Some big avoidance cases involving structured finance or optional convertible notes arise only because legislation is not clear on its face. Photo / Getty Images
You could hardly call it a rush job.
Inland Revenue's interpretation statement on tax avoidance has taken the best part of 10 years to finalise, with successive drafts put out for submissions from tax practitioners and amended in the light of them, while the jurisprudence has evolved, to put it mildly, through some high-profile cases, most notably the Supreme Court's ruling on Ben Nevis in 2008.
It represents the department's understanding of where the law on avoidance is at. And it spells out in a methodical way the process it will apply in coming to a view on whether a particular arrangement falls foul of what is a very general anti-avoidance provision in the legislation.
It is an area where the law is difficult and the financial stakes are high.
If an arrangement is found to constitute tax avoidance, not only will the tax benefits be reversed, but the taxpayer is also liable to be found to have adopted an abusive tax position in terms of the penalties regime.
That is only one step down from outright evasion and the penalty will double the tax to be paid, plus interest. Court costs are likely to be hefty as well.
"Taxpayers don't wander into the provision unaided," says IRD's chief tax counsel, Martin Smith. "It tends to be when they have been advised to."
So the interpretation statement is intended to provide guidance not only for the department's own staff but also for tax practitioners. "Tax avoidance is when the Income Tax Act is used in a way that Parliament did not intend by an arrangement that technically complies with the act, but the commercial and economic reality is not reflected in the form of the arrangement. This test was established by the Supreme Court in its decision in Ben Nevis," Smith said.
Inland Revenue's approach is to "ascertain" Parliament's purposes for the provisions of the act the arrangement uses, including the facts Parliament would expect to see present for the provisions to apply. It then looks at the arrangement to see if those facts are present, as a matter of commercial and economic reality. If not, it is tax avoidance, except if the avoidance of tax is "merely incidental".
The problem with all this is that it relies on some philosophically slippery concepts. Purpose and intent and what is contemplated are things which have to be divined from what an actor, in this case Parliament, has actually said and done.
Lots of room for argument here.
And when the argument comes down to "This cannot be what Parliament would have expected or wanted if it had turned its mind to a case like this, can it, your Honour?", then you are dealing in what logicians call counterfactual conditionals and you are on boggy epistemological ground.
Robin Oliver, a former deputy commissioner in charge of tax policy and now a principal of OliverShaw, says parliamentary intent is not about what a few MPs sitting in the House late on a Wednesday night were thinking.
"It's what the policy intent was," he says.
"But who decides that? I was at the centre of it for many years and sometimes I'm not 100 per cent sure!"
Oliver supports having a general anti-avoidance rule as a backstop to the thousands of pages of black-letter law in the tax act, because it is just too hard to foresee everything inventive tax advisers will come up with.
"Over time what the courts have said is that if you can produce a result that is very favourable to yourself in an artificial and contrived manner and the only reason to do it is tax, then it is struck down. Most practitioners would regard that as a fair cop," he said.
"The court's [more recent] comments, which the interpretation statement fairly reflects, mean that you can no longer really rely on this vast amount of legislation which Parliament spends hours and hours enacting. Parliament is effectively delegating taxing rights to the Revenue and the courts," Oliver says.
It is just about getting the balance right, he says, and the balance at the moment is tilting too far towards the Revenue.
Thomas Pippos, Deloitte's chief executive and a senior tax practitioner, says the parliamentary contemplation test gives the tax department a lot more than wiggle room.
"They could play a football game in the space that's available to them," he says.
"If the department views something negatively, there is a huge amount of opportunity to conclude it's avoidance. And it's very hard for taxpayers to successfully argue it's not."
In the past the courts, influenced by former Court of Appeal president Sir Ivor Richardson, had felt more constrained by the legal form of an arrangement, and the department rarely invoked the general anti-avoidance provision, Pippos says.
"Since he moved on, the court has become more liberal and the department is in a much better place from a judicial interpretation point of view than it has been in the past."
But Martin Smith rejects the idea that the courts have flipped in some binary way from "literalism" under Sir Ivor to a "purposive" approach since the Ben Nevis case. "Some advisers portray Sir Ivor as close to literalism. We never did."
Smith sees the fact that the department has been winning its avoidance cases as evidence not only that it has been getting the law right, but also that it has been pursuing cases that were not borderline, but well over the line into territory where the legal form of an arrangement does not reflect the commercial and economic reality of the situation.
He rejects the claim from some practitioners that, encouraged by success in the courts, tax officials have become more wont to cry "Avoidance!" while taxpayers, looking at the risks and costs of litigation, capitulate.
"Investigators can't just blast off and do their own thing," Smith says. "Sign-off for avoidance decisions is taken at a high level [within the department]."
Craig Elliffe, professor of tax law at Auckland University, says that in recent decisions, ranging from Ben Nevis to Penny and Hooper, the courts did a much better job of articulating what the test of tax avoidance is.
"But it seems to me the courts have wanted to change the law. They wanted to change some of Sir Ivor Richardson's scheme and purpose approach, and that is why they have used parliamentary contemplation as a whole new vehicle."
The result is a situation where the level of judicial discretion is quite high.
"You could view it as a devolution of power from Parliament to the courts," Elliffe says.
Pippos argues that increased reliance on the anti-avoidance provision can be a sign of sloppy policy design or legal draughtsmanship in the first place.
Some big avoidance cases involving structured finance or optional convertible notes arise only because legislation is not clear on its face, he says.
"The IRD ends up trying to put a bandage on bad legislation. Both of those situations could have been and should have been addressed through tax policy means, not by going through the courts."