Ben Nevis Forestry v Cir
[2008] NZSC 15
•19 December 2008
IN THE SUPREME COURT OF NEW ZEALAND
SC 43/2007
[2008] NZSC 115
BETWEENBEN NEVIS FORESTRY VENTURES LTD, BRISTOL FORESTRY VENTURES LTD, CLIVE RICHARD BRADBURY, GREENMASS LTD, GREGORY ALAN PEEBLES AND ESTATE OF THE LATE KENNETH JOHN LAIRD
Appellants
ANDCOMMISSIONER OF INLAND REVENUE
Respondent
SC 44/2007
AND BETWEEN ACCENT MANAGEMENT LTD, LEXINGTON RESOURCES LTD AND REDCLIFFE FORESTRY VENTURES LTD
Appellants
ANDCOMMISSIONER OF INLAND REVENUE
Respondent
Hearing:23 - 27 June 2008
Court:Elias CJ, Tipping, McGrath, Gault and Anderson JJ
Counsel:C R Carruthers QC, R B Stewart QC and G J Harley for Appellants in SC 43/2007
C T Gudsell QC, M S Hinde and R J Southall for Appellants in SC 44/2007
D J White QC, R J Ellis and J H Coleman for Respondent
Judgment:19 December 2008
JUDGMENT OF THE COURT
A The appeals are dismissed.
BThe appellants are ordered to pay costs to the respondent (for which the appellants will be jointly and severally liable) of $75,000 together with reasonable disbursements to be fixed if necessary by the Registrar.
REASONS
Para No
Elias CJ and Anderson J [1]
Tipping, McGrath and Gault JJ [11]
ELIAS CJ AND ANDERSON J
[1] We have had the advantage of reading in draft the reasons of Tipping, McGrath and Gault JJ. We agree with their conclusion that the Trinity scheme is a tax avoidance arrangement. It is void as against the Commissioner for income tax purposes under s BG 1 of the Income Tax Act 1994.[1] The Commissioner was therefore entitled to counteract the tax advantage obtained by the appellants even when they were not parties to the arrangement entered into by their loss attributing qualifying companies. They are “persons affected by that arrangement” within the meaning of s GB 1 of the Income Tax Act.[2] We also agree that in acting on the arrangements the taxpayers have adopted an abusive tax position within the meaning of s 141D of the Tax Administration Act 1994. It follows that the penalties provided by that Act, as adjusted where applicable by s 141FC to prevent doubling up of the penalties through their application to both the investors and their loss attributing qualifying companies, properly attach to the taxpayer appellants.
[1]Section BG 1(1) makes a “tax avoidance arrangement” void as against the Commissioner for income tax purposes. The definitions contained in s OB 1 must be read with it. They define “arrangement” as “any contract, agreement, plan or understanding (whether enforceable or unenforceable), including all steps and transactions by which it is carried into effect”. “Tax avoidance” is defined as including “directly or indirectly altering the incidence of any income tax”, “directly or indirectly relieving any person from liability to pay income tax” and “directly or indirectly avoiding, reducing or postponing any liability to income tax”. “Tax avoidance arrangement” is defined as one:
whether entered into by the person affected by the arrangement or by another person, that directly or indirectly -
(a) Has tax avoidance as its purpose or effect; or
(b) Has tax avoidance as one of its purposes or effects, whether or not any other purpose or effect is referable to ordinary business or family dealings, if the purpose or effect is not merely incidental.
[2]Which permits the Commissioner to adjust the calculation of the taxable income of “any person affected by that arrangement”, so as to counteract any tax advantage obtained by that person.
[2] We write separately to express reservations on aspects of the reasoning adopted by Tipping, McGrath and Gault JJ, not essential to their conclusions on the application of s BG 1 and the consequences. We differ from them in being of the view that the specific statutory allowances under the Income Tax Act are not in potential conflict with the general anti-avoidance provision and that the two do not need reconciliation. Rather, both are to be purposively and contextually interpreted, as is required by s 5 of the Interpretation Act 1999[3] and s AA 3 of the Income Tax Act.[4] Recourse to the general anti-avoidance provision is not necessary “to prevent uses of the specific provisions which fall outside their intended scope in the overall scheme of the Act”.[5] If the use of a specific provision falls outside its intended scope in the scheme of the Act, the use is not authorised within the meaning of the specific provision. This approach is in our view required by settled principles of statutory construction. It avoids the distortion of overuse and unnecessary expansiveness in application of the general anti-avoidance provision. On this view, we do not think that there are stark differences between the general approach to statutory interpretation of specific tax provisions in New Zealand and in the United Kingdom, at least since W TRamsay Ltd v Inland Revenue Commissioners[6] and Furniss (Inspector of Taxes) v Dawson.[7] The rejection of literal interpretation described by Lord Steyn and Lord Cooke in Inland Revenue Commissioners v McGuckian[8] applies equally in construing the New Zealand specific tax provisions.
[3]Which provides that the meaning of an enactment must be ascertained from its text and in the light of its purpose and makes it clear that the matters to be considered include the indications contained in the enactment including by its organisation.
[4]Section AA 3(1) provides a “principle of interpretation”:
(1)The meaning of a provision of this Act is found by reading the words in context and, particularly, in light of the purpose provisions, the core provisions [which include s BG 1] and the way in which the Act is organised.
[5]Compare para [106] of the reasons of Tipping, McGrath and Gault JJ.
[6][1982] AC 300.
[7][1984] 1 AC 474.
[8][1997] 1 WLR 991 at p 1000 per Lord Steyn and at p 1005 per Lord Cooke (HL).
[3] The first question is whether the claimed allowance or deduction falls within the meaning of the specific provision, purposively construed. If it does not, the Commissioner can disallow the claim and, if of the view that it is itself a tax avoidance arrangement (because its purpose or effect is to alter the incidence of tax), can treat it as void under s BG 1. If the claim is within the meaning of the specific tax provision, purposively interpreted, an arrangement on which it is based may nevertheless constitute tax avoidance if it has the purpose or effect of altering the incidence of tax. If however the basis of claim is not, in itself or as part of a wider scheme, an arrangement with the purpose or effect of altering the incidence of tax, it is not tax avoidance under s BG 1.
[4] In a fiscal statute the terms and concepts used may, depending on purpose and context, be used in a business or accounting sense.[9] It would be wrong to start with any preconception that “ordinary meaning” or “legal meaning” is to be preferred to the meaning a term has in business or accounting. Similarly, where the substance of an arrangement needs to be gauged in application of the provision of a tax statute, a purposive construction of the provision may indicate that it is legal substance which is in issue or it may indicate that the statute is concerned with business substance. The provisions of a tax statute apply to many different financial structures. It may use, according to the context, legal, commercial or accounting terminology. There is no general rule. Lord Millett, writing extra-judicially, thought that the purposive approach to the interpretation of tax statutes, affirmed in Ramsay and the cases which followed it, had destroyed two “allied and dangerous myths”.[10] The first was “that in tax cases to an extent unknown in other areas of law, form prevails over substance”.[11] The second was that “the substance of a transaction, and the only thing to be regarded, is its legal effect”.[12] When interpreting the specific provisions of tax legislation, care should be taken not to resurrect either myth.
[9]So in Commissioner of Inland Revenue v Mitsubishi Motors New Zealand Ltd [1995] 3 NZLR 513 at p 517 per Lord Hoffmann the Privy Council expressed the view that the context of a taxing statute makes a term like “incurred” more likely to be used in its commercially accepted meaning rather than in a more general sense.
[10]Millett, “Artificial Tax Avoidance: The English and American Approach” (1986) 6 British Tax Review 327, p 333.
[11]Millett, p 333 – 334.
[12]Millett, p 334.
[5] The meaning of any term used by the statute in a particular provision must be contextually accurate. We do not therefore accept that when considering the application of a specific tax provision, and before considering the question of avoidance, the Court is concerned primarily with the legal structures and obligations created by the parties, and not with the economic substance of what they do.[13] It depends on the context. The critical question is whether “the relevant provision of the statute, upon its true construction, applies to the facts as found”.[14] Those facts must be viewed “realistically”[15] because, as Lord Wilberforce put it in Ramsay, tax is “created to operate in a real world, not that of make-believe”.[16] In Barclays, the House of Lords quoted with approval[17] the explanation of Ribeiro PJ that the ultimate question is whether the statutory provisions “construed purposively, were intended to apply to the transaction, viewed realistically”.[18] To similar effect, Lord Cooke in McGuckian considered the “ultimate question” to be “the true bearing of a particular taxing provision on a particular set of facts”.[19]
[13]Compare para [47] of the reasons of Tipping, McGrath and Gault JJ.
[14]Barclays Mercantile Business Finance Ltd v Mawson [2005] 1 AC 684 at para [32] per Lord Nicholls, delivering the single opinion of the House of Lords.
[15]As emphasised by Ribeiro PJ in Collector of Stamp Revenue v Arrowtown Assets Ltd (2003) 6 HKCFAR 517 at para [35].
[16]At p 326.
[17]At para [36].
[18]In Collector of Stamp Revenue v Arrowtown Assets Ltd (2003) 6 HKCFAR 517 at para [35].
[19]At p 1005.
[6] The taxpayers here had claimed allowances in respect of amortisation of a licence fee for use of land for forestry purposes and in respect of premiums for insurance against the risk that the forest would not yield a specified return. It is not necessary in the present case to determine whether these claims were properly made under the specific provisions of the Income Tax Act, ss EG 1 and OB 1, and ss DL 1 and OB 1 respectively. We agree that they were part of a wider tax avoidance arrangement, and that is sufficient to determine the appeal. But we would not want to be taken to accept, as Tipping, McGrath and Gault JJ are prepared to do, that the claims “satisfied the ordinary meaning of the specific provisions relied on to claim the deductions”.[20] We think it doubtful that the claims fell within the scope of the relevant specific statutory provisions, properly construed. In that connection, we doubt that Commissioner of Inland Revenue v Glen Eden Metal Spinners Ltd,[21] referred to by Tipping, McGrath and Gault JJ at paras [117] – [119] without endorsement, should be followed as generally applicable. Whether expenditure is incurred for fiscal purposes when promissory notes are granted, depends on whether such obligation is within the purpose of the tax provision. In a fiscal context, the Glen Eden approach would be unusual, as the Privy Council suggested in Commissioner of Inland Revenue v Mitsubishi Motors New Zealand Ltd.[22]
[20]Compare para [156] of the reasons of Tipping, McGrath and Gault JJ.
[21](1990) 12 NZTC 7,270 (CA).
[22][1995] 3 NZLR 513.
[7] As already indicated, we do not see the specific tax provisions and the general anti-avoidance provision as potentially conflicting. In McGuckian, Lord Cooke described a purposive approach to the construction of specific tax provisions as being “antecedent to or collateral with … general anti-avoidance provisions such as are found in Australasia”.[23] We agree with that view of the relationship between the specific tax provisions and the general anti-avoidance provision. The specific provision is antecedent in application to the general anti-avoidance provision if the arrangement is not within the purpose of the specific provision. It is collateral if, in addition, it is entered into with the purpose or effect of altering the incidence of tax. This sequencing and co-operation between the provisions does not seem to us to place less emphasis on the application of the general anti-avoidance provision than in the past.[24]
[23]At p 1005.
[24]Compare para [100] of the reasons of Tipping, McGrath and Gault JJ.
[8] In application of the general anti-avoidance provision contained in s BG 1 we agree with the reasons why Tipping, McGrath, and Gault JJ conclude that the scheme, including the licence fee component and the insurance premium, constituted tax avoidance. We consider it plainly established that fiscal advantage was the purpose or effect of the arrangement. Nor was this object merely incidental to a business purpose. It was a principal object in itself. Although it does not affect the disposition of the case, we should not be taken to accept that the composite term “purpose or effect” can be collapsed into “effect”. In Tayles v Commissioner of Inland Revenue,[25] McMullin J (with whom the other members of the Court of Appeal expressed agreement) applied the approach adopted in Newton v Commissioner of Taxation of the Commonwealth of Australia[26] that:
The word ‘purpose’ means, not motive but the effect which it is sought to achieve – the end in view. The word ‘effect’ means the end accomplished or achieved. The whole set of words denotes concerted action to an end – the end of avoiding tax.
