

Ibid, at [50].

41

Ibid, at [144 (c)] .

42

Commissioner of Inland Revenue v Willoughby (1997) 70 TC 57, at p 116.

43

Ibid, at [126] CA.


14

In Ch’elle Properties (NZ) Ltd both the High Court and the Court of Appeal concluded that the arrangement defeated the intention of the application of the GST Act and was contrary to section 76 of that Act, because the invoices issued by the 114 companies were not going to be paid for 10-20 years (and consequently no output tax was payable in the immediate future) whereas the taxpayer was immediately entitled to input tax credits for the purchase of the properties.

Although the owner of the 114 companies was not, strictly speaking, associated44 to the owner of the purchaser Ch’elle, there was suspicion that the transaction was artificial, given that the owner of Ch’elle was a friend of the vendor shareholder’s former wife and Ch’elle’s owner had no commercial experience or expertise relative to property trading. The Court of Appeal, with Robertson J giving the judgment on behalf of Chambers, Robertson and Ellen France JJ held:45

“The wider the temporal gap between the taxpayer’s eligibility for an input tax credit and its liability for output tax, the less likely the arrangement conforms with the intent of the Act. We do not suggest the Act intends that there be no delay but that significant delay can indicate a crossing of the line into tax avoidance.

“We endorse the finding of Rodney Hansen J (at [47]) but in the circumstances of this case the balance between outputs and inputs is grossly distorted by the gap of 10 and 20 years between Ch’elle receiving an input credit and the time at which liability might arise for output tax on Ch’elle’s taxable supply. The 10-20 year delay in all the circumstances defeats the intent of the Act and accordingly triggers section 76”.

44

Section 2A of the Goods and Services Tax Act 1985.

45

Ch’elle Properties Limited [2008] 2 NZLR 342, at [41].


15

Notwithstanding that it is clear that the legal burden assumed under the purchase was the acquisition of the properties, this case could be analysed under a Peterson type approach. The effect of doing so would be that the extended terms of settlement were such that the economic burden of payment for the properties simply did not arise or would not arise in the foreseeable future in the same way as the obligation to pay the licence premiums in Accent Management would not arise until the expiry of the 50 year period.

The majority decision (Robertson and Ellen France JJ) in Glenharrow in the Court of Appeal can be similarly viewed. Although the mining licence was sold for the princely sum of $45 million, the transaction involved only a cash deposit of $80,000 and vendor finance for the balance, initially with interest after two years at 10% per annum but ultimately with interest as and when demanded. Glenharrow of course claimed an input tax GST refund based upon the acquisition price of $45 million but this was refused by the Commissioner, allowing instead only an input tax credit on the amount actually expended in cash being the $80,000. The majority in the Court of Appeal (the same panel of the Court as in the Ch’elle decision) concluded that the arrangement constituted tax avoidance because in economic terms the arrangement was only a conditional obligation to repay the loan and there was no definitive commitment to repay irrespective of the success or failure of the venture.46

The majority had no difficulty in supporting Chisholm J’s findings that the transaction was not a sham, and nor was the provision of vendor finance anything other than bona fide.47

Nonetheless, the majority followed down the now well-

trodden path of Peterson, Accent Management and Ch’elle, making reference to

46

Glenharrow Holdings Ltd v Commissioner of Inland Revenue [2008] 1 NZLR 222, at [81] per Robertson J.

47

Ibid, at [163].


16

the words of Lord Nolan in Commissioner of Inland Revenue v Willoughby as follows:48

“The hallmark of tax avoidance is that the taxpayer reduces his liability to tax without incurring the economic consequences that Parliament intended to be suffered by any taxpayer qualifying for such reduction in his tax liability”.

The majority held:49

“Chisholm J was not wrong to find tax avoidance on the basis of a grossly inflated

valuation.

We

accept

the

Commissioner’s

submission

that

transactions at non-market value can in some circumstances defeat the intent and application of the Act. It is the case that the explicit recognition of the need for transactions to be at open market value is defined to be transactions which are not at arm’s length. However the need for a particular rule for these transactions merely reflects the increased potential to transact at non-market value in those situations given the absence of the normal tension between buyer and seller”.

The majority continued:

“However genuine the parties were, and despite the absence of pretence, when assessed objectively, the only way in which the vendor finance could be repaid was from working the mine”.

Thus the economic liability was entirely conditional on the success of the Glenharrow project. To treat this as a basis for an input tax credit in the month that the documents were entered into defeated the intention and application of

48

(1997) 70 TC 57, at p 116.

49

[2008] 1 NZLR, at [77].


17

the GST Act.

50

Although there was an expressed legal obligation, it was artificial.

The majority concluded:51

“We are satisfied that, in the context of this case, the arrangement was artificial and failed to incur the economic burden intended by Parliament to entitle Glenharrow to input tax credits”.

