Tax Planning, Avoidance and Evasion

Revenue Alert 11/02

- Addresses issues of diverting personal services income by structuring revenue earning activities through an associated entity Whether it is legitimate focuses on 2 issues - Is the individual controller appropriately compensated? - If not, any valid commercial reasons?

Sham

- An allegation of sham is serious CIR's view of sham - An act or document created with the intention of causing the appearance or illusion of rights or obligations to third parties persons different to those actually intended by the creators of the act or document.

White v Commissioner of Inland Revenue (2010)

- Anaesthetist incorporates a company called Wharfedale and becomes employee of company which he runs at a loss - Losses offset against Wharfedale's income which was principally derived from the taxpayer's personal efforts - Taxpayer received no salary, paid no tax. -Inland Revenue reassessed. Wharfedale had no money to pay. - Distinguished Penny & Hooper (not a case where reduced salary deliberately paid) - Close company regime allows small families to account for the tax payable under the provisional tax regime rather than the PAYE regime - Ability to defer receipt of a salary until year end means in fragile financial circumstances a working shareholder can donate their time if funds are not available to pay proper remuneration. - Conclusion - 'permissible' tax advantage. - Inland Revenue did not ultimately appeal this decision.

CIR v BNZ Investments Limited (2001)

- BNZI funded by BNZ and preference shares investments in entities provided by Capital Markets Ltd - CML and BNZI affected by transactions involving conversion of interest received abroad into dividends of an exempt character by movement through tax haven jurisdictions. Held - Must be a contract, agreement, plan or understanding in which taxpayer was a participant which did not exist for BNZI

Tax Mitigation

- The legitimate minimisation of tax - Is practised by taking genuine advantage of incentives and choices provided for in the tax legislation, as part of sound commercial practice - A 'permissible' tax advantage

Case Law

- CIR v Challenge Corporation (1986) - Hadlee & Sydney Bridge Nominees Ltd v CIR (1993) - CIR v BNZ Investments Limited (2001) - Peterson v CIR (2005) - O'Neil v CIR (2001) - Ch'elle Properties (NZ) Ltd v CIR (2007) - Ben Nevis Forestry Ventures Limited v CIR [2008] - CIR v Penny [2010] - Penny v CIR [2011] - Russell v Commissioner of Inland Revenue (2010) - Russell v Commissioner of Inland Revenue [2011] - Russell v Commissioner of Inland Revenue [2012] - Russell v Commissioner of Inland Revenue [2012] - White v Commissioner of Inland Revenue (2010) - Alesco New Zealand Ltd v Commissioner of Inland Revenue (No 2) (2011) - Alesco New Zealand Ltd v Commissioner of Inland Revenue [2013] - Glenharrow Holdings Limited v Commissioner of Inland Revenue (2009)

CIR v Challenge Corporation (1986)

- Challenge entered into arrangement to purchase two subsidiaries of Merbank companies with accumulated losses to reduce tax by 2.85 million if successful - Challenge tried to rely on s IC 1 to offset the losses of the two companies against the income of other members of the Challenge Group. Held - tax avoidance under s IC 1, as it contained its own anti avoidance provision. - Tax avoidance as Challenge never suffered the loss which led to the tax losses.

Application of s BG 1

- Courts have adopted a 'principal purpose' test to determine whether or not a purpose or effect is 'merely incidental' - Section BG 1 is widely drafted. If it were given a literal interpretation, it would result in many transactions rendered void, which cannot have been Parliaments' intention. - The courts have created a number of 'glosses' to limit the application of the section (s GA 1) - Courts look to both tax and non tax purposes to determine this

Legal Principles arising from Ben Nevis

- Courts must apply a principled approach - Tax avoidance can be found in individual steps or, more often, a combination of steps - If it is apparent that the taxpayer has used the specific provision, and thereby altered the incidence of income tax, in a way which cannot have been within the contemplation and purpose of Parliament when it enacted the provision, the arrangement will be a tax avoidance arrangement - Courts should also consider the use made of the specific provisions in the light of the commercial reality and the economic effects of that use The use of a specific provision which alters the incidence of tax is permitted in two situations: - Within Parliamentary contemplation. - Tax avoidance purpose or effect is 'merely incidental