[25][1982] 2 NZLR 726 at p 734.
[26][1958] AC 450 at p 465 per Lord Denning (PC).
More recently, Sir Anthony Mason, sitting in the Hong Kong Court of Final Appeal, has also said of the application of tax legislation purposively construed to a transaction or arrangement that it is concerned with “the aim or end in view”.[27] In this case it is not necessary to revisit that approach. Applying it, “effect” is part of a composite term so that the general anti-avoidance provision is concerned with arrangements having the “intended effect” or object of altering the incidence of tax. That is not to say that purpose is to be equated with the motive of the taxpayer or the motives of the architects of the arrangement. It is well established that motive is not determinative, although it may be evidence which sheds light on a purpose of tax avoidance and so is not wholly irrelevant.[28]
[27]Shiu Wing Ltd v Commissioner of Estate Duty (2000) 3 HKCFAR 215 at p 238.
[28]As Sir Anthony Mason NPJ thought to be the case in Shiu Wing Ltd at p 238.
[9] Tax avoidance occurs when the object or end in view or design of an arrangement is alteration of the incidence of tax and that object is not incidental to a business purpose. Such assessment does not entail reconstruction of the arrangements entered into. It requires realistic assessment of their purpose or effect. The evaluation required is a “question of mixed fact and law”, as Lord Cooke suggested in McGuckian.[29] The fact that some business effect is also achieved does not prevent a conclusion that the purpose or effect of an arrangement is to alter the incidence of tax. As s BG 1 makes clear, an arrangement tips into tax avoidance if the fiscal effect intended is more than “merely incidental” to the business or family purpose. The fiscal implications of an arrangement that is “merely incidental” to a business purpose may in some cases be substantial and still within the statutory scheme and purpose. “Merely incidental” may properly be contrasted with the end in view, the “purpose or effect”.
[29]At p 1005.
[10] We would dismiss the appeal, with the consequences proposed by Tipping, McGrath and Gault JJ.
TIPPING, McGRATH AND GAULT JJ
(Given by Tipping and McGrath JJ)
Table of Contents Para No
Introduction [11]
Facts and contractual terms [14]
Sham issues [32]
Specific tax concession issues [40]
Licence premium and its deductibility [40]
Insurance premiums: deductibility and spreading [55]
Tax avoidance: legislative provisions [69]
Tax avoidance: legal principles [71]
Legislative history [71]
Legislative change in 1974 [80]
Challenge Corporation and purposive interpretation [84]
Reconciling the legislative policies [100]
Appraisal for avoidance purposes [115]
Introduction [115]
The licence premium [116]
Insurance arrangements [131]
Accent Management’s new point [149]
Tax avoidance: conclusion [156]
Participation [157]
Reconstruction [169]
Penalties [172]
General [172]
Unacceptable interpretation [181]
Decision in Europa 2 [189]
Dominant purpose [204]
Tax shortfall [210]
Redcliffe position [216]
Outcome [219]
Introduction
[11] New Zealand has had a general anti-avoidance provision in tax legislation since 1878. The Commissioner’s active reliance on it began during the 1960s, leading to extensive litigation over the scope and effect of the provision in force at that time.[30] Judicial criticism of its terms and their limits led to its expansion by Parliament in 1974.[31]
[30]The general anti-avoidance provision at that time was s 108 of the Land and Income Tax Act 1954.
[31]See s 9 Land and Income Tax Amendment Act (No 2) 1974. The amended s 108 was the model for its successor, s 99 of the Income Tax Act 1976. The anti-avoidance provisions relevant to the present appeals are ss BB 9 (1997 year), BG 1 (1998 year) and GB 1 of the Income Tax Act 1994.
[12] The expanded provision, and its successors, did not, however, explicitly resolve a central issue that had arisen with s 108 of the 1954 Act. That was the relationship between the general anti-avoidance provision and the many “specific provisions” that allow tax concessions, principally through authorising deductions and depreciation allowances. Taxpayers enter into many transactions which have been structured with the purpose of taking advantage of specific provisions in order to reduce tax. While the general anti-avoidance provision is expressed broadly, its purpose cannot be to strike down arrangements which involve no more than appropriate use of specific provisions. On the other hand, strict compliance with the requirements of specific provisions cannot have been intended to immunise all arrangements involving their use against being categorised as tax avoidance arrangements, which it was the purpose of the general provision to avoid.
[13] The present appeals are the first occasion this Court has had to consider when use of specific provisions will amount to proscribed tax avoidance.[32] There is little explicit guidance in the legislation and the current case law has become complex, through being encumbered by considerations and tests that the legislation does not specify. Through a process of interpretation of all the relevant statutory provisions, we must identify a means for determining where permissible use of specific provisions ends and tax avoidance begins.
Facts and contractual terms
[32]The appellants in this case were unsuccessful in both the High Court and Court of Appeal: Accent Management Ltd v Commissioner of Inland Revenue (2005) 22 NZTC 19,027 (HC); Accent Management Ltd v Commissioner of Inland Revenue (2007) 23 NZTC 21,323 (CA).
[14] The nine appellants are investors, or loss attributing qualifying companies (LAQCs) of investors, in a syndicate that has been involved in the development of a Douglas Fir forest project as part of what is known as the Trinity scheme. The forest has been planted in Southland. Douglas Fir has a 50 year rotation and the forest is due to be harvested by 2048.
[15] The contractual arrangements for investment in the forestry project are complex. The scheme, including its contractual aspects, was devised and set up by Dr Garry Muir, who is a tax lawyer. At the relevant time he was the partner of a Mr Bradbury in the law firm Bradbury & Muir, which acted in the establishment and implementation of the scheme. Dr Muir and Mr Bradbury were both also investors. Mr Bradbury and the LAQCs of both Dr Muir and Mr Bradbury are appellants.
[16] The initial steps in the implementation of the Trinity scheme were taken early in 1997 when an agreement was entered into for the purchase of the land on which the forest was to be established. Investors did not at any stage acquire ownership of the land. Rather, title was acquired and retained by three subsidiaries of Trinity Foundation Ltd, a company owned by the Trinity Foundation Charitable Trust. The issues which are the subject of these appeals concern that part of the forest that is situated on land owned by one of the subsidiaries, Trinity Foundation (Services No 3) Ltd, which we will refer to as Trinity 3. It owns Lot 3 of the property known as Redcliffe Station. Lot 3 comprises 538 hectares on part of which the forest was planted.
[17] The investors in the Trinity 3 part of the Trinity scheme all became members of a syndicate through which they made their investments. It is called the Southern Lakes Joint Venture. A company, Southern Lakes Forestry Ltd, was formed to act as the contracting or “documentary” agent of the joint venture. We will refer to that company as Southern Lakes Forestry and to the joint venture as the syndicate. On the syndicate’s behalf Southern Lakes Forestry entered into the various contracts, which constituted the scheme.
[18] Trinity 3 and Southern Lakes Forestry entered into an agreement for the grant of an occupation licence to the syndicate and, later, a licence agreement. The two agreements are to be read together along with a subsequent modification agreement entered into by the parties.
[19] The first of these agreements provided for Trinity 3, as owner of the land, to grant a licence to the syndicate to use Lot 3 “for the purpose of carrying on [the syndicate’s] forestry business on the property”. This agreement required the syndicate to pay a premium for the licence on the expiry of its term. The licence premium is stipulated to be the sum of $2,050,518 multiplied by the number of plantable hectares in the licensed land. Under the second agreement, the licence term commenced on 24 March 1997 and expired on 31 December 2048. Ultimately 484 of the 538 hectares, which were the subject of the agreements between Trinity 3 and the syndicate, were certified as plantable.
[20] The second agreement confirmed the terms of the licence grant. Under it the syndicate had an obligation, at its own expense, to establish, manage and protect a Douglas Fir forest on the licensed land in accordance with sound forestry principles. The modification agreement required the syndicate to enter into a Forestry Planting and Management Agreement with Pine Plan New Zealand Ltd (Pine Plan), which is a forestry management company.
[21] As well, the second agreement requires the syndicate to arrange for the sale of the forest on the basis that cutting and extraction should be completed during the period of four years prior to expiry of the term of the licence in 2048. Purchase monies recovered are to be applied by the land owner towards first GST, secondly costs of the sale, and thirdly payment of promissory notes given by investors covering their obligations to pay an insurance premium, shortly to be discussed, and the licence premium. The balance of the net stumpage proceeds is to be paid to the syndicate on 31 December 2048.
[22] Under the licence agreements the syndicate investors were also obliged to pay Trinity 3, on 21 March 1997, $1,350 per plantable hectare for the establishment of the forest, $1,946 per plantable hectare for an option to purchase the licensed land in 2048, and $1,000 each, irrespective of hectares taken, for a lease option. They were also required to pay a $50 annual licence fee during the term of the licence. These payments are in addition to the obligation to pay the licence premium in 2048.
[23] In this manner, the scheme involving Trinity 3 was structured so that the investors effectively met the initial costs of buying the land and planting the forest and the continuing costs of its future maintenance and management. The syndicate does not at any point during the term of the licence become owner of the land or the trees. It did, however, obtain an option to acquire the land the subject of the licence in 2048 from Trinity 3 for half of its then market value.
[24] The agreements contemplated that the syndicate would have the net proceeds of the sale of harvested trees at the end of the period of 50 years applied to its liability to pay the licence premium. There was, however, on the face of these arrangements a risk that the net proceeds would be insufficient to meet the liability for the premium. One further aspect of the structure of the contractual arrangements is seemingly directed to this potential gap. It is an arrangement for insurance to be taken out by individual syndicate members, through Southern Lakes Forestry, and Trinity 3.
[25] To this end Dr Muir caused CSI Insurance Group (BVI) Ltd to be incorporated in the British Virgin Islands. We will refer to the company as CSI. It is licensed in the British Virgin Islands to conduct business as an insurer. In broad terms, cover under the policy is triggered by an event or events having the effect of preventing the market value of stumpage of Douglas Fir from reaching $2,050,518 per plantable hectare during the period between occurrence of the event and 31 December 2048. The insured are the members of the syndicate and Trinity 3.
[26] For this cover the syndicate was obliged to pay two insurance premiums to CSI. The first was of $1,307 per plantable hectare in 1997. The second is of $32,791 per plantable hectare payable on or before 31 December 2047. Trinity 3 is also obliged to pay an insurance premium of $410,104 per plantable hectare on or before 31 December 2047. That premium is subject to increase up to a maximum of $1,230,311 per plantable hectare, dollar for dollar, to the extent that the market value of stumpage at 31 December 2047 is less than $2,050,518 per plantable hectare.
[27] Therefore, CSI insured Trinity 3 and the investors up to $2,050,518 per plantable hectare in the event that the net stumpage did not reach this value. However, as a result of the increasing premiums to be paid by Trinity 3 as well as the premiums to be paid by the investors, the maximum CSI would have to pay would be $787,416 per plantable hectare. This would be in the worst case scenario where the net stumpage value was zero. If the net stumpage value reaches $787,416 per plantable hectare, CSI will not have to pay anything at all on the policy. Likewise, cover does not attach if fewer than 300 trees mature, that being an event when cover would, seemingly, be most needed.
[28] Syndicate members provided promissory notes to cover their obligations to pay the licence premium of $2,050,518 per plantable hectare in 2048 and to meet their liability to pay the insurance premium in 2047. Trinity 3 likewise provided a promissory note for its 2047 insurance premium liability. Debentures creating charges over the assets and undertakings of the syndicate and Trinity 3 secured the money payable under the promissory notes. Their overall effect was to give CSI first rights over the forest until its value exceeded the deferred portion of the insurance premium. Trinity 3, and the syndicate, had second ranking priority covering the obligations each had to the other.
