White v Commissioner of Inland Revenue HC Auckland CIV 2010-404-1188
[2010] NZHC 1826
•12 October 2010
IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY
CIV 2010-404-1188
BETWEEN PHILIPPA CATHERINE WHITE Appellant
ANDTHE COMMISSIONER OF INLAND REVENUE
Respondent
Hearing: 31 May and 1 June 2010
Counsel: M S Hinde for Appellant
M Deligiannis and M M Burr for Respondent
Judgment: 12 October 2010
JUDGMENT OF HEATH J
This judgment was delivered by me on 12 October 2010 at 2.30pm pursuant to Rule 11.5 of the High
Court Rules
Registrar/Deputy Registrar
Solicitors:
Webb Ross, Private Bag 9012, Whangarei
Crown Law, PO Box 2858, Wellington
Counsel:
M S Hinde, PO Box 455, Shortland Street, Auckland
WHITE V THE COMMISSIONER OF INLAND REVENUE HC AK CIV 2010-404-1188 12 October 2010
CONTENTS
The appeal [1] Background [2] Grounds of appeal [9] The alleged “tax avoidance arrangement” [13] The Authority’s decision [25] Was the reasonableness of the orchard rental properly in issue? [32] Was there a “tax avoidance arrangement”? [36] (a) Definitional issues [36] (b) How do the anti-avoidance provisions work? [38] (c) The impact of Commissioner of Inland Revenue v Penny [53] (d) Was the Taxation Review Authority right to find
“tax avoidance”? [65] The “reconstruction” issue [78] Result [79]
The appeal
[1] Dr White appeals against a decision of the Taxation Review Authority dismissing her challenge to amended income tax assessments.[1]
[1] Case Z24 (2010) 24 NZTC 14,354 (NZ TRA).
Background
[2] Dr White is an anaesthetist who works in both the public and private sectors. Together with her husband, Mr Foster, she has interests in two avocado orchards, on one of which the couple live.
[3] In September 2002, Wharfedale Ltd was incorporated, both to employ Dr White (in respect of her private work) and to lease the two avocado orchards. As a result of transactions that took place at the instigation of Dr White and her husband, those purposes were given effect, from 1 November 2002.
[4] From 1 November 2002, the whole of Dr White’s income from private practice was paid to Wharfedale. Both orchards ran at a loss during the 2003 and
2004 tax years. The losses were off-set against Wharfedale’s income, which was
derived principally from Dr White’s personal effort. No salary was paid by Wharfedale to Dr White for her services during these periods. In consequence, Dr White paid no personal income tax for the five months to 31 March 2003 and for the year ended 31 March 2004.
[5] The Commissioner of Inland Revenue (the Commissioner), after auditing
Dr White’s affairs, issued amended assessments. Additional income of $34,844 and
$95,644 respectively was attributed to Dr White, for the two tax years.
[6] Tax in dispute for the period to 31 March 2003 is $13,589.16, while
$37,301.16 is in issue for the year to 31 March 2004. While those amounts are relatively modest, the approach taken by the Commissioner, if correct, will apply equally to subsequent tax years. The real amount at stake for Dr White is significantly higher.
[7] The Commissioner’s reassessment of Dr White’s taxable income was based on an assertion that the transactions entered into from 1 November 2002 represented a “tax avoidance arrangement”,[2] for the purposes of s BG 1 of the Income Tax Act
[2] The basis for which is set out at para [21] below.
1994 (the Act).[3]
[3] Although now repealed this case is governed by the 1994 Act.
[8] Before the Taxation Review Authority (the Authority), Dr White contended that there was no avoidance arrangement. No salary was declared because the company had no money to pay anyone. In a judgment given on 4 February 2010, the Authority (Judge Barber) upheld the Commissioner’s decision.[4]
[4] Case Z24 (2010) 24 NZTC 14,354 (NZ TRA).
Grounds of appeal
[9] Mrs Hinde, for Dr White, raised three grounds of appeal:
a) Did the Authority err in allowing evidence to be called on the question whether rent paid by Wharfedale to the trustees of the Foster Family Trust (as owners of the orchards) was inflated?[5]
[5] The leasing arrangements are discussed at paras [14], [15] and [18] below.
b)Did the Authority err in holding that there was a “tax avoidance arrangement”, for the purposes of s BG 1 of the Act?
c) If a tax avoidance arrangement did exist, was the reconstruction power exercised by the Commissioner under s BG 1 of the Act correctly exercised?
