On 2 August the Supreme Court granted the taxpayers leave to appeal the Court of Appeal’s majority decision in Commissioner of Inland Revenue v Penny and Hooper (2010) 24 NZTC 24,287.
The high-profile tax avoidance case involves two orthopaedic surgeons who carried on their practices through companies and trusts, while paying themselves a below-market salary. The Commissioner of Inland Revenue argues that the surgeons’ arrangements breach the general anti-avoidance rule (GAAR) in the Income Tax Act 2007. The majority of the Court of Appeal agreed.
Given the Commissioner’s recent winning streak in tax avoidance cases, practitioners and taxpayers alike will await the Supreme Court’s judgment with bated breath, hoping that the Supreme Court will shed some light on where the boundary lies between legitimate tax planning and impermissible tax avoidance.
Commissioner’s recent successes
If tax planning was a game, pitting the might of the Commissioner of Inland Revenue against the ingenuity of taxpayers, then Associate Judge Bell aptly summarised the current score in his 9 July judgment:
"…the tide is running strongly in favour of the Commissioner of Inland Revenue on tax avoidance litigation."
In fact, the current score in tax avoidance cases is running 10 – 1 in favour of the Commissioner.
Empowered by the favourable Supreme Court judgment in the high profile forestry tax avoidance case Ben Nevis v CIR, the IRD has gone on to take and win a number of tax avoidance cases involving arrangements previously regarded by many taxpayers as ‘kosher’.
Such arrangements included:
the structured finance transactions undertaken by NZ’s major trading banks
the use of companies and trusts by professionals (such as doctors) to run their practices
the treatment of current account drawings by the shareholder of a closely held company as a loan, and
loss attributing qualifying companies renting properties to their shareholders.
In our view, a sea-change in the judicial attitude towards tax avoidance is emerging from the case law, and potentially a shift in the boundary line between legitimate tax planning and impermissible tax avoidance.This puts taxpayers in an uncertain position when planning their affairs. What is acceptable use of the Income Tax Act and what is outside the ‘contemplation of Parliament’? Taxpayers’ pleas for greater certainty in this area have fallen on deaf ears, with the Supreme Court stating that “Parliament has left the general anti-avoidance provision deliberately general.”
What does this mean for you?
As a result of the IRD’s recent success, we can expect more audit activity, especially (the IRD warns) in the property industry.We can also expect to see the IRD rely more readily on the GAAR when challenging arrangements which offer tax benefits or simply contain features which the IRD does not like (e.g. a below-market salary). The IRD may also be more likely to engage taxpayers in the dispute resolution process, knowing that there is a sympathetic court to hear the case at the end of the IRD’s internal process.Looking forward, taxpayers need to be aware that the boundary lines in tax avoidance have shifted. To protect yourself from long and costly disputes with the IRD (not to mention the possibility of 100% penalties) we recommend that you:
seek tax advice before entering into transactions
in appropriate cases, seek a binding ruling from the IRD if there is a risk that your transaction could be subject to the GAAR, and
watch out for the IRD’s “Revenue Alerts” which identify tax avoidance arrangements that the IRD has identified and is actively targeting.
If you are presented with an arrangement with tax benefits which seem too good to be true, they probably are!
How can we help you?
If you would like to know more about the issues discussed above, please contact our experts to the right or register for our upcoming Hothouse seminar: Tax Avoidance: "Parliamentary contemplation" a.k.a the judicial sniff test? Please click here for details.
Chapman Tripp’s tax team can provide you with expert advice on the tax effect of transactions. In addition, our cross-disciplinary tax and litigation team is able to represent you at all stages of the tax dispute process. Please contact Graeme Olding
for further information.