[29] Investors took up proportionate shares in the syndicate by reference to a number of plantable hectares. In the 1997 year they claimed the following deductions from assessable income in their tax returns:
(a)$34,098 per plantable hectare for the insurance premiums. This figure was made up of the sum of $1,307 paid in March 1997 and $32,791 to be paid in cash terms in 2047;
(b)A small proportion of the licence premium of $2,050,518 per plantable hectare, payable in 2048. The proportion was claimed as a depreciation allowance. The sum reflected amortisation of that cost over the 50 year period and, in the 1997 tax returns, the fact that the transaction had been entered into only ten days before the end of the financial year.
[30] In the 1998 year the investors claimed in their tax returns the amortised licence premium figure for a full year of about $41,000 per plantable hectare.
[31] None of the expenses claimed related to the costs to the syndicate of planting and tending trees. No issue has arisen concerning the tax treatment of those costs. Putting them aside, in order to qualify for the deductions and allowances claimed, the investors had to spend in cash terms a little under $5,000 per plantable hectare in the 1997 year. In the 1998 year they had to spend only the $50 per plantable hectare licence fee.
Sham issues
[32] The Commissioner argued that the insurance arrangements were a sham so far as they involved the LAQCs associated with Dr Muir and Mr Bradbury, and Mr Bradbury himself. Those investors were distinguished from the other investors on the basis that through Dr Muir and Mr Bradbury their intention could be more confidently established than that of other investors who were not so closely implicated in the setting up of the mechanics of the Trinity scheme. Both Venning J and the Court of Appeal, the latter “by a narrow margin”, rejected the Commissioner’s sham argument.[33] He has raised the point again in this Court.
[33]At paras [225] of the High Court judgment and [63] of the Court of Appeal judgment.
[33] There is no need for us to engage in any extended discussion of what constitutes a sham for present purposes. In essence, a sham is a pretence. It is possible to derive the following propositions from the leading authorities.[34] A document will be a sham when it does not evidence the true common intention of the parties. They either intend to create different rights and obligations from those
evidenced by the document or they do not intend to create any rights or obligations, whether of the kind evidenced by the document or at all. A document which originally records the true common intention of the parties may become a sham if the parties later agree to change their arrangement but leave the original document standing and continue to represent it as an accurate reflection of their arrangement. A sham in the taxation context is designed to lead the taxation authorities to view the documentation as representing what the parties have agreed when it does not record their true agreement. The purpose is to obtain a more favourable taxation outcome than that which would have eventuated if documents reflecting the true nature of the parties’ transaction had been submitted to the Revenue authorities.
[34]Snook v London & West Riding Investments Ltd [1967] 2 QB 786 (CA); Paintin and Nottingham Ltd v Miller Gale and Winter [1971] NZLR 164 (CA) and NZI Bank Ltd v Euro-National Corporation Ltd [1992] 3 NZLR 528 (CA).
[34] It is important to keep firmly in mind the difference between sham and avoidance. A sham exists when documents do not reflect the true nature of what the parties have agreed. Avoidance occurs, even though the documents may accurately reflect the transaction which the parties intend to implement, when, for reasons to be discussed more fully below, the arrangement entered into gives a tax advantage which Parliament regards as unacceptable.
[35] We consider the Courts below were right to reject the Commissioner’s sham argument. Even if it were possible to sever the Bradbury and Muir LAQCs and Mr Bradbury himself from the other investors for present purposes, we are of the view that despite what can be said about the insurance arrangements for avoidance purposes, the documents evidencing them did not misrepresent the nature of the rights and obligations which the parties to them intended to enter into. Nor can it be said that the insurance arrangements were entered into, even by the Bradbury and Muir LAQCs and Mr Bradbury himself, without any intention of creating legal rights and obligations of the kind purportedly created.
[36] There is no need for us to traverse in any detail the reasons of the High Court and the Court of Appeal which led those Courts to this conclusion. The essence of the Court of Appeal’s reasoning was as follows:[35]
Although the issue whether the contracts between the taxpayers and CSI were truly by way of insurance did not loom large in the arguments before us, we should say that we see no reason to differ from the conclusion of the Judge. No doubt the purpose of the arrangement (at least when viewed from the point of view of the architects of the scheme) was not mitigation of risk and, as well, the arrangements made for CSI meant that it incurred no practical risk in relation to the wash up transactions. But the contract did nonetheless, as Venning J recognised, satisfy the requirements for an insurance contract at law. As well, while there were no doubt other mechanisms which would have been cheaper and at least as effective for mitigating the risk the taxpayers were taking as to the value of the forest on maturity, the actual mechanism that was chosen was insurance. We see no reason to treat this as mislabelling.
[35]At para [65].
[37] Venning J’s conclusion was expressed in this way:[36]
In the present case CSI exists. It has been issued with a licence to provide insurance. Contracts have been signed between CSI and Southern Lakes Forestry Limited for SLFJV. There is a Douglas Fir forest growing in Southland. The initial insurance premiums of $1,307 per hectare have been paid. It may be that CSI is not particularly sound financially, and also that Dr Muir (in particular) and Mr Bradbury had their own reasons for incorporating CSI and for fixing and controlling the insurance premiums to be paid to it but those reasons, while they may be relevant to other factors in the case, particularly the issue of whether the insurance arrangements are part of a tax avoidance arrangement, do not themselves support a finding of sham.
[36]At para [225].
[38] The Courts below correctly applied the law and arrived at concurrent findings with which we agree. In short, we consider it has not been shown that the parties to the relevant documents were intending to deceive the Commissioner as to the nature of their arrangement in respect of insurance or as to their intention to implement the insurance arrangements according to their tenor. The fact that the insurance arrangements were constructed in a way that, as will later be demonstrated, materially contributed to the whole Trinity scheme being characterised as a tax avoidance arrangement does not, according to proper principles of law, mean that the insurance aspect of the whole scheme was a sham. The fact that the insurance arrangements were put in place with the purpose or effect of obtaining a tax advantage does not mean they were a sham.
[39] The shifting nature of the Commissioner’s allegations of sham as this litigation proceeded, and the contradiction which derives from the Commissioner’s acceptance that the initial premium was prima facie deductible, makes it difficult for the Commissioner to sustain the proposition that the insurance arrangement was a sham. An allegation of sham, being akin to an allegation of fraud, should not be lightly made. Those engaging in a sham are in reality seeking to deceive others as to the true nature of what they have agreed and are intending to achieve. That is not shown here.
Specific tax concession issues
Licence premium and its deductibility
[40] Venning J held that, under the applicable legislation, the syndicate was not able to deduct as an expense in the 1998 year the amortised portion of the licence premium of $2,050,518 per plantable hectare. The Court of Appeal decided to the contrary, holding that the licence premium was deductible under the relevant specific provision, but subject to avoidance issues.
[41] The basis on which the deduction was claimed was that the licence premium was a payment for a capital asset for which depreciation could be claimed under the tax legislation. Section EG 1 of the Income Tax Act allows a taxpayer a deduction in an income year on account of depreciation for any “depreciable property” owned by the taxpayer during that year.[37] Section OB1 defines “depreciable property” as meaning property of the taxpayer which may reasonably be expected to decline in value while being used in deriving gross income or in carrying on a business for that
purpose. The definition, however, excludes “intangible property” unless it falls within the defined category of “depreciable intangible property”.[38]
[37]EG 1 Annual Depreciation Deduction
(1)Subject to this Act, a taxpayer is allowed a deduction in an income year for an amount on account of depreciation for any depreciable property owned by that taxpayer at any time during that income year.
[38]Section OB 1 states:
“Depreciable property”, in relation to any taxpayer, —
(a)Means any property of that taxpayer which might reasonably be expected in normal circumstances to decline in value while used or available for use by persons —
(i)In deriving gross income; or
(ii)In carrying on a business for the purpose of deriving gross income; but
(b)Does not include
…
(iv)Intangible property other than depreciable intangible property.
[42] The licence premium meets the requirements for deduction as long as the licence it relates to is “depreciable intangible property”. That term is defined to mean “intangible property of a type listed in Schedule 17” of the 1994 Act.[39] That schedule covers certain intangible property that, in broad terms, is described in the legislation, first, as having a finite useful life that can be estimated with reasonable certainty on its creation or acquisition, and secondly, which is at low risk of being used in tax avoidance schemes if made depreciable. One type of property specified in Schedule 17 is “the right to use land”.[40] Accordingly, the deductibility of the licence premium turns on whether it was to be paid for “the right to use land”. That phrase is not governed by, but must be interpreted in light of, the statutory description of “intangible property” of a type listed in Schedule 17.[41]
[39]Section OB 1 states:
“Depreciable intangible property” means intangible property of a type listed in Schedule 17, which Schedule describes intangible property that has —
(a)A finite useful life that can be estimated with a reasonable degree of certainty on the date of its creation or acquisition; and
(b)If made depreciable, a low risk of being used in tax avoidance schemes.
[40]Clause 4 of Schedule 17.
[41]Trustees of the Simkin Trust v Commissioner of Inland Revenue [2003] 2 NZLR 315 at para [18] (CA).
[43] Reading the definitions in this way, and putting aside at this stage the question of tax avoidance, which must be considered separately, we are satisfied that the effect of the legislative provisions is that the licence premium payable by the syndicate is depreciable property and deductible if, on the proper meaning of the words, the payment is for the “right to use land”. The words of description in Schedule 17 do not add any gloss to that meaning.
[44] The Commissioner contends that the syndicate is obliged to pay the “licence premium” for the right to share in the proceeds of the net stumpage and not for the right of the syndicate to gain access to the land. Mr White QC emphasised the obligatory nature of what the syndicate had to do in relation to establishing and maintaining the forest on the land. He submitted that these obligations were inconsistent with giving the syndicate a right of access to the land, in consideration for a substantial premium, in order to do this work. Access to the land was wholly incidental to the syndicate’s obligations and it did not make commercial sense for a premium to be paid for the right to enter the land to carry out obligations to the owner. These arguments reflected and developed the reasoning and conclusions of Venning J in the High Court.
[45] Mr Carruthers QC on the other hand argued that the Court of Appeal was right on this point. He submitted that, under the syndicate’s contracts with Trinity 3, the licence premium payment was for purposes that were capital in nature. The syndicate had the expectation that it would derive income through carrying out business operations under the licence. He submitted that the High Court had recharacterised the payment, in the guise of interpreting the contract in order to make commercial sense of it, and had done so wrongly by reference to concepts of economic equivalence. The High Court had thereby sought to transform what the syndicate was obliged to do into something different from what had been agreed, and on that basis had decided that the legal character of the licence premium was not for the use of Trinity 3’s land at all. Counsel submitted it was not open to the High Court to determine the nature of the payment for tax purposes in that way.
[46] Under the legislation the licence premium is deductible if it is for “a right to use land”. Whether that is the legal character of the payment of $2,050,518 per plantable hectare which is to be made in 2048 requires an analysis of the nature of the arrangements actually entered into. The Court must construe the relevant documents, in their commercial context, to ascertain the parties’ obligations to each other, as if it were determining a dispute between them over the meaning and effect of their contractual arrangements.[42]
[42]Commissioner of Inland Revenue v Renouf Corporation Ltd (1998) 18 NZTC 13,914 at p 13,919 (CA).
[47] In proceeding in this way, the Court must also respect the fact that frequently in commerce there are different means of producing the same economic outcome which have different tax consequences. When considering the application of a specific tax provision, before reaching any question of avoidance, the Court is concerned primarily with the legal structures and obligations the parties have created and not with conducting an analysis in terms of their economic substance and consequences, or of alternative means that were available for achieving the substantive result.
[48] On the other hand, it is the true meaning of all provisions in a contract that will determine the character of a transaction rather than the label given to it. The label “licence premium” is accordingly not what is important in the present case, but rather the true contractual nature of the legal rights for which payment is to be made and the effect of applying the tax legislation to a payment of that character. Once the nature of the contractual rights and obligations has been determined in this way, the specific provision can be applied.