[10] The first question turns on the scope of disputes capable of being determined by the Authority. Mrs Hinde, for the taxpayer, submitted that the appropriateness of the rent assessed was not put in issue when the Commissioner lodged his Statement of Position. Therefore, she contended, the Commissioner was barred from raising the point before the Authority. Reliance was placed on s 138G of the Tax Administration Act 1994.
[11] The second point involves a consideration of the circumstances in which a “tax avoidance arrangement” will exist. That question has been discussed extensively in five recent cases: Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue,[6] Glenharrow Holdings Ltd v Commissioner of Inland Revenue,[7]
[6] Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2009] 2 NZLR 289 (SC).
[7] Glenharrow Holdings Ltd v Commissioner of Inland Revenue [2009] 2 NZLR 359 (SC).
BNZ Investments Ltd v Commissioner of Inland Revenue,[8] Westpac Banking
[8] BNZ Investments Ltd v Commissioner of Inland Revenue (2009) 24 NZTC 23,582 (HC).
Corporation v Commissioner of Inland Revenue[9] and Penny v Commissioner of
[9] Westpac Banking Corporation v Commissioner of Inland Revenue (2009) 24 NZTC 23,834 (HC).
Inland Revenue.[10]
[10] Penny v Commissioner of Inland Revenue [2009] 3 NZLR 523 (HC), reversed on appeal:
Commissioner of Inland Revenue v Penny [2010] NZCA 231.
[12] The third point only arises if the second is answered in the Commissioner’s favour. It involves a factual assessment of the way in which the power to reconstruct the taxpayer’s financial affairs should be undertaken. While this issue was before
the Authority, no finding was made on it. Rather, the question of reconstruction was left open for “further discussion” between the parties, with leave to apply to the Authority reserved.[11]
[11] Case Z24 (2010) 24 NZTC 14,354 (NZ TRA) at [108]. No application, under the leave reserved, appears to have been made.
The alleged “tax avoidance arrangement”
[13] Until 1 November 2002, Dr White practised as an anaesthetist, in two different capacities. She was employed on a full-time basis by a public hospital, accounting for income from that source through the PAYE regime. Dr White also practised on her own account, by providing contracted services to a dental clinic and a private hospital. Before 1 November 2002, she rendered those services under the trading name of Maunu Anaesthetic Group, an unincorporated entity.
[14] In mid-2002, Dr White and Mr Foster, after taking advice, decided to make changes to the way in which their personal affairs and assets were organised. As at
20 August 2002, one of the orchards (the home orchard) was sold to the trustees of the Foster Family Trust (the Trust). On 1 November 2002, Wharfedale was given rights of access to the property. A formal lease was entered into on 31 March 2003, with effect from 1 April 2003.
[15] The second orchard is known as the Hawken Orchard. That orchard was acquired by the trustees of the Trust at auction, on 20 September 2002. The trustees took title to the property and allowed Wharfedale to have access to it from
1 November 2002. A lease of the orchard was entered into on 31 March 2003. Wharfedale became the tenant from 1 April 2003.
[16] The business known as Maunu Anaesthetic Group had been acquired, on 1
October 1997, by the trustees of the Trust. On 1 November 2002, the trustees sold the goodwill of Maunu Anaesthetic Group to Wharfedale and also leased equipment used in that business to that company.
[17] Mr Foster operated a business called DM Inspection Services. The equipment for that business was leased on 1 November 2002, to Wharfedale. Mr Foster was also employed by Wharfedale, with the intent that income from his business would be paid directly to the company. Similarly, as from 23 October
2002, Dr White ceased to be self-employed. From 1 November 2002, she was employed by Wharfedale. Her income from private sources was to be paid directly to Wharfedale.
[18] The leases of the two orchard properties fixed rental to be paid from Wharfedale to the trustees and the Trust. The amount fixed, in each case, was $4230 per month, from 1 April 2003.
[19] As a result of these transactions:
a) The trustees of the Trust became owners of both orchards.
b)Wharfedale was entitled to use the equipment formerly owned by Mauna Anaesthetic Group and to carry on business providing private anaesthetic services, through Dr White’s labours.
c) Wharfedale had a licence to occupy the two orchard properties from 1
November 2002, until it became the lessee of each property, with effect from 1 April 2003. As lessee, Wharfedale was responsible for operating the orchards.
d)From 1 November 2002, Wharfedale leased equipment for Mr Foster’s business, and, thereafter was responsible for carrying on that business.
e) Wharfedale employed both Dr White and Mr Foster to provide human services for the businesses previously carried on as DM Inspection Services and Maunu Anaesthetic Group.