Settlements

- In Accent Management Ltd v CIR courts have confirmed the Commissioner's power to settle tax disputes on a compromise basis. - IRD now in line with ATO practice - can make rational decisions over how tax is collected and which disputes should be pursued. - Consider operation of ss 6 and 6A TAA 1994: Care & Management - McLaren & Keating (2009) observe that the settlement of disputes in NZ decided on an ad hoc basis, & Inland Revenue should move to establish clear policy and procedures regarding how it will exercise that power. Such a policy should address: - When settlements may be entered into; - How a settlement can be proposed; and - To whom that proposal should be directed. IRD- Sec 6A Settlements starting point is, where the facts are clear and the law is settled, CIR must apply the law correctly. If not, then: - Deciding whether a section 6/6A decision is required - Who can exercise the delegation and when? - The General Process for Considering a Settlement - The Decision Itself The Factors to be Considered: - Inland Revenue's Resources - Likelihood of Success in the Dispute - Promoting Voluntary Compliance - The Integrity of the tax system - Precedential Value of the Dispute - Quantum of Tax in Dispute - The Taxpayer's Capacity to Pay

Tax Evasion

- Is illegal - Includes falsification, non-disclosure, failure to meet legal obligations - An example of evasion would be the 'cash economy' Large scale tax evasion schemes are classified as fraud, can be dealt with by Serious Fraud Office (SFO)

Tax Avoidance

- Is the minimisation of tax through legal means which are artificial and contrived and have no rationale other than to obtain a tax benefit - Generally there is a distinct lack of commercial reality in the arrangement. - The distinction between mitigation and avoidance is sometimes blurred

Russell v Commissioner of Inland Revenue (2010)

- John Russel template arrangement - Commercial Management Partnerships received consultancy fees from companies in the template group - Taxpayer controlled all entities in group - Mr Russell devoted his personal exertions to the generation of income - losses in loss companies - avoided paying tax on the income. - Wylie J (High Court) held tax avoidance not merely incidental. - Not within the contemplation of Parliament - Court of Appeal - held tax avoidance, Supreme Court dismissed the appeal Track E attempt by IRD to tax all income derived by the CM partnership to Mr Russell personally. - Russell bankrupt in 2015, OA investigation in progress - Never about the money - about getting rid of him - vendetta

Tax Minimisation Tips

- Make tax planning arrangements at the beginning of the business rather than in the course of it. - Always have commercial as well as tax considerations in implementing an arrangement. - Minimise tax by exercising a choice provided for in the Acts. - Keep the scheme simple - complicated arrangements are more likely to be challenged by Inland Revenue. - Don't be greedy - the more money saved, the more likely the Commissioner may challenge.

Peterson v CIR (2005)

- Peterson was a member of a syndicate of investor who invested in two films with one being actual cash investment, the other being a limited resource loan and were lead to believe the actual cost of the film was both Held - 3:2 in favour of the taxpayer - Investors were entitled to depreciate the full acquisition cost of both films - Did not matter that half the price was obtained by loan it did not mean taxpayers hadn't suffered economic burden of purchasing two films - Minority were prepared to examine the circular nature of the limited recourse loan by focusing on what actually happened to the money. - Form v Substance approach - Privy Council's approach has since been applied in New Zealand. The Majority made the following points: - CIR may identify whole or part of scheme as the arrangement under s BG1. - Arrangement under s BG1 does not require a consensus or meeting of minds. - A taxpayer does not need to be a party to an arrangement to be affected by it, knowledge of arrangement's details is also unnecessary

O'Neil v CIR (2001)

- Shareholders entered schemes devised by JG Russell for avoiding income tax - JGR scheme took advantage of company grouping rules to offset losses against future profits by enabling client company profits to pass into the loss-owning group of JGR companies, which were then paid back to shareholders as capital payments, rather than receiving company profits as revenue. - Considerable litigation - objection, judicial review. - Held: Purpose or effect was tax avoidance (TRA, High Court, Court of Appeal, Privy Council).

Substance versus Form

- Transactions may be analysed according to its legal form (according to legal transactions actually entered into), or on the basis of the substance of the transaction (the overall economic consequences of the transaction). - Generally courts do not adopt the 'substance' approach when dealing with tax problems. - Tax is to be imposed on the plain words of the legislation applied to facts and circumstances of the case, people are not taxed by inference, analogy, or according to the spirit of the legislation (IRC v Duke of Westminster) Exceptions to the 'legal form' principle: - When the genuineness of the transaction is challenged and the transaction is established as a sham - When a statutory provision such as the general anti-avoidance section requires a broader or different approach

Glenharrow v CIR (SC)

- Valuation was discussed - length to run of mining licence - Valuation was discussed - length to run of mining licence. - Commerciality of a vendor loan of that amount. -Use of hand tools to mine the mountain- how much could actually be extracted in the time frame left to mine. - Newton, Ashton, Challenge, Miller, Cecil Brothers, Ch'elle Properties cases all mentioned. Held - Appeal dismissed - costs paid to the Commissioner.