[49] In the present case, Trinity 3, and Southern Lakes Forestry, as agent for the syndicate, entered into what they called an “Agreement to Grant Licence and Options” on 28 February 1997. They also entered into a “Licence Agreement” on 21 March 1997 and a “Modification of Agreement to Grant Licence and Options” on 25 July 1997. These three documents together set out the parties’ respective obligations in relation to the establishment, management and harvesting by the syndicate of the forest on the land.
[50] By clause 3.1 of the first of these agreements, in consideration for the syndicate’s agreement to pay the licence premium, Trinity 3 agreed:
to grant [the syndicate] a licence to use the Property for the purpose of carrying on the [syndicate’s] forestry business on the Property for a term and on the conditions set out in the Licence Agreement.
[51] Clause 17 of the second agreement precluded any use of the land except for purposes of establishing and maintaining a Douglas Fir forest and generally carrying out the syndicate’s forestry business on the land.
[52] Under the agreements, Trinity 3 retained ownership of the land and the trees at all times. The syndicate became obliged to enter into a management agreement with Pine Plan for the supply and planting of the forest. Pine Plan also assumed the role of managing the forest for the first five years. The agreements also provided for the licence premium of $2,050,518 per plantable hectare to be paid in 2048 and for the term of the licence and the annual licence fee.
[53] As the Court of Appeal pointed out,[43] it would have been open to the parties to set up their joint venture to produce the same economic consequence in a more straightforward way, which simply reflected that in return for planting and maintaining a forest on the land of Trinity 3, the syndicate was to receive a share of the eventual stumpage proceeds and certain options.
[43]At paras [100] – [101].
[54] The ultimate question on this aspect of the appeals is whether, under the agreements, the licence premium is paid for the right to use land in terms of the specific provision. The transaction has been set up on the basis that the syndicate assumes obligations to establish and maintain a forest on the land which remains in the ownership of Trinity 3. The syndicate receives the net proceeds when the forest is harvested but the payment of the premium is not linked to this benefit under the terms of the contracts. The licence provides the syndicate with the necessary access to Trinity 3’s land to perform its forestry obligations, for which it incurs the licence premium as a cost. To treat the agreement as linking the premium payment to the right to share in profits or the options would be to allow overall economic consequences to dictate the character of the payment. That character is plain on the terms of the documents. That the access is to enable the syndicate to perform obligations to the land-owner does not in any sense contradict the contractual terms. Nor does it make the legal construct something other than what on its face it is – a right of the taxpayer to go onto land to conduct an aspect of its business. In these circumstances the character of the payment, which the parties called a licence premium, is a “right to use land” within the terms of the specific provision. It follows that, subject to the issue of avoidance, the payment is deductible as depreciation on depreciable property.
Insurance premiums: deductibility and spreading
[55] It will be recalled that the syndicate members were contractually obliged to pay CSI an initial premium of $1,307 per plantable hectare in 1997, and a second premium of $32,791 per plantable hectare on or before 31 December 2047. At the time s DL 1(3) of the Income Tax Act provided that a person carrying on a forestry business in New Zealand could deduct, for the purpose of calculating assessable income, expenditure “by way of … insurance premiums … or other like expenses”.[44]
[44]Section BB 7 of the Act was a wider deduction provision to the same effect but does not require separate discussion.
[56] After considering the evidence and the legal nature of an insurance contract, Venning J held that both premiums were prima facie deductible under s DL 1(3).[45] The transactions were not shams and liability for the second premium had been “incurred” in 1997.[46] Hence, subject to avoidance and spreading issues, both premiums were deductible in 1997. For the reasons he gave, Venning J concluded that no spreading of the second premium throughout the period from 1997 to 2047 was required. The Court of Appeal differed from Venning J on this last point and held that the second premium could not be deducted in one sum in 1997 but had to be spread over the 50 year period of the policy.
[45]At para 186].
[46]At para [194].
[57] Absent sham, the Commissioner did not challenge Venning J’s prima facie deductibility conclusion in the Court of Appeal. The taxpayers have challenged in this Court the Court of Appeal’s spreading conclusion. Hence two aspects of the insurance premium issue are live in this Court: the spreading issue, which is a matter of statutory interpretation, and the contribution, if any, which the insurance arrangements make to the avoidance issue. This section of our reasons is concerned with the spreading issue, the practical implications of which will depend on the ultimate avoidance determination.
[58] The spreading issue turns on whether the second premium was “accrual expenditure” within the meaning and purposes of s EF 1[47] in the light of s EH 2. Accrual expenditure is defined in s OB 1. If the insurance premium comes within the s OB 1 definition, the premium could not be deducted in full in 1997. Rather, it had to be spread, with 2 per cent being deductible in each of the 50 years during which the policy ran. Spreading would, of course, heavily reduce the deductible amount in year one from 100 per cent of the premium to 2 per cent, and hence substantially reduce the amount individual investors could deduct in that year against their other income, either directly or through their LAQCs.
[47]EF 1 Accrual Expenditure
(1) Where any person has incurred any accrual expenditure —
(a)That expenditure is allowed as a deduction when it is incurred in accordance with this Act; and
(b)The unexpired portion of that expenditure at the end of an income year shall be included in the gross income of the person for that income year and shall be allowed as a deduction in the following income year.
[59] Section OB 1 provided that accrual expenditure, that is, expenditure which had to be spread, meant any deductible expenditure other than expenditure incurred in respect of any financial arrangement.[48] So, to avoid spreading under s EF 1, the taxpayers had to show that the insurance premium was expenditure in respect of a financial arrangement.
[48]“Accrual expenditure”, in sections EF 1 and FE 4, in relation to any person, means any amount of expenditure incurred … by the person that is allowed as a deduction under this Act … other than expenditure incurred —
…
(b)In respect of any financial arrangement;
[60] Financial arrangement was defined in s OB 1:
“Financial arrangement”—
(a) Subject to paragraph (b), means—
(i) Any debt or debt instrument; and
(ii)Any arrangement (whether or not such arrangement includes an arrangement that is a debt or debt instrument, or an excepted financial arrangement) whereby a person obtains money in consideration for a promise by any person to provide money to any person at some future time or times, or upon the occurrence or non-occurrence of some future event or events (including the giving of, or failure to give, notice); and
(iii)Any arrangement which is of a substantially similar nature (including, without restricting the generality of the preceding provisions of this subparagraph, sell-back and buy-back arrangements, debt defeasances, and assignments of income);—
but does not include any excepted financial arrangement that is not part of a financial arrangement: [emphasis added].
[61] A contract of insurance comes within paras (a)(i) and (a)(ii). So the effect of the final words we have emphasised is crucial.
[62] As the Court of Appeal said:[49]
The double negative at the end of this definition obscures the meaning intended by Parliament. Further, the definition does not seem to make sense unless the word “wider” is interposed before “a financial arrangement”. We treat this part of the definition as if it read:
but does not include any excepted financial arrangement unless it is part of a wider financial arrangement.
[49]At para [69].
[63] The expression “excepted financial arrangement”, as defined, included a contract of insurance. Hence a contract of insurance was an excepted financial arrangement. The effect of the crucial words is, however, that a contract of insurance is not included within the definition of financial arrangement when it is entered into in isolation of any wider financial arrangement. But it is common ground that the contract of insurance in the present case was entered into as part of a wider financial arrangement. That being so, the present insurance contract is not excluded by the crucial words from the definition of financial arrangement. It is a financial arrangement for the purposes of s OB 1. It is therefore outside the reach of the definition of accrual expenditure and the spreading rules do not apply to it.
[64] In summary, insurance contracts are within the principal definition of financial arrangement. They are then taken out of that definition because they are excepted financial arrangements. But they are brought back in again if they are, as here, part of a wider financial arrangement. The end result is that the insurance contracts in this case were within the definition of financial arrangement and therefore excluded from the definition of accrual expenditure. Hence the premium did not have to be spread.
[65] The Court of Appeal nevertheless concluded[50] that the insurance premium was not excepted from the definition of “accrual expenditure” in s OB 1 because of the application of s EH 2, which states:
EH 2 Excepted Financial Arrangement that is Part of Financial Arrangement
The amount of the gross income deemed to be derived or the expenditure deemed to be incurred by a person in respect of a financial arrangement under the qualified accruals rules shall not include the amount of any income, gain or loss, or expenditure, that is solely attributable to an excepted financial arrangement that is part of the financial arrangement.
[50]At paras [71] and [72].
With respect the Court of Appeal’s approach is not correct. There are two accrual regimes in the Act. One is provided by s EF 1, requiring spreading on a straight line basis, ie 2 per cent per year over the 50 years. The other is the Financial Arrangements “qualified” accruals regime in Part EH of the Act that requires the yield to maturity approach. When these separate regimes are kept in mind, the logic of the exclusions is more easily appreciated.
[66] Section EF 1 relates to defined “accrual expenditure”. The definition in s OB 1 is expressly for the purposes of ss EF 1 and FE 4 (not part EH) and excludes expenditure incurred in respect of any financial arrangement. That exclusion from the application of s EF 1 is understandable because there is a separate accruals regime for financial arrangements. That part EH regime, however, does not apply to “excepted financial arrangements” as defined in s OB 1 to include a contract of insurance.
[67] As part of his argument the Commissioner contended that s EH 2 negated the operation of the exclusion for financial arrangements in the definition of “accrual expenditure” for the purposes of s EF 1. But s EH 2, in its express terms, is directed to the Financial Arrangements “qualified” accruals regime and merely maintains the exclusion from that of excepted financial arrangements, even when part of a wider financial arrangement. We do not see s EH 2 as relating in any way to the definition of “accrual expenditure” in s OB 1. We consider the Court of Appeal erred in accepting the Commissioner’s argument to this effect.
[68] It is unnecessary to go into the competing arguments in any greater detail as the whole spreading issue in this case is rendered moot by the conclusion, to which we come later, that the insurance contracts were part of a tax avoidance arrangement. Hence the insurance premiums were, for that reason, not deductible on any basis.
Tax avoidance: legislative provisions
[69] Section BG 1 is currently the principal general anti-avoidance provision in the 1994 Act. It provides:
BG 1 AVOIDANCE
Arrangement void
(1)A tax avoidance arrangement is void as against the Commissioner for income tax purposes.
Enforcement
(2)The Commissioner, in accordance with Part G (Avoidance and Non-Market Transactions), may counteract a tax advantage obtained by a person from or under a tax avoidance arrangement.
This section must be read with the definitions in s OB 1 of “arrangement”, “tax avoidance” and “tax avoidance arrangement”:
“Arrangement” means any contract, agreement, plan, or understanding (whether enforceable or unenforceable), including all steps and transactions by which it is carried into effect:
“Tax avoidance”, in sections BG 1, EH 1, GB 1, and GC 12, includes—
(a)Directly or indirectly altering the incidence of any income tax:
(b)Directly or indirectly relieving any person from liability to pay income tax:
(c)Directly or indirectly avoiding, reducing, or postponing any liability to income tax:
“Tax avoidance arrangement” means an arrangement, whether entered into by the person affected by the arrangement or by another person, that directly or indirectly—
(a)Has tax avoidance as its purpose or effect; or
(b)Has tax avoidance as one of its purposes or effects, whether or not any other purpose or effect is referable to ordinary business or family dealings, if the purpose or effect is not merely incidental:
[70] Closely associated with these provisions is a provision conferring consequential powers of reconstruction when an arrangement is void. Section GB 1 relevantly provides:
GB 1 Agreements purporting to alter incidence of tax to be void
(1)Where an arrangement is void in accordance with section BG 1, the amounts of gross income, allowable deductions and available net losses included in calculating the taxable income of any person affected by that arrangement may be adjusted by the Commissioner in the manner the Commissioner thinks appropriate, so as to counteract any tax advantage obtained by that person from or under that arrangement, and, without limiting the generality of this subsection, the Commissioner may have regard to —
(a)Such amounts of gross income, allowable deductions and available net losses as, in the Commissioner’s opinion, that person would have, or might be expected to have, or would in all likelihood have, had if that arrangement had not been made or entered into; or
(b)Such amounts of gross income and allowable deductions as, in the Commissioner’s opinion, that person would have had if that person had been allowed the benefit of all amounts of gross income, or of such part of the gross income as the Commissioner considers proper, derived by any other person or persons as a result of that arrangement.
