Privy Council calls time on $10m tax dodge

By BRIAN FALLOW economics editor

The law lords have ruled in favour of the Inland Revenue over tax schemes devised by Auckland accountant John George Russell.

The tax department is now warning that people who continue to rely on such schemes risk doubling their tax bills.

Like every New Zealand judge who has considered the schemes, the Privy Council found them to breach anti-avoidance provisions of the Income Tax Act.

The Commissioner of Inland Revenue, David Butler, said that from the date of the judgment (April 10) any taxpayer who filed returns claiming the alleged tax advantages of the scheme was likely to receive the severe monetary penalties laid down for taking an "an abusive tax position" and might be prosecuted for fraud.

The penalty for abusive tax position is 100 per cent of the tax involved, not counting any use of money interest.

The Taxation Review Authority, Judge Paul Barber, estimates up to 3500 taxpayers might be affected by Russell schemes.

The way they work is that a small businessman, say a shopkeeper, "sells" his company to a company controlled by Mr Russell, who pays no money up front but gives the vendor a mortgage over the shares. The vendor remains a director and continues to run the company as before.

The aim is to make the trading company part of a group of companies controlled by Mr Russell, some of which have tax losses, and to establish a debt from the purchasing company to the vendor.

Every six months the trading company's net profits are paid to the purchasing company, described as an administration charge. This is taxable income to the purchasing company but group relief from the tax-loss companies is claimed.

To complete the circle, the profit is repaid to the vendor, described as an instalment payment for the purchase of the business, and therefore a capital item. The tax avoided is split between the vendor and Mr Russell.

Once the business is "paid for," after say seven or eight years, the vendor has an option to buy it back for a nominal sum, or roll the deal over.

The IRD's director of litigation, Mike Lennard, said he hoped the judgment marked the end of the legal road for the Russell schemes.

"But I would be pleasantly surprised if it did. It is like trench warfare. It has been going on for 10 years. It has been extremely wasteful and expensive litigation, but there seems from our point of view to be no option, except saying that these schemes can flourish outside the law."

The amount of tax at issue is $10.3 million, but it is spread over a large number of arrangements.

Mr Lennard said the case helps show that cynicism about the effectiveness of the general anti-avoidance provisions (section 99 of the 1976 Income Tax Act) is misplaced.

"Last fiscal year we closed off cases worth $148 million involving what we said was tax avoidance. Of that, 94 per cent ($139 million) was resolved in our favour. That's pretty reliable, when our overall success rate in tax litigation, in money terms, is about 50 per cent."