Ben Nevis Forestry Ventures Limited v CIR [2008]

- Wealthy investors bought 50 year licence to grow trees on land owned by the Trinity Foundation - Agreed to pay 2 million per hectare in 2047 when the trees were harvested - Investors depreciated the $2 million per hectare fee and claimed tax deductions of $40,000 per hectare, a claim challenged by IRD Held - CA dismissed taxpayer appeal as the purpose of the investment scheme was the generation of spectacular tax benefits rather than the conducting of a forestry business for profit - Well and truly 'over the line' referred to in BNZ - SC dismissed the appeal

Methods of Tax Planning

1. Diversion of Income 2. Eliminating Prospective Income 3. Increasing the Amount of Deductions 4. Reducing the Rate of Tax Payable

CIR v Penny and Hooper (CA)

Applying the Parliamentary contemplation test - Two surgeons practised on their own account then incorporated company structure/family trusts - Both conduct a private practice as well as practice in the public sector - CIR challenged the tax rate they were paying under the trust (33%) as opposed to the top marginal tax rate (39%) Mackenzie J - applied the Parliamentary contemplation test. - structures adopted were a legitimate choice for the conduct of their businesses - way Penny and hooper conducted their affairs did not constitute tax avoidance. - found arrangement not contrary to the scheme and purpose of the ITA and that the allocation of a commercially realistic salary was not a concept recognised by the Act. Randerson J - arrangements altered the incidence of income tax - purpose not 'merely incidental' - No criticism of corporate vehicle - satisfied at least one of the purposes was to to alter the incidence of income tax. - could be reasons why a reduced salary paid but none here Hammond J - Agreed with judgment of Randerson J - "use of specific provision viewed in light of the arrangement as a whole" - Economic analysis and realities are expressly embraced as being relevant. Dissent Ellen France J: - Not all arrangements which produce a tax advantage will constitute tax avoidance - Personal services attribution rules - this case is not income splitting like Hadlee - commercially realistic salary issue discussed

Alesco New Zealand Limited v CIR

Cross Border Avoidance - Interest deductions for optional convertible notes (OCNs). - Intra group financing. - Interest notionally received by Alesco - - Corporation Limited in return for advances not taxable under Australian tax legislation. - No more than 'interest free advances stapled to valueless and purposeless warrants'. - Abusive tax position penalty imposed. - Appeal allowed

Ch'elle Properties (NZ) Ltd v CIR (2007)

GST and Tax Avoidance - s 76 GSTA is a general anti-avoidance provision - Taxpayer entered into conditional contracts with the 114 companies to purchase the properties for a total price of $80 million. - Deferred settlement - between 10 and 20 years - GST return filed claiming 9 million in input tax credits based on estimated market value on respective settlement dates 10 to 20 years into the future - CIR disallowed the claims, 114 conditional contracts were cancelled - failed to settle.

Penalties

Either - Abusive Tax Position - Evasion

Ethical Considerations

Ethical considerations have an important role to play in tax planning 1. Large scale tax avoidance results in a transfer of responsibilities for paying tax to other taxpayers in the community 2. The so called 'rule of law' entitles taxpayers to organise their affairs in such a way that their legal liability to tax is minimised Difficulty is that a dividing line between acceptable tax planning and unacceptable tax planning needs to be drawn

Glenharrow Holdings Ltd v CIR (HC, CA)