In these reasons we refer to these provisions in combination as “the general anti-avoidance provision”. The case was argued, and we proceed on the basis of the general anti-avoidance provision as it stood following the Taxation (Core Provisions) Act 1996.[51]
Tax avoidance: legal principles
Legislative history
[51]The provision that applied in the 1997 year was s BB 9 rather than s BG 1 but counsel were agreed that there was no meaningful difference.
[71] As mentioned in our introduction, there has been a general anti-avoidance provision in New Zealand tax legislation since 1878.[52] For some years the focus of successive legislative provisions was on agreements having the purpose or effect of defeating or evading land tax. In 1891 that was extended to cover income tax.[53] In 1916 tax evasion was addressed separately and a redrafted provision was directed to tax avoidance.[54] The form of the 1916 provision was followed without material change until 1974.
[52]Section 62 of the Land Tax Act 1878.
[53]Section 40 of the Land and Income Tax Assessment Act 1891.
[54]Section 162 of the Land and Income Assessment Act 1916.
[72] The provision in force, when the Inland Revenue Department began actively to enforce the provision in the courts during the 1960s, was s 108 of the Land and Income Tax Act 1954 which provided:
Every contract, agreement, or arrangement made or entered into, whether before or after the commencement of this Act, shall be absolutely void in so far as, directly or indirectly, it has or purports to have the purpose or effect of in any way altering the incidence of income tax, or relieving any person from his liability to pay income tax.
[73] In 1958 the Privy Council delivered its judgment on the equivalent Australian provision in Newton v Commissioner of Taxation of the Commonwealth of Australia.[55] Two of its findings were of particular importance to the ensuing New Zealand decisions on s 108. First, the Privy Council considered what the Australian provision meant when referring to “the purpose or effect” of an arrangement:[56]
The word “purpose” means, not motive but the effect which it is sought to achieve – the end in view. The word “effect” means the end accomplished or achieved. The whole set of words denotes concerted action to an end – the end of avoiding tax.
[55][1958] AC 450. The advice of the Judicial Committee was written by Lord Denning. The Australian provision was s 260 of the Income Tax and Social Services Contribution Assessment Act 1936 – 1951 (Cth). This provision was replaced in 1981 by Part IVA of the Income Tax Assessment Act 1936 (Cth). This new scheme is significantly more elaborate and detailed than the earlier s 260.
[56]At p 465.
[74] Second, in relation to concerns over the type of transactions that might be caught by such breadth of meaning, Lord Denning, for the Privy Council, said of the words of the Australian provision:[57]
They show that the section is not concerned with the motives of individuals. It is not concerned with their desire to avoid tax, but only with the means which they employ to do it … In order to bring the arrangement within the section you must be able to predicate – by looking at the overt acts by which it was implemented – that it was implemented in that particular way so as to avoid tax. If you cannot so predicate, but have to acknowledge that the transactions are capable of explanation by reference to ordinary business or family dealing, without necessarily being labelled as a means to avoid tax, then the arrangement does not come within the section.
[57]At pp 465 – 466.
[75] An early and influential judgment in New Zealand at first instance was that of Woodhouse J in Elmiger v Commissioner of Inland Revenue.[58] Woodhouse J pointed out that difficulties arose in determining the general limits of s 108’s application because the legislature adopted a “method of general proscription”.[59] He went on to say:[60]
This is, of course, a problem of definition and one which is peculiarly complicated by the fact that nearly all dispositions of property or income must carry with them some consequential effect upon income tax liabilities. In relation to s 108 it is necessary, therefore, to find some suitable way of testing the purposes and effect of contracts, agreements or arrangements, against the words of the section; and this is not a need which can be resolved by a possibly over-confident belief in some intuitive capacity to place a particular arrangement on one side of the line or the other.
[58][1966] NZLR 683 (SC).
[59]At p 687.
[60]At pp 687 – 688.
[76] In applying the approach adopted in Newton he said:[61]
[I]t is my opinion that family or business dealings will be caught by s 108 despite their characterisation as such, if there is associated with them the additional purpose or effect of tax relief (in the sense contemplated by the section) pursued as a goal in itself and not arising as a natural incident of some other purpose. If this were not so I suppose an appropriate legal window dressing could still be devised to defeat the general objects of the section.
[61]At p 694.
[77] The Judge applied s 108 because at least one purpose of the transaction was to diminish income by facilitating deductions and thereby reducing liability to tax. This approach was generally upheld by the Court of Appeal,[62] which decided that s 108 operated fiscally as well as between parties.[63] It also decided that it applied to both accrued and future liabilities.[64]
[62]Elmiger v Commissioner of Inland Revenue [1967] NZLR 161.
[63]At pp 181 – 182 per North P, at pp 187 – 188 per Turner J and at p 190 per McCarthy J. This conclusion was later confirmed by the Privy Council in Mangin v Commissioner of Inland Revenue [1971] NZLR 591 at p 595.
[64]At p 182 per North P.
[78] In a dissenting judgment delivered in 1970 in Mangin v Commissioner of Inland Revenue,[65] Lord Wilberforce made a number of criticisms of the drafting of s 108 which he said had created difficulties in the interpretation of the section. His general criticism was that the section, which had been drafted initially to deal with land tax, had to be approached “without any predisposition to believe it adequately embodies or gives effect to modern fiscal policy”.[66] It had been abbreviated in 1916 with the result that it arguably covered less ground than the more comprehensively expressed Australian provision. With only minor changes from its original form, it had to confront all the sophistications of modern tax avoidance.[67]
[65][1971] NZLR 591 (PC).
[66]At p 601.
[67]At pp 601 – 602.
[79] These criticisms of the legislation were echoed in the Court of Appeal in 1974 by McCarthy P.[68] He described s 108 as being “notoriously difficult”, adding:[69]
It cannot be given a literal application, for that would … result in the avoidance of transactions which were obviously not aimed at by the section. So the Courts had to place glosses on the statutory language in order that the bounds might be held reasonably fairly between the Inland Revenue authorities and taxpayers.
[68]Commissioner of Inland Revenue v Gerard [1974] 2 NZLR 279.
[69]At p 280.
The President called on the Legislature to state in precise language what classes of transactions should be struck down.[70]
Legislative change in 1974
[70]At pp 280 – 281.
[80] Changes effected to s 108 in 1974[71] went some way to addressing the judicial concerns. They confirmed that s 108 had fiscal effect by stating that the arrangement was absolutely void as against the Commissioner for income tax purposes.[72] The Commissioner was also empowered to adjust the assessable income of any person affected by the arrangement so as to counteract any tax advantage obtained by that person under the arrangement. This solved two problems. First, it provided the Commissioner with reconstruction powers after s 108 had been used to defeat an arrangement. The lack of such powers had caused problems in Commissioner of Inland Revenue v Gerard.[73] It also confirmed what had been decided in Commissioner of Inland Revenue v Ashton and Wheelans,[74] that s 108 applied whether or not the taxpayer was a party to the arrangement.[75]
[71]By s 9 of the Land and Income Tax Amendment (No 2) Act 1974.
[72]As decided in Elmiger (CA) and in Mangin (PC). See para [77] above.
[73][1974] 2 NZLR 279 (CA).
[74][1974] 2 NZLR 321 at p 329 (CA).
[75]Turner J had expressed a contrary view in Wisheart, Macnab and Kidd v Commissioner of Inland Revenue [1972] NZLR 319 at p 327 (CA).
[81] The changes to s 108 went some way towards clarifying the types of transactions that the section was intended to cover. The tax avoidance definition was extended to cover a wider range of tax advantages that could amount to tax avoidance, largely bringing it into line with the Australian provision.[76] The section also expressly included future income and potential liability, reflecting one of Lord Wilberforce’s criticisms.[77] The new definition of “tax avoidance arrangement” included an arrangement where one of its purposes was tax avoidance, that not being a “merely incidental” purpose. At the same time the legislation dispensed with Lord Denning’s predication test in Newton by stating that an arrangement could amount to tax avoidance whether or not other purposes or effects of the arrangement were referable to ordinary business or family dealings.
[76]This resolved issues raised in Elmiger (CA) and Mangin (PC).
[77]In Mangin (PC) at p 602 and earlier in Elmiger per North P at p 182 (CA).
[82] One of four particular concerns raised by Lord Wilberforce in Mangin, which he saw as contributing to the uncertainty in the meaning and application of s 108 was:[78]
(c)It fails to specify the relation between the section and other provisions in the Income Tax legislation under which tax reliefs, or exemptions, may be obtained. Is it legitimate to take advantage of these so as to avoid or reduce tax? What if the only purpose is to use them? Is there a distinction between “proper” tax avoidance and “improper” tax avoidance? By what sense is this distinction to be perceived?
[78]At p 662.
[83] The amendments to s 108 in 1974 did not, however, explicitly address how to discern the relationship between allowing tax concessions for certain arrangements and the general anti-avoidance provision, which struck down arrangements having a purpose of tax avoidance that was not merely incidental. The amended form of s 108 was substantively carried through to the subsequent general anti-avoidance provisions, initially as s 99 of the Income Tax Act 1976 and currently as ss BG 1 and GB 1 of the Income Tax Act 1994.The result is that this difficulty remains, and is the central issue in this case.
Challenge Corporation and purposive interpretation
[84] The first real opportunity for the Court of Appeal to address the effect of the 1974 changes to the general anti-avoidance provision was in the 1985 decision of Challenge Corporation Ltd v Commissioner of Inland Revenue.[79] Woodhouse P directly considered these changes. He concluded that s 99(2) was designed to catch an arrangement having a tax avoidance purpose, even if it had another real purpose which was not tax avoidance.[80] Where, however, tax avoidance was a “merely incidental” purpose of an arrangement, the statute provided that it should be disregarded in applying s 99. As Woodhouse P saw it, s 99 was reconciled with the operation of relevant specific provisions as long as any purpose of tax avoidance was “merely incidental” to a taxpayer’s other purpose. This required that it be necessarily linked, without contrivance, as a natural concomitant of the other purpose.[81] Woodhouse P saw the breadth of those qualifying words and the ambit of the section, as raising a question of fact and degree in each case.[82]
[79][1986] 2 NZLR 513 from p 529.
[80]At p 533.
[81]At p 533.
[82]At p 534.
[85] In Challenge Corporation the arrangement involved the taxpayer taking into its group an unconnected company with no assets or debts but having a large deductible loss. The loss was then transferred, using a specific provision, to other subsidiaries in order to reduce the assessable income of the group. Woodhouse P concluded that the sole purpose of this arrangement was to obtain a tax saving. Accordingly he decided it was caught by s 99. Woodhouse P’s approach was based on the view that the legislative response in 1974 to the question of when it was legitimate to take advantage of specific legislative entitlements to avoid tax, lay in the exclusion of “merely incidental” purposes.
[86] Richardson J’s judgment in Challenge Corporation took a different view of s 99(2). He accepted that the 1974 legislation had confirmed the central importance of s 108 in the scheme of New Zealand tax legislation,[83] but concluded that the 1974 amendment had not resolved earlier uncertainties in the application of the general anti-avoidance provision. In particular, the legislation had not defined its relationship with specific deduction provisions. It remained the task of the Court to resolve the question whether there was a distinction between proper and improper tax avoidance.[84] He accepted that the influence of taxation considerations in many ordinary business activities could never be regarded as a “merely incidental” purpose or effect.[85] The qualification in s 99(2) excluding arrangements in which the tax avoidance purpose was “merely incidental” did not apply to this issue.
[83]At p 545 Richardson J said that the 1974 legislative changes indicated that s 108, re-enacted as s 99, was perceived legislatively as “an essential pillar of the tax system designed to protect the tax base and the general body of taxpayers from what are considered to be unacceptable tax avoidance devices”.