In dissent, Chambers J took quite a different approach. His Honour first determined that, without reference to the general anti-avoidance provision, the consideration actually paid for the mining licence might not have been $45 million, but indeed was something less taking into account the time value of money and the value of the consideration really paid (taking into account the vendor loan of $44,920,000 on completely non-commercial terms)52. Chambers J then went on to distinguish the Ch’elle decision and say that in respect of section 76 the Commissioner ought not to be able to rely upon its application. In essence his Honour applied the majority decision in Peterson, and concluded that the decision in the High Court was inconsistent, insofar as Chisholm J found that he could invoke section 76 because the consideration for the mining licence was “grossly inflated.” His Honour could not reconcile this conclusion with what was otherwise viewed as a finding of fact as to the genuineness of the consideration and agreement between the vendor and purchaser. Chambers J concluded:53

“With respect, I find that conclusion sits uneasily with other findings he made as to the parties’ genuineness and as to there being a “rational explanation” for the purchase price. But, more important than this is the fact that, even if the price was grossly inflated, that of itself could not trigger section 76”.

50

Ibid, at [82].

51

Ibid, at [101].

52

Ibid, at [139].

53

Ibid, at [167].


18

He concluded with a reference to the Peterson decision:

54

“In my respectful view, Chisholm J’s approach was at odds with the Privy Council’s advice”.

In analysing these three Court of Appeal decisions, and the Privy Council’s decision in Peterson, it appears that there is a real focus by the Judges on the substance of the transaction rather than its legal form and scrutiny as to whether the economic burden is truly being borne by the taxpayer when the obligation to pay the legal liability generates the purported tax advantage. But it is clear that findings of fact and evidence of non-commercial arrangements are absolutely crucial because the Commissioner must demonstrate the fact that the taxpayer has not truly economically borne the cost of the deduction. Likely features of such factual enquiries will be non-recourse loans, economic compensation to other associated taxpayers, circular fund flows and possible capital guarantees.

The concept of whether the taxpayer has suffered the economic burden must also be related to another significant principle, namely what is the economic burden intended to be borne by the taxpayer under the statutory provisions of the Income Tax Act? This is what William Young P was referring to when he related the need to examine the real economic consequences to the type of expenditure contemplated by the legislature when the rules were enacted.55 This matter is referred to in the next section of this paper.

The scheme and purpose of the Act Of course the relevant test of economic burden, when considering the cost of a depreciable asset or the acquisition cost of an insurance premium, relies upon a parliamentary intention that the taxpayer has actually incurred the expenditure

54

Ibid, at [168].

55

Accent Management Ltd v Commissioner of Inland Revenue (2007) 23 NZTC21,323, at [125].


19

for which the deduction has been sought. As already discussed earlier in this paper, when acquiring depreciable property (such as in the Peterson case, or Accent Management or in the High Court decision of Erris Promotions Ltd56 involving software) the cost of the property being acquired must actually be borne economically by the taxpayer. This is the statutory frame of depreciation, that the original cost of an asset is amortised as a deduction, over its economic life. Contrast however, the economic cost incurred by a holding company when its subsidiary has a trading loss and the two companies seek to offset this trading loss against the holding company’s profit. In this situation the subsidiary company can be funded by other parties than the holding company and often is. For instance, the subsidiary company may have borrowed by incurring debt, or been funded by equity such as redeemable preference shares issued to shareholders outside the holding company. The holding company may have suffered no economic loss whatsoever, but may still be entitled to enjoy the benefits of a taxgrouping loss offset. In this case the scheme of the Act is to focus on where common voting interest and ownership rights are held, irrespective of the parties providing the economic funds for the entity.57 There are also numerous regimes which could be considered circular or artificial until the statutory framework is considered in its entirety. A good example might be the foreign investor tax credit regime.58

56

Erris Promotions Ltd v Commissioner of Inland Revenue [2004] 1 NZLR 811; (2003) 21 NZTC 18,330.

57

Subpart IC, Income Tax Act 2007.

58

Subpart LP, Tax Credits for Supplementary Dividends, Income Tax Act 2007, where the tax credit or rebate provided to the corporate taxpayer economically compensates the company. The shareholder receives a greater dividend (as a result of this compensation) but the shareholder will suffer a higher amount of non-resident withholding tax. Overall the burden of tax is shifted from the company to the shareholder as part of the statutory scheme.


20

Transactions that make commercial sense after the tax benefits are utilised What if a taxpayer borrows at say 9% interest rates to receive an 8% fully imputed dividend? Although economically he or she is suffering a financial burden, the tax outcomes are that their taxable income, which includes the imputation credit, are greater than their deductible expenses. The resultant tax benefit associated with the imputation credit is available to be offset against other income.

It seems that Lord Millett in the majority judgment of Peterson would not have been troubled to conclude that this was acceptable tax planning as he noted:59

“The leverage obtained by use of non-recourse loans meant that the investors did not sustain an economic loss after the tax deduction is taken into account. Their Lordships suspect it is this feature of the scheme which has most exercised the Commissioner, but a moment’s reflection shows that what Lord Templeman had in mind was expenditure or loss before any tax advantage is taken into account. Tax relief often makes the difference between profit and loss after tax is taken into account; and a transaction does not become tax avoidance merely because it does so”.

