Response to Susan Edmunds' article

Tax avoiders in the Cannon
Susan Edmunds article in the Herald on Sunday [1 April 2012] Tax avoiders in the gun provides an interesting insight into the effect of the recent decision of the New Zealand Supreme Court in Penny and Hooper v CIR [2011] NZSC 95. The Inland Revenue Department is about to send risk review letters to taxpayers who may have entered into a structure similar to the one seen in Penny and Hooper. However Ms Edmunds makes some fundamental errors in her article that need correction. I consider these below.

Requirement of non tax object not new

The first mistake made by Ms Edmunds is the comment attributed to the anonymous accountant who apparently says that after Penny and Hooper "[Taxpayers] ... would have to [now] prove there were commercial reasons for the way their affairs were structured. Moreover, the article in suggesting that prior to the Penny and Hooper decision it was acceptable for taxpayers to undertake structures that were driven by tax reasons relies on the statement that "Previous High Court rulings had indicated the practice [in Penny and Hooper] was legitimate." Sadly, nothing could be further from the truth. In point of fact the High Court (it used to be called the Supreme Court when New Zealand still used the Privy Council) 1966 decision of Justice Woodhouse in Elmiger v CIR [1966] NZLR 683 was the basis for the current form of the "general anti-avoidance rule" s BG 1 of the Income Tax Act 2007.

In Elmiger the two Elmiger brothers established a family trust and sold several items of heavy earthmoving plant to it (they operated in partnership and had the lucrative Government hydroelectric power contracts in the Waikato). They leased the items back and paid a rental reducing their personal income tax liability by having their family trust derive the income at approximately half the rate of tax. The killer blow however came from the fact that the trust retained the after tax earnings to be distributed back to the brothers in five years time. The Inland Revenue was successful in arguing the only reason for the Elmiger brothers setting up the trust was to divert their income to be derived at a much lower rate of income tax and with the benefit of that saving being returned to them. Justice Woodhouse concluded that the general anti-avoidance rule at the time (s 108 of the Land and Income Tax Act 1954 - it was not materially different from the current rule) applied. The Judge noted that (at p 694):

"On the principles laid down by the Privy Council [Newton v FCT [1958] AC 450] ... it seems that the application of [s BG 1] ... will depend first upon whether an income tax advantage was one of the actuating purposes of the transaction ... And this decision is to be made objectively by looking at the overt acts done in pursuance of the whole arrangement ."

The structure at issue in Elmiger was virtually the same as Penny and Hooper with the addition of a company.

When the Norman Kirk Labour Government swept into power in 1972 the reform programme eventually included the introduction of s BG 1 Income Tax Act 2007 (which was formerly s 99 of the Income Tax Act 1976).

Section BG 1 however simply reinforced the concepts already extant in Newton and Elmiger and essentially codified the Elmiger approach into the statutory language. Some new additions were the power of reconstruction given to the Commissioner of Inland Revenue (CIR) and the removal of the evidential rule that an "ordinary business or family dealing" would automatically fall outside the scope of the rule by virtue of that label.

Penny and Hooper not limited to trusts and companies

The second false impression created by the article is the fact that s BG 1 is limited to trust and company structures. The Penny and Hooper decision is of far wider impact and clarifies and returns the law to what it should have been prior to the problematic earlier decision of the Supreme Court in Ben Nevis Forestry Ventures Ltd v CIR (2009) 24 NZTC 23,188. In Ben Nevis the five members of the Supreme Court all correctly concluded the investment structure was caught by s BG 1. The problem came when the members of the Supreme Court gave their reasons why the avoidance rule applied. The minority decision of Elias CJ and Anderson J was a clear and accurate statement of the principles laid down in Newton and Elmiger. The majority decision of Tipping, McGrath and Gault JJ creates problems in that the Judges developed the "Parliamentary contemplation test" to gauge when s BG 1 would apply. Under this test a taxpayer relying on a specific provision of the Income Tax Act 2007 to gain a tax advantage (and argue that s BG 1 should not apply) would face a two-fold inquiry by the CIR and eventually the Court. The first proposition established under the Parliamentary contemplation test was that a taxpayer relying on a specific provision to excuse the label of "tax avoidance" must show the transaction creating the tax advantage fell within the intended scope of the provision. The second proposition was that the specific provision had to be read in context with s BG 1 to determine whether Parliament had intended (contemplated) that the taxpayer might gain a deliberate tax advantage. The other problem created by the Ben Nevis majority was that in deciding whether a transaction had as one of its main purposes of tax avoidance, the Court had to focus on a range of predetermined factual "tests" such as artificiality. This reasoning was at odds with the Elmiger approach which simply required an objective examination of the arrangement as a whole.

The future

The recent Inland Revenue Draft Interpretation Statement (16 December 2011) does little to clarify the law on s BG 1 and it is hoped the Newton/Elmiger approach will be consistently applied by the New Zealand Courts. It is ironical that as early as 1982 the New Zealand Court of Appeal in Tayles v CIR (1982) 5 NZTC 61,311 had already clarified the law in relation to what is now s BG 1. Justice Cooke (later Lord Cooke) noted (at p 61,312) that s BG 1 would only apply to transactions having as their main purpose or one of their main purposes tax avoidance. His Honour went on to note that the position reached in Tayles equally applied to s BG 1 as it now stands.

- Professor Chris Ohms and Dr Karin Olesen, AUT School of Business