[84]At p 548.
[85]At pp 548 – 549.
[87] Richardson J saw the problem as requiring reconciliation of provisions in tax legislation which were in tension. He said:[86]
[86]At p 549.
Section 99 thus lives in an uneasy compromise with other specific provisions of the income tax legislation. In the end the legal answer must turn on an overall assessment of the respective roles of the particular provision and s 99 under the statute and of the relation between them. That is a matter of statutory construction and the twin pillars on which the approach to statutes mandated by s 5(j) of the Acts Interpretation Act 1924 rests are the scheme of the legislation and the relevant objectives of the legislation. Consideration of the scheme of the legislation requires a careful reading in its historical context of the whole statute, analysing its structure and examining the relationships between the various provisions and recognising any discernible themes and patterns and underlying policy considerations.
Later he added:[87]
For the inquiry is as to whether there is room in the statutory scheme for the application of s 99 in the particular case. If not, that is because the state of affairs achieved in compliance with the particular provision relied on by the taxpayer is not tax avoidance in the statutory sense. Reading s 99 in this way is to give it its true purpose and effect in the statutory scheme and so to allow it to serve the purposes of the Act itself. It is not the function of s 99 to defeat other provisions of the Act or to achieve a result which is inconsistent with them.
Later again he observed in relation to the type of liability that s 99 attacked:[88]
A complicating fact is that every financial transaction of the taxpayer may effect a tax change and it is not to be supposed that the potential or prospective liability in respect of future income to which the definition refers was intended to have that reach. On the contrary, if the analysis of which I have been speaking leads to the conclusion that there is no room for the application of s 99, that is because the tax change which has occurred has not affected the liability to income tax which the Act itself contemplates.
[87]At p 549.
[88]At p 550.
[88] In Challenge Corporation, Richardson J decided that taking advantage of the statutory provisions in relation to the tax treatment of subvention payments was consistent with the very specific scheme and purpose of the statutory provisions relating to grouping of companies and treatment of losses. These provisions had no purpose but to allow an offset for tax purposes. The transactions contemplated were simply tax concepts which had no reality except in relation to income tax.[89] Parliament could not have intended that s 99 would deprive taxpayers of a specific structure provided for by the Act. Richardson J held, in effect, that literal compliance
met the statutory purposes and it was not necessary for him to take into consideration the circumstances in which the loss company became part of the group. It was not consistent with the statutory purposes to treat such subvention arrangements as tax avoidance.[90][89]At pp 552 – 554.
[90]At p 555.
[89] The effect was to reconcile conflicting provisions by reading down the scope of s 99 so that it did not operate on arrangements that complied with the particular specific provision in the legislation. The scheme and purpose of the legislation required that s 99 be read in the context of the special concession provisions which were dominant.
[90] Cooke J agreed with the judgment of Richardson J in the result, but not on the scope of s 99. Cooke J considered s 99 to be more extensive in its wording and effect than the old s 108, especially in the breadth of the defined term “tax avoidance”.[91] He would have applied the general anti-avoidance provision but for the effect of a further specific, but confined, anti-avoidance provision, which displaced s 99 in relation to the specific provisions in issue.[92]
[91]At p 541.
[92]At p 543.
[91] On appeal, the Privy Council[93] took a view which differed from that of the majority on the impact of the specific anti-avoidance provision. The Court of Appeal’s judgment was reversed and s 99 was applied to avoid the transaction. The Board treated the case as one of “tax avoidance” in contrast to “tax mitigation”.[94] A tax avoidance arrangement was one where a taxpayer derived a tax advantage from a transaction without suffering the reduction in income, loss or expenditure which Parliament intended those qualifying for a reduction in tax liability to suffer.[95]
[93]Challenge Corporation Ltd v Commissioner of Inland Revenue [1986] 2 NZLR 513 from p 555.
[94]At pp 560 – 561.
[95]At p 561.
[92] As well, in delivering the judgment of the majority of the Privy Council, Lord Templeman rejected an argument that satisfaction of the requirements of the specific statutory provisions concerning subvention payments excluded s 99:[96]
That argument cannot be correct. Tax avoidance schemes largely depend on the exploitation of one or more exemptions or reliefs or provisions or principles of tax legislation. Section 99 would be useless if a mechanical and meticulous compliance with some other section of the Act were sufficient to oust s 99. Richardson J, giving judgment in the Court of Appeal in favour of Challenge, nevertheless recognised that “s 99 would be a dead letter if it were subordinate to all the specific provisions of the legislation”.
[96]At p 559.
[93] Finally, the Privy Council took a different view of the outcome of the application of the scheme and purpose approach. Lord Templeman classified the circumstances as tax avoidance, and not tax mitigation, because the Challenge group “never suffered the loss … which would entitle them to a reduction in their tax liability”.[97] Earlier, the Privy Council had said that s 191 of the 1976 Act, the specific provision, “was intended to give effect to the reality of group profits and losses”.[98] The reality was that the Challenge group did not make a loss. There was, therefore, a failure to construct the transaction in a way that met the purpose of s 191. It was that element in the transaction that meant s 99 applied to strike down an arrangement which otherwise complied with s 191.
[97]At p 562.
[98]At p 558.
[94] The Privy Council majority accepted the central importance of the scheme and purpose of the specific provision. But it differed from Richardson J’s conclusions on the application of that approach to the case. The Privy Council did not accept that on a purposive approach the application of s 99 could be limited in a way that ignored the economic reality of the transaction as contemplated by the specific provision. For a profitable company to buy into the shareholding of a loss company outside its group, and then to offset those losses, involved “pretence”. When a taxpayer sought to obtain a tax advantage without suffering the cost Parliament intended be suffered, this would amount to tax avoidance.[99]
[171] Furthermore, when taxpayers challenge an assessment based on a reconstruction adopted by the Commissioner, the onus is on them to demonstrate, not only that the reconstruction was wrong, but also by how much it was wrong. Unless the taxpayer can demonstrate with reasonable clarity what the correct reconstruction ought to be, the Commissioner’s assessment based on his reconstruction must stand. This is settled law.[144] In this case we are of the view that the appellants have not shown that the Commissioner’s assessment based on his reconstruction was wrong. Even if they had shown that to be so, they have not shown on any reasonably clear basis to what extent it should be varied. The appellants did not submit any specific proposed reconstruction of their own, the validity of which the Court could then have evaluated. The Commissioner’s assessment must therefore stand.
Penalties
General
[144]Buckley & Young v Commissioner of Inland Revenue [1978] 2 NZLR 485 at p 498 (CA). See also to the same effect Commissioner of Taxes v McCoard [1952] NZLR 263 (SC).
[172] In 1996 a new regime of civil penalties for failures by taxpayers to comply with their tax obligations in relation to self-assessment was introduced in the Tax Administration Act 1994.[145] Part 9 of that Act was repealed and substituted by the new provisions.
[145]By s 43 of the Tax Administration (No 2) Act 1996.
[173] Having concluded that they had each taken an abusive tax position resulting in a tax shortfall, the Commissioner assessed the appellants with a penalty of 100 per cent of the tax shortfall in the 1998 year. The legislation empowering the imposition of penalties did not apply to the 1997 year. The imposition of these penalties was challenged in the High Court where Venning J addressed a number of wide ranging arguments. He decided that the appellants had incorrectly claimed deductions for the licence premium and insurance premium in their relevant returns and that the tax position they had taken did not meet the statutory standard of being “about as likely as not to be correct” at the time of filing the return.[146] He also held that the incorrectness of the position taken was due to the general anti-avoidance provision and that the appellants entered the Trinity scheme with the dominant purpose of tax avoidance.[147] It followed that the Commissioner’s assessment was a lawful exercise of his powers and the appellants’ challenge was dismissed. Venning J’s judgment on this point was upheld by the Court of Appeal on the general anti-avoidance ground.[148]
[146]At para [365].
[147]At para [370].
[148]At paras [168] and [170].
[174] The scheme of Part 9 is to impose civil penalties on taxpayers who take an incorrect tax position which results in a tax shortfall. The provisions impose specified penalties, based on varying percentages of the resulting tax shortfall, which are set by the statute itself, according to the relative culpability of the taxpayer. At one end of the scale are instances where the taxpayer has not taken reasonable care where the penalty is 20 per cent.[149] Where the taxpayer is grossly careless, the penalty is 40 per cent.[150] At the other end is evasion where the penalty is 150 per cent.[151] In the appellants’ case the penalties were imposed under s 141D which applies where the taxpayer has taken an “abusive tax position”. The penalty in such cases is 100 per cent of the tax shortfall.
[149]Section 141A.
[150]Section 141C.
[151]Section 141E.
[175] Section 141D states as follows:
141D Abusive Tax Position
(1)The purpose of this section is to penalise those taxpayers who, having applied an unacceptable interpretation to a tax law, have entered into or acted in respect of arrangements or interpreted or applied tax laws with a dominant purpose of taking, or of supporting the taking of, tax positions that reduce or remove tax liabilities or give tax benefits.
(2)A taxpayer is liable to pay a shortfall penalty if the taxpayer takes an abusive tax position (referred to as an abusive tax position).
(3)The penalty payable for taking an abusive tax position is 100% of the resulting tax shortfall.
(4)This section applies to a taxpayer only if —
(a)The taxpayer’s tax position involves an unacceptable interpretation of a tax law; and
(b)The tax shortfall arising from the taxpayer’s tax position exceeds $10,000.
(5)Section 141B(6) applies for determining the time when a taxpayer takes an abusive tax position.
(6)A taxpayer’s tax position may be an abusive tax position if the tax position is an incorrect tax position under, or as a result of, either or both of —
(a)A general tax law; or
(b)A specific or general anti-avoidance tax law.
(7)For the purposes of this Part, an abusive tax position means a tax position that, —
(a)At the time at which the taxpayer’s tax position is taken, involves the taking of an unacceptable interpretation of a tax law; and
(b)Viewed objectively, the taxpayer takes —
(i)In respect, or as a consequence, of an arrangement that is entered into with a dominant purpose of avoiding tax, whether directly or indirectly; or
(ii)Where the tax position does not relate to an arrangement described in subparagraph (i), with a dominant purpose of avoiding tax, whether directly or indirectly.
[176] There are three requirements to be met before a taxpayer will be found to have adopted an “abusive tax position”. First, a taxpayer must have taken a tax position which involves an “unacceptable interpretation of a tax law”.[152] An unacceptable interpretation is an interpretation or application of that tax law which “fails to meet the standard of being … about as likely as not to be correct” when viewed objectively.[153] Whether an interpretation is unacceptable is determined at the time the tax position is taken by the taxpayer.[154] In the case of positions taken in tax returns, the tax position is taken when the taxpayer provides the return.[155] Secondly the tax position must be one that, viewed objectively, is taken by the taxpayer in respect, or as a consequence, of an arrangement that is entered into with a dominant purpose of avoiding tax, whether directly or indirectly.[156] Alternatively, where there is no arrangement, the tax position itself must be taken by the taxpayer for that dominant purpose.[157] Thirdly, the provision imposing a penalty for taking an abusive tax position applies only if the tax shortfall arising from the taxpayer’s tax position exceeds $10,000.[158] That requirement is satisfied for all appellants in the present case.
[152]Section 141D(4) and (7)(a).
[153]Section 141B(1)(b).
[154]Section 141B(5).
[155]Section 141B(6).
[156]Section 141D(7)(b)(i).
[157]Section 141D(7)(b)(ii).
[158]Section 141D(4).
[177] The penalty provisions, particularly at the higher end of the scale, are onerous. This reflects Parliament’s statement of the purposes of Part 9, which are:[159]
(a)To encourage taxpayers to comply voluntarily with their tax obligations and to cooperate with the Department; and
(b)To ensure that penalties for breaches of tax obligations are imposed impartially and consistently; and
(c)To sanction non-compliance with tax obligations effectively and at a level that is proportionate to the seriousness of the breach.
[159]Section 139.