In the case of the fully imputed dividend, the taxpayer has fully borne the economic cost of the interest expense, whilst the imputation credit attached to the dividend delivers an element of tax relief against other income which makes it commercially sensible for the investor to invest. It is the writer’s view that this is the sort of tax relief, expressly contemplated and mandated by the statute, which

59

Peterson v Commissioner of Inland Revenue [2006] 3 NZLR 433, at [45].


21

a taxpayer can take into account and in the words of Lord Millett “a transaction does not become tax avoidance merely because it does so.”60

Lord Millett was referring to the Commissioner’s concern that in Peterson the true cost of the film was not economically borne by Mr Peterson, but their Lordships held, absent evidence to the contrary, that the full X + Y components were expended on the purchase of the film.

Likewise, should a taxpayer incur an interest expense at say 9%, whilst they receive a dividend of 8% which is relieved of tax by virtue of a conduit relief exemption, then they have also fully borne the economic cost of the interest expense. If the tax relief is provided by the scheme of the Income Tax legislation, so that investors see it as a commercially sensible investment, then the utilisation of that tax relief does not necessarily become tax avoidance. Provided the transaction was made upon commercially normal and market based parameters, it is submitted that the tax outcome is one that is contemplated by the Income Tax Act, namely that the interest expense has been incurred and is deductible,61 and the conduit income relieved of foreign dividend withholding payment obligations.62

In this sense it is no different from the expected tax outcome when a taxpayer incurs interest expense63 and invests in a portfolio tax rate entity64 which derives excluded income, or when a taxpayer incurs interest expense65 in investing in a qualifying

company

that

derives

exempt

income

(if

the

dividends

are

unimputed66). In these situations the Income Tax Act defines the outcomes which

60

Ibid, at [45].

61

Section DB 7 Income Tax Act 2007.

62

Section RG 7 Income Tax Act 2007.

63

Section DA 1 (1)(ii) Income Tax Act 2007.

64

Section CX 56 (2) Income Tax Act 2007.

65

Section DB 9 (2) Income Tax Act 2007.

66

Section CW 15 Income Tax Act 2007.


22

can generate valid tax deductions for interest expense, and then prescribes either relieved, exempt or excluded income, as a clear statutory scheme.

Conclusions Professor Prebble was almost certainly correct when he stated:67 “This passage68 drives a coach and four through the Cecil Bros rule.” Provided the Commissioner can provide the necessary evidence to establish that what was paid for was in substance only X, then it is likely that the Supreme Court, following Lord Millett’s approach, will look through the form of the payment.

Evidencing the true nature of the economic burden suffered by the taxpayer is no doubt easier when there are non-market or non-commercial transactions. The facts of the three decisions of

the Court of Appeal in 2007 had many

non-commercial features, although the Glenharrow decision is somewhat closer to the line given the findings in the High Court, and indeed the approach of the minority (Chambers J) could be upheld.

To this writer’s mind three key issues arise following Peterson and the Court of Appeal decisions, which the Supreme Court will need to address.

First, the further development of the concept, in cases including deductibility, of whether the economic burden has truly been suffered by the taxpayer and the effect that this has on the legal purpose for the expenditure. This test though is

67

“Taxation Issues in the Twenty-First Century” (2006) at page 122 Sawyer (Editor).

68

Referring to Lord Millett’s reframing of the Cecil Bros principle as a test that examines not only the legal purpose of expenditure, but also its economic purpose “Where, however, a single consideration [here the X + Y] is given for the supply of two or more goods or services the Commissioner is probably entitled even without section [BG 1] to go behind the allocation agreed between the parties and allocate the consideration among the several goods or services for which it was paid on a proper basis”. Accent Management Ltd v Commissioner of Inland Revenue (2007) 23 NZTC 21,323 at [51].


23

very importantly overlaid by the question of “what is the expected economic burden anticipated by the specific tax legislation?”

Secondly, it is to be expected that the concept of non-commercial features (or artificial contrivances) will receive further clarification. In a sense the “more than merely incidental purpose of tax avoidance” is such a low threshold test, it may be that the two cases (Accent Management and Glenharrow) are not the best examples of where the line is to be drawn. Indeed, given the non-commercial features of these cases, the test of whether a dominant purpose of tax avoidance is present may well be the question answered by the Court.

Lastly, there is the question whether the approach of Peterson and the Court of Appeal is to be followed by the Supreme Court at all. It is to be hoped that if a new direction is charted, it is a clearer direction than that charted in the last 10 years. It is also to be hoped that the Supreme Court will recognise Godot, and clearly describe him, should he in fact arrive.

This article was accepted for publication on 18 July 2008
