The Inland Revenue Department will be able to take a tougher stance on tax avoidance after its win against Christchurch orthopaedic surgeons Ian Penny and Gary Hooper, experts say.
The pair used company structures and family trusts to artificially lower their salaries and avoid paying the top personal income tax rate.
In a unanimous decision yesterday, a bench of five Supreme Court judges, led by Chief Justice Dame Sian Elias, agreed with an earlier Court of Appeal ruling against Penny and Hooper.
"Income derived from personal exertion should belong in its appropriate taxation band and should not be inappropriately diverted away," the judgment said.
The surgeons declared annual incomes of between $655,000 and $832,000 in the years before the April 2000 increase in the top personal tax rate to 39 cents in the dollar.
Following the increase, they declared personal incomes of between $100,000 and $120,000, while putting income previously declared as personal through companies they established to employ them, distributing that income to their families through family trusts.
Total tax avoided between 2001 and 2004 amounted to no more than $90,000 each. But the principles around the use of such structures saw the issue fought all the way to the country's highest court, which sided with the IRD yesterday.
Deloitte managing tax partner Thomas Pippos said the Supreme Court's judgment was a big win for the taxman.
"As a consequence, Inland Revenue will have greater confidence and vigour in relation to challenging the avoidance boundary," he said.
"In the meantime taxpayers need to be conscious that they have to take greater care in documenting the commerciality of their arrangements.
"A she'll be right attitude is not appropriate - that's what the Penny and Hooper case demonstrates yet again."
Pippos said the judgment had not clarified exactly what constituted tax avoidance, and what did not.
"More so than ever we anticipate a period of prolonged uncertainty, at least from a judicial perspective, as to where the avoidance boundaries actually lie," he said.
Neil Russ, a tax partner at law firm Buddle Findlay, said the IRD would be "over the moon" with the decision.
"I don't think [the judgment] rules out the use of company and corporate structures in every professional situation, but I do think it's a significant blow for those who thought they could structure their affairs that way as a right," he said.
Russ said he was concerned that a person could have a "completely legitimate and unexceptional business structure", but if the IRD Commissioner took the view that salaries paid were below market rates, people could be taxed accordingly.
"I find the commissioner substituting his views for how people ought to behave commercially a little bit unsatisfactory," he said.
Acting Commissioner of Inland Revenue Mary Craig said the department welcomed the Supreme Court's decision, which upheld its view that income allocation or diversion arrangements constituted tax avoidance.
But the IRD would take a measured approach to how the decision was applied to other taxpayers.
"The decision does not mean that every incorporated business, or one that is managed through a family or trading trust, is a tax avoidance arrangement, and the court gives clear advice on that," Craig said.
The IRD also said the Supreme Court's judgment confirmed that avoidance did not arise, despite a low salary being paid, in some circumstances - such as when a business was experiencing financial difficulties, or when there were capital investment requirements.
"If one person is generating the profits, but is diverting their income into other structures and declaring a reduced salary for the financial benefit to themselves or their family, then that is tax avoidance," Craig said.
PricewaterhouseCoopers New Zealand chairman John Shewan, who appeared as an expert witness in the case, said yesterday's judgment was a landmark decision, and showed there was a "new playing field with regard to the application of tax avoidance rules in New Zealand".
Penny and Hooper were ordered to pay $25,000 in costs to the IRD, together with reasonable disbursements in connection with the appeal.
- Additional reporting BusinessDesk
Shewan's evidence 'put to one side'
The Supreme Court "put to one side" evidence presented in the Penny and Hooper case by PricewaterhouseCoopers chairman John Shewan.
Commissioner of Inland Revenue Robert Russell objected to portions of evidence given by Shewan in which the accountant expressed his legal views.
"It is undesirable and wasteful of the time and effort of both parties when such material appears in expert briefs of evidence," the judgment said.
Shewan told the Herald: "I think it's an exaggeration to say [my evidence] was admonished and criticised - that's not the case. [The judgment] just said it went further than was acceptable because it strayed into, in their judgment, legal areas. I'm perfectly comfortable with that."