[178] The broad statutory goal of the penalty provisions is to secure compliance by taxpayers with their legal obligations in relation to the positions they take regarding their tax affairs. Part 9 supports the integrity of the tax system in its dependence on voluntary compliance by taxpayers with their responsibility to inform the Revenue concerning their tax affairs in a proper and accurate way. It provides sanctions which increase in severity according to the gravity of the circumstances of what the legislation treats as inappropriate tax positions. These sanctions create strong incentives for taxpayers to meet standards of conduct in their tax affairs, in particular in relation to tax positions that may be characterised as involving tax avoidance or evasion.
[179] The Act imposes penalties under Part 9 if the statutory requirements are met. In deciding whether those requirements are met, the Commissioner exercises a judgment, which is akin to making findings based on evidence, as to whether the elements of, in this case, an abusive tax position are made out. The limited role for discretionary judgment in the Commissioner’s decision-making on penalties reflects the purpose of ensuring there is impartiality and consistency in the imposition of penalties.[160]
[160]As set out in s 139(b).
[180] The standard of proof in civil proceedings relating to the imposition of penalties is the balance of probabilities.[161] The penalties under Part 9 are, however, severe, particularly for those taking incorrect tax positions at the more serious end of the scale. This includes the penalties for those taking an abusive tax position. The evidence required to meet the standard will accordingly reflect the seriousness of the circumstances of the particular case.[162] We also agree with an academic writer that when it is considering whether penalties have been correctly imposed, a court must give the matter the careful consideration appropriate in a penal context.[163] Subject to that, the penalty provisions must be read in light of the statement of statutory purposes for Part 9.
Unacceptable interpretation
[161]Section 149A(1).
[162]ZvDental Complaints Assessment Committee [2009] 1 NZLR 1(SC).
[163]Griffith, “Tax Penalties” [2008] NZLJ 223.
[181] Applying these principles, the first issue in deciding if the appellants took an abusive tax position in their 1998 year returns, is whether the interpretation of tax law on which those returns were based was an unacceptable one. The term “unacceptable interpretation” is defined in the legislation:
141B Unacceptable Interpretation
(1)For the purposes of this Part, an unacceptable interpretation of a tax law is, in relation to a tax position taken by a taxpayer, an interpretation that —
(a)Involves the interpretation or application of that tax law; and
(b)Fails to meet the standard of being, viewed objectively, about as likely as not to be correct.
[182] We have decided, in relation to the claims for deductions with respect to the licence premium and insurance premium, that the expenditure in each case satisfied the ordinary meaning of the specific provisions relied on. Satisfying the specific provisions on their own, however, was not enough. The appellants were unable to show that they had been used in a manner consistent with Parliament’s overall purpose in enacting them. There were features in the arrangement which led us to conclude that the arrangement was clearly a tax avoidance arrangement. The effect of this conclusion in terms of s 141D(6) is that the appellants in their returns took an incorrect tax position under a general anti-avoidance tax law.
[183] The next question in relation to the abusive tax position issue is whether the incorrect interpretation failed to meet the standard of, objectively, being “about as likely as not to be correct”. If so, the incorrect tax position will involve an “unacceptable interpretation” under s 141B(1).
[184] On its terms this standard does not require that the appellants’ tax position had a 50 per cent prospect of success but, subject to that qualification, the merits of the arguments supporting the taxpayer’s interpretation must be substantial. The stipulation of an objective test means that the taxpayer’s belief that the position taken was correct, or not unacceptable, is irrelevant.
[185] There is a helpful observation of Hill J concerning the statutory standard made in the context of a similar provision in Australian legislation:[164]
The word “about” indicates the need for balancing the two arguments, with the consequence that there must be room for it to be argued which of the two positions is correct so that on balance the taxpayer’s argument can be said to be one that while wrong could be argued on rational grounds to be right.
[164]Walstern Pty Ltd v Commissioner of Taxation (2003) 138 FCR 1 at para [108] (FCA).
Whether a taxpayer’s interpretation meets the standard in any case accordingly comes down to a judgment of the weight of the arguments that support the taxpayer’s position in the application of the law to the relevant facts. The Act requires that the application of all tax laws, including the general anti-avoidance provision, be taken into account in making this judgment.[165] As well, discussions of the courts and Taxation Review Authority on the interpretation of relevant tax laws must be considered.[166]
[165]Section 141B(7)(a).
[166]Section 141B(7)(b).
[186] On behalf of the appellants, Mr Harley put the argument that the appellants’ tax position was based on an interpretation of tax law that met the “about as likely as not to be correct” standard in this way. The first premise was that the expenses for which deductibility was claimed, being the licence premium and insurance premiums, met the terms of the specific deductibility provisions. This Court has accepted that premise to be correct. The next premise is that the expenses were genuinely incurred in a business in the years in issue, with the consequence, on the authority of the Privy Council’s judgments in the two Europa Oil cases,[167] that the general anti-avoidance provision did not override those specific provisions for deductibility. Much emphasis was placed by Mr Harley on the key passage in the Europa 2 judgment, said to be directly in point:[168]
Their Lordships’ finding that the monies paid by the taxpayer company to Europa Refining is deductible under s 111 as being the actual price paid by the taxpayer company for its stock-in-trade under contracts for the sale of goods entered into with Europa Refining, is incompatible with those contracts being liable to avoidance under s 108. In order to carry on its business of marketing refined petroleum products in New Zealand the taxpayer company had to purchase feedstocks from someone. In respect of these contracts the case is on all fours with Cecil Bros Pty Ltd v Federal Commissioner of Taxation (1964) 111 CLR 430 in which it was said by the High Court of Australia “it is not for the Court or the commissioner to say how much a taxpayer ought to spend in obtaining his income” (ibid, 434), to which their Lordships would add: it is not for the court or commissioner to say from whom the taxpayer should purchase the stock-in-trade acquired by him for the purpose of obtaining his income.
[167]Commissioner of Inland Revenue v Europa Oil (NZ) Ltd [1971] NZLR 641 (Europa 1); Europa Oil (NZ) Ltd v Commissioner of Inland Revenue [1976] 1 NZLR 546 (Europa 2).
[168]At p 556 per Lord Diplock.
As well, the appellants rely on the Privy Council judgment in Peterson, arguing that it endorses what Lord Diplock said in Europa 2.[169]
[169]Reliance is placed on paragraphs [43] and [44] of the Privy Council judgment in Peterson.
[187] In the event that this Court decides not to accept Mr Harley’s submission based on this passage in Europa 2, the appellants argue in relation to penalties that they reasonably relied on that judgment as a statement of New Zealand tax law at the time they entered into the syndicate’s investment. They made their statements of position in their tax returns on that basis. They say that in this complex area, where
the Privy Council and New Zealand Court of Appeal Judges have commonly differed on the application of the general anti-avoidance provision, their position was based on an interpretation of the law that met the stipulated standard of being acceptable. They also say it was not the purpose of Part 9 of the Tax Administration Act to penalise a position taken in these circumstances. They emphasise, and it is common ground, that a finding that a tax interpretation was wrong, does not of itself contradict their argument.
[188] It is accordingly necessary to identify the state of New Zealand tax law in relation to the application of the general anti-avoidance provision as at 1998 when the tax returns were filed by the appellants and to consider in relation to it the interpretation advanced to justify the appellants’ position.
Decision in Europa 2
[189] The principle that the appellants draw from the Europa 2 judgment is that if it is shown that a legal entitlement gained under a contract from expenditure qualifies that expenditure for deductibility under tax law, a general anti-avoidance provision cannot apply to bar the deduction.
[190] It was, however, by no means clear from its judgment that the observations of the Privy Council were intended to state such a broad proposition that would be applicable in all situations. Prior to the Privy Council’s judgment the New Zealand courts had held in Elmiger[170] and Wisheart[171] that the Commissioner could apply s 108 to avoid arrangements involving contrived deductions in artificial situations which had the principal end of reducing tax otherwise payable, even though on a purely legal analysis of the arrangement the expenditure in issue was deductible under a specific tax provision. In Mangin, the Privy Council appeared by its general approach to have approved the opinions expressed in the Court of Appeal’s judgment in Elmiger.
[170]At p 179 per North P in the Court of Appeal confirming the approach of Woodhouse J in the Supreme Court.
[171]At p 324 per North P and at pp 328 – 330 per Turner J.
[191] In adopting the Cecil Bros Pty Ltd v Commissioner of Taxation of the Commonwealth of Australia[172] approach in Europa 2, the Privy Council made no reference to its earlier approval of Elmiger in Mangin. Nor did it refer to the Court of Appeal judgment in Wisheart refusing to apply Cecil Bros in a case involving a highly artificial arrangement. The Privy Council’s conclusion of incompatibility rested on the factual finding that the taxpayer had actually paid the price claimed as a deduction. The judgment did accept that there might be wider considerations in other cases that would lead to a conclusion of tax avoidance. This suggests that the Privy Council was not overruling the earlier New Zealand decisions and did not intend its observations to be read as applicable to arrangements of a contrived or artificial kind.
[172](1964) 111 CLR 430.
[192] Consistently with this narrower view of Lord Diplock’s observations in Europa 2, Casey J held in 1977[173] that the Privy Council had not determined that s 108 could never apply to deductions falling within s 111. He concluded that there was an area in which s 108 continued to operate in appropriate cases to avoid deductions conforming with s 111. After referring to passages in Cecil Bros and Europa 2, Casey J explained how s 108 should be applied in deduction cases:[174]
Where the need for the expenditure can be regarded as a normal incident of the business or undertaking forming the source of the taxpayer’s income, then he may select his own means of incurring it, and may spend what he thinks fit. So long as that expenditure conforms with s 111, it cannot be attacked under s 108. But s 108 can still apply where the need for such expenditure has been contrived in an existing source of income, as part of an arrangement having tax avoidance as one of its main purposes, and which is not a usual business or family dealing.
[173]In Halliwell v Commissioner of Inland Revenue [1978] 1 NZLR 363 (SC).
[174]At pp 372 – 373.
[193] In Challenge Corporation, Richardson J addressed the argument concerning the limited scope of the general anti-avoidance provision in the course of his discussion of s 99: [175]
Clearly the legislature could not have intended that s 99 should override all other provisions of the Act so as to deprive the tax paying community of structural choices, economic incentives, exemptions and allowances provided for by the Act itself. …
On the other hand s 99 would be a dead letter if it were subordinate to all the specific provisions of the legislation. It, too, is specific in the sense of being specifically directed against tax avoidance and it is inherent in the section that but for its provisions the impugned arrangements would meet all the specific requirements of the income tax legislation. In some cases then the section imposes an additional requirement. In others, this is a common application of the section in cases where trusts and companies are employed for planning purposes, while the use of that machinery is regarded as perfectly legitimate and not on its own affected by s 99, it may be only one element in a wider arrangement which is caught by the section.
[175]At pp 548 – 549.
[194] In the second paragraph above, Richardson J rejected the argument that the application of the general anti-avoidance provision was incompatible with specific provisions.[176] What he said was approved by the Privy Council in Challenge Corporation. [177]
[176]Earlier, at pp 546 – 547 of his judgment, Richardson J had referred to the argument that the general anti-avoidance provision could not apply to bar deductions otherwise allowable as one of the constructional arguments “designed to constrict the scope and application of the old s 108”.
[177]At p 559.
[195] In Hadlee v Commissioner of Inland Revenue,[178] decided in 1991, the Court of Appeal distinguished Europa 2, saying that the judgment:[179]
contains nothing to suggest that their Lordships intended the taxpayer to be free to produce income from the source by his own exertions, yet treat the product for tax purposes as not derived by him.
[178][1991] 3 NZLR 517 (CA).
[179]At p 524.