Facts - Meate Mining license purchased for period of 10 years for $10,000 - sold license for $45 million a year later to Fahey after valuation carried out by Meate's cousin - Fahey set up the taxpayer company, Glenharrow Holdings Ltd to act as the purchaser of the licence - Deposit of $80,000 paid - Fahey claimed input tax on the sum of $44,920,000. - CIR allowed claim for $80,000 but denied the $44,920,000 as a sham or not having principle purpose of making taxable supplies HC - found transaction not a sham and principle purpose was making taxable supplies - However s 76 GSTA applied and arrangement void - consideration of $45 million was grossly inflated - arrangement had grossly inflated the input tax, therefore defeating the intent and application of the statue - disallowed the input tax credit on the $44,920,000 but allowed an input tax credit on $9,757,000. - This figure reflected the High Court's finding as to the value of the licence. CA -taxpayer appealed and argued Peterson, the CIR could not go behind the consideration paid where the dealing is at arm's length - CIR argued although transaction complied with black letter terms the scheme and purpose of the GST Act were frustrated - Held HC correct to find find tax avoidance in the transaction - although not a sham valuation was grossly inflated - no definitive commitment to repay - entirely conditional on the success of the Glenharrow project - obligation of $44million on shelf company worth $100 - significant timing mismatches can indicate that the line is crossed into tax avoidance (Ch'elle Properties) - the arrangements were artificial and failed to incur the economic burden intended by Parliament for entitlement to input tax credits (distinguished Peterson) CA dissent (Chambers J) - CIR's concession on consideration for the grant of the mining licence was not actually $45 million as not purely monetary, but a mixture of payments and promises. - If the view as to actual consideration was wrong, s. 76 did not in any event apply. - approach violated the principle that it is not for the Commissioner to say how much a taxpayer ought to spend in obtaining their income: Europa Oil (NZ) Ltd v CIR - valuation also ignored the fact that the deal was structured for proper business reasons, to reflect the risk that Mr Meates was taking - wrong to rely on Ch'elle Properties as taxpayer might have been paying GST on outputs soon after the arrangement had been entered into, had the venture been successful. CA Held - transaction lacked commercial reality - The taxpayer's appeal was dismissed. The value of the mining licence adjusted to $290,000 to correct the tax advantage

Legal Doctrines

Fiscal Nullity - Preconceived series of transactions may be disregarded for tax purposes when their purpose is only one of tax avoidance Choice principle - In most cases courts have applied the general anti- avoidance provision notwithstanding compliance with another section of the Act (not applied the choice principle) Newton predication test - Under the predication test an arrangement may not be avoidance if it could be explained as ordinary business or family dealing - Amendment in 1974 to counteract this restrictive gloss

Hadlee v CIR (1993)

General rule - not possible to assign income which is the result of personal services or exertion. - Hadlee partner in accounting firm assigned units that the partnership allocated profit on to a family trust - CIR treated income as being derived by Hadlee and not the family trust Held - CoA and PC both agreed with CIR as a taxpayer cannot transfer income (and therefore the liability to tax on that income) from personal services to another taxpayer - Assignment was void under s BG 1 as it involved seeking a tax advantage over otherwise comparable taxpayers, and consequently was not mere tax mitigation but tax avoidance

Tax Planning

Tax planning is the ordering of a person's business affairs in such a way as to minimise tax. Two types of tax planning - in relation to the overall business structure or organisation of an enterprise, - in relation to a particular transaction or event where the focus is on the tax consequences of various methods of implementation Objective - Reduce the amount of tax payable in respect of given quantity of receipts or profits, but - This must be balanced against implementation costs of any plan and disruption to the taxpayer's affairs

Certainty

The courts should not strive to create greater certainty than Parliament has chosen to provide - Glenharrow - BNZ Investments

What is a Tax Avoidance Arrangement?

Three elements to satisfy for s BG 1 to apply 1. There must be an arrangement within the meaning of the section. 2. The purpose or effect, or one purpose or effect, of such an arrangement must be 'tax avoidance' as defined. 3. That purpose or effect must not be a 'merely incidental' purpose or effect.

Case Y1 (2007)

Trading Trusts and Tax Avoidance - Bakery business - trading trust structure used - Artificially low management fee between trading trust and a partnership of the two taxpayers. - Allowed one of the taxpayers to maximise family support benefits. - Accountant evidence - no clear response. - Taxpayers had to 'borrow' from the trading trust to pay their living expenses. - Manner in which the trading trust structure was used was artificial and contrived.

The General Anti Avoidance Provision

s BG 1 ITA 2007 Function is twofold - To protect the integrity of the tax system from avoidance arrangements designed to frustrate - To protect the liability for income tax established under other provisions of the Income Tax Act Section BG 1 states: 'A tax avoidance arrangement is void as against the Commissioner for income tax purposes'.

Penny and Hooper v CIR (SC)

Unanimous decision of Supreme Court - use of company and trust structure not in itself problematic - in fact 'it was a choice the taxpayers were entitled to make' - Tax avoidance found in an individual step which was part of a wider arrangement - the setting of the salary on an annual basis. - The tax advantage produced by the fixing of the salary at low levels was seen as a predominant purpose of the arrangement and hence tax avoidance