[196] In a judgment delivered in the High Court in 1997, the scope of the application of the anti-avoidance provision in deductibility cases was further clarified. In Miller v Commissioner of Inland Revenue[180] Baragwanath J referred to Europa 2 and said that Lord Diplock’s reference to “incompatibility” appeared to turn on the Privy Council’s reluctance to review decisions that may be justified on commercial grounds. After observing that the Privy Council in Challenge Corporation had declined to treat s 191 (a specific anti-avoidance provision) as establishing a code independent of s 99, Baragwanath J, in an observation which we consider accurately summarised the legal position reached at the time said:[181]
It is a section that deals with transactions altogether lawful in terms of the general law and the general provisions of the Income Tax Act but which nevertheless infringe its terms. Section 99 does concern reality and lawfulness, but in a sense quite different from the general provisions. It begins to bite when their operation is complete.
[180](1997) 18 NZTC 13,001 (HC).
[181]At p 13,027.
[197] The appellants’ tax returns for the 1997 and 1998 years were filed and their tax positions in relation to the Trinity scheme taken against these interpretations of the relevant tax laws. Even in 1976, while objectively tenable, it was by no means clear that the Privy Council had intended its observations to apply to cases of contrived deductions or artificial situations lacking any apparent commercial purpose. But by the time the tax positions were taken in the present case, the proposition that the New Zealand courts, including the Privy Council, would have reverted to the simplistic and very restrictive approach to the application of s 99, based on a literal reading of Europa 2, was remote, given the less than sympathetic treatment that case had received subsequently.
[198] Nor would it assist the appellants if the Court were to consider the later decision in Peterson. The Court of Appeal discussed the principles in Cecil Bros and Europa 2 and observed:[182]
But we find nothing in the judgments in those cases precluding the Commissioner from declining to recognise costs not truly incurred.
[182]Commissioner of Inland Revenue v Peterson [2003] 2 NZLR 77 at para [46].
[199] Our approach to Europa 2 is consistent with the judgment of the Privy Council in Peterson, although the taxpayer’s appeal was successful in that case. In Peterson the Privy Council, by a majority, applied the approach it had taken to trading expenditure in Europa 2 to capital expenditure incurred to acquire rights to a film.[183] The taxpayer in Peterson had claimed a depreciation allowance based on the total sum he was contractually required to pay to acquire the interest in the film. Part of the consideration was a contrived sum, which was financed by a non-recourse loan, that had no relationship to production costs and indeed was immediately repaid to the lender. The majority, in the judgment of Lord Millett, decided the appeal on the basis of a concession of fact made by the Commissioner that contractually the taxpayer had paid the full consideration to acquire the film, there being no additional
purpose. In these circumstances, the majority applied the Europa 2 principle to determine the appeal in favour of the taxpayer.
[183]At para [43].
[200] But the majority’s judgment turned on the concession. Lord Millett went on to say that, in general, where parties stipulate a single consideration for supply of two or more goods or services, the Commissioner can go behind the allocation agreed on by the parties and reallocate the consideration on a proper basis.[184] The effect is that taxpayers must show that the economic purpose of the entire expense incurred, rather than simply the legal benefit, relates to the income earning process. Otherwise only the appropriate proportion will be deductible. As well, and importantly, the majority went on to indicate that the Commissioner could have contended in the alternative that:[185]
the arrangement by which the production company allocated the payment of $y as part of the consideration for acquiring the film instead of as consideration for the procurement of the loan (which affected the investors whether or not they were parties to it) could be counteracted under s 99.
[184]At paras [47] – [53]. The passages are discussed in Prebble, “The Peterson Case and its Impact on the Rules in BNZ Investments Ltd and Cecil Bros”, in Sawyer (ed), Taxation Issues in the Twenty-First Century (2006), pp 122-124.
[185]At para [52].
[201] The conclusion we reach is that the appellants’ argument that, by satisfying the specific provisions for deduction of the licence and insurance premiums in their 1998 returns, they were free from the application of the general anti-avoidance provision, would have been a highly speculative one at the time. The law had been considerably developed since the 1976 decision on which the argument relies. While Europa 2 has not been expressly overruled on this point, there is nothing in the case law directly addressing the case, nor other tax jurisprudence available in 1998 that supports a finding that the appellants’ argument has a sufficient rational basis to be one that at the time would have had close to a 50 per cent prospect of success.
[202] On general principles concerning the application of the general anti-avoidance provision, the points made earlier concerning the highly contrived nature of the whole arrangement, in conjunction with the mismatch of timing between when deductions were claimed and payments were to be made, always meant this arrangement was highly likely to be set aside.
[203] Accordingly the appellants’ tax position failed to meet the standard of being about as likely as not to be correct and was an unacceptable interpretation of tax law.
Dominant purpose
[204] The second requirement for the appellants to have taken an “abusive tax position” is that, under s 141D(7)(b)(i), the appellants took their tax position:[186]
In respect or as a consequence, of any arrangement that is entered into with a dominant purpose of avoiding tax, whether directly or indirectly.
[186]See para [175] above for the full provision.
[205] The appellants’ submission is that this provision requires that their dominant purpose in entering into the relevant arrangement must be considered, rather than, as the Courts below decided, the dominant purpose of the arrangement itself.
[206] Mr Harley argued that the statute required an objective assessment of each appellant’s dominant purpose in entering the arrangement. The proposition that the concept relates to the taxpayer’s mind may on first impression appear arguable, but we are satisfied that there are allied provisions within the section which make it untenable. Our conclusion is that s 141D(7)(b)(i) refers to a tax position that is taken by a taxpayer by means of an arrangement which has a dominant purpose of avoiding tax.
[207] The qualification in s 141D(7)(b), “viewed objectively”, substantially answers the appellants’ argument. It directs attention to features of the arrangement rather than intentions of a taxpayer in taking a tax position linked to the arrangement. Subpara (ii) of s 141D(7)(b) reinforces this interpretation in its reference to “an arrangement described in subpara (i), with a dominant purpose”. This makes it clear that it is the purpose of the arrangement itself, not the purpose in the mind of the
taxpayer, that is referred to in s 141D(7)(b)(i). This aspect of the definition of an “abusive tax position” is concerned with the means employed rather than intentions of taxpayers in taking a tax position. The section requires that the arrangement itself be examined to ascertain its dominant purpose from its terms, irrespective of what may be known or inferred concerning the motives of individual investors.
[208] Mr Harley referred us to observations of the Federal Court of Australia[187] concerning construction of the equivalent penalty provision in the Commonwealth Income Tax Assessment Act 1936 (Cth). That provision does not have the direction in s 141D(7)(b) to view the provision objectively and the dicta referred to are of no assistance in this case. As the Commissioner’s written submissions point out, the provision read in this way is consistent with the objective test for tax avoidance first articulated in Newton.[188]
[187]Federal Commissioner of Taxation v Starr (2007) 164 FCR 436.
[188]At p 465.
[209] It follows that the appellants each took an abusive tax position and, subject to particular arguments advanced by Ben Nevis, Greenmass and Redcliffe, are liable for the 100 per cent penalty imposed by the legislation. We turn to consider these appellants’ arguments concerning their positions.
Tax shortfall – Ben Nevis and Greenmass
[210] Ben Nevis and Greenmass contend there was no relevant tax shortfall in the case of their LAQCs. The Commissioner’s approach has resulted in penalties being separately imposed on those companies as well as on the shareholders with the result that two penalties of 100 per cent have been imposed in respect of one tax shortfall.
[211] The issue here arises from the terms of the definition of “tax shortfall” in the Tax Administration Act:[189]
[189]Section 3.
Tax shortfall, for a return period, means the difference between the tax effect of —
(a) A taxpayer’s tax position for the return period; and
(b) The correct tax position for that period, —
When the taxpayer’s tax position results in too little tax paid or payable by the taxpayer or another person or overstates a tax benefit, credit, or advantage of any type or description whatever by or benefiting (as the case may be) the taxpayer or another person.
A “tax position” is defined as:
Tax position means a position or approach with regard to tax under one or more tax laws, including without limitation a position or approach with regard to —
…
(g)The incurring of an amount of expenditure or loss, or the allowing or denying as a deduction of an amount of expenditure or loss:
(h)The availability of net losses, or the offsetting or use of net losses.
[212] The Court of Appeal concluded that the LAQCs each took a tax position in their returns as to the losses claimed, and that the tax effect of their positions differed from the correct tax position for the relevant return period. The end tax position of the LAQCs was no different from the correct tax position, as the losses they returned were negated. The appellants associated with the LAQCs alone carried the losses through to their end tax position.
[213] In these circumstances the imposition of tax shortfall penalties on the LAQCs as well as the appellant taxpayers involved a double penalty. The Court of Appeal, however, thought this was the inescapable consequence of the plain meaning of the legislation and in particular the words “or another person” which covered LAQCs.
[214] The appellants submitted that the penalty regime operated to treat LAQCs as accounting vehicles which “attribute” tax losses which effectively pass through them to shareholders.[190] While that is the way LAQCs are treated in respect of gains and losses, the Tax Administration Act is not so specific as to penalties associated with unacceptable and abusive tax positions. The Court of Appeal was of the view that the language of the definition of “tax shortfall” covered the position of each LAQC whose tax position resulted in a relevant tax shortfall associated with the tax payable by their shareholders. We share the view that this is the effect of the ordinary meaning of the words used in their context and do not see that the general scheme of subpart HG of the Income Tax Act provides a context that enables the Court to read down the words of the definition.
[190]See s HG 1 of the Income Tax Act.
[215] This does not, however, conclude the matter as s 141FC of the Tax Administration Act, enacted in 2003, provides a mechanism for relief against double penalties imposed from 1 April 1998. The section applies where an LAQC has attributed a loss to a shareholder and, as a result of the subsequent disallowance of one or more deductions, penalties have been imposed on both the LAQC and the shareholder. Under the mechanism for relief, the shortfall penalty on the shareholder must be reduced where the LAQC pays in full the amount of the shortfall penalty and the shareholder requests application of the section. The penalty must be reduced by a specified amount which it is unnecessary to go into. At this point the mechanism has not been triggered but if that eventuates, the element of double penalty will disappear.
Redcliffe position
[216] Ms Hinde argued that Redcliffe Forestry Venture Ltd, a syndicate member, had taken a correct tax position in its return so that there was no tax shortfall in its case that could result in penalties. Counsel emphasised that Redcliffe ultimately made a “nil” return of taxable income or net loss. She said the return correctly recorded what had been calculated and attributed in respect of its investment, the relevant sums being passed through to shareholders.
[217] In its return for the 1998 year Redcliffe recorded that it had incurred a gross loss of $1,208,382, largely being due to its share of the amortised licence premium of $41,000 per plantable hectare. The return showed that Redcliffe was an LAQC and that it had allocated the sum of $1,208,382 to its shareholders with the result that it had no income (or loss). The three shareholders in Redcliffe, who included Dr Muir, returned attributed losses in proportion to their shareholdings.[191]
[191]In the 1998 year Dr Muir claimed $966,705 as his share of the loss attributed by Redcliffe. In the previous year he had claimed a loss of $897,869.
[218] The definition of “tax position” is very broad. It covers any position or approach with regard to tax under any laws. These include “without limitation” any position or approach with regard to the incurring of a loss, the allowing of a deduction of an amount of loss or the availability of losses or the offsetting or use of net losses. What Redcliffe did in its return in our view is caught by these provisions. Redcliffe recorded its share of the loss under the Trinity scheme and claimed status as an LAQC to facilitate the attribution of the losses to its shareholders and the proportionate claims made by Dr Muir and others. In doing so Redcliffe took an incorrect tax position in relation to itself, giving rise to a tax effect different from the correct tax position for the period. It is not in point that its own ultimate position did not claim a loss. Viewed as a whole, which is what the Act requires, Redcliffe’s return involved taking a tax position in relation to the Trinity scheme which resulted in too little tax being paid by Redcliffe’s shareholders. That was a tax shortfall which resulted in Redcliffe being correctly held liable to a shortfall penalty.
Outcome
[219] In the light of our conclusions, the appeals must be dismissed. The appellants must pay costs to the respondent (for which the appellants will be jointly and severally liable) of $75,000 together with reasonable disbursements to be fixed if necessary by the Registrar.
Solicitors:
Wynyard Wood, Auckland for Appellants
Crown Law Office Wellington for Respondent
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