[20] As at 1 November 2002, Mr Foster and Dr White had no expectation that the home orchard would be profitable. It was still in a state of development. Nor did
they expect that any significant income would be derived through DM Inspection Services. While Mr Foster and Dr White expected that Wharfedale would receive income from the profitable operation of the Hawken Orchard, it is clear that the bulk of the company’s income was to come from Dr White’s private practice, as an anaesthetist.
[21] Following the audit of Dr White’s tax affairs, the Commissioner alleged that an “arrangement” had been entered into, for the purposes of the general anti- avoidance provisions of the Act . The Commissioner alleges that the “arrangement” has the following component parts:
a) The incorporation of Wharfedale, in September 2002.
b) The transfer of Dr White’s anaesthetist business to Wharfedale. c) The Trust leasing:
i) the anaesthetic equipment to Wharfedale; and ii) the orchards, plant and vehicles to Wharfedale.
d)The offsetting of Wharfedale’s losses from the orchard business against profits from the anaesthetist’s business.
e) Dr White carrying out the anaesthetic services for Wharfedale:
i) for no consideration in 2003; and
ii)for less consideration (approximately $4785) than she had previously been receiving in 2004.
f) Wharfedale failing to remunerate Dr White adequately for anaesthetic services, even if that failure arose out of the insufficiency of company funds.
On the other hand, Dr White and her husband contend that the transactions they entered into did not constitute a “tax avoidance arrangement”.[12] They say that they took advantage (legitimately) of a provision entitling them to use a company structure in this way. The Act allows individual taxpayers to establish closely held companies, by which they may be employed. Such taxpayers, if employed, pay tax on a provisional, rather than a PAYE, basis.[13]
[12] See the definition of “arrangement” and “tax avoidance arrangement”, set out at para [37] below.
[13] See s OB 2 of the Act. See also the discussion at para [70] below.
[22] The Commissioner accepts that Dr White had no subjective intention to avoid the payment of income tax. Rather, reliance is placed on the definitions of “tax avoidance” and “tax avoidance arrangement”.[14] Ms Deligiannis submits that, objectively assessed, the steps taken before and after 1 November 2002[15] constitute an arrangement that had the effect of illegitimately relieving Dr White from a
[14] Both terms are defined in s OB1 of the Act and are set out at para [37] below.
[15] As detailed in para [21] above.
personal taxation liability.
[23] In his Statement of Position, the Commissioner put some reliance on receipt, by Dr White’s three children, of wages totalling approximately $30,000, during the
2004 income tax year. These “wages” were said to have been paid for work on the orchard and administration. At the time, the three daughters were students without other salaried employment and were employed by Wharfedale, on a PAYE basis.[16]
[16] Case Z24 (2010) 24 NZTC 14,354 (NZ TRA) at para [19].
However, the Authority did not regard those payments as adding to the Commissioner’s case on tax avoidance. Judge Barber said that there was nothing “sinister” about:
a) the employment of the three daughters. He accepted that Wharfedale was able to pay them about $10,000 per annum each, “probably earned for orchard work” while “their parents awaited annual results to determine their salaries,”[17] or
b) the fair payments to the children.[18]
[17] Ibid.
[18] Ibid, at para [85](1).
[24] Although mentioned in passing in Ms Delegiannis’ submissions in this Court, no real weight was placed on the payments to the children to support the claim of tax avoidance. For that reason, I have not had regard to those payments in determining whether the arrangements did or did not constitute tax avoidance. Having said that, nothing I say in this judgment should be taken as necessarily endorsing the legitimacy (in general terms) of making payments to young children for services rendered in similar circumstances.
The Authority’s decision[19]
[19] Case Z24 (2010) 24 NZTC 14,354 (NZ TRA).
[25] Judge Barber accepted that, as at 1 November 2002, Dr White and her husband reconstructed their affairs due to a concern about their exposures to claims by clients in respect of their separate private professional services/businesses and for the protection of their family. He found that the restructuring was initiated when a motel unit and the family orchard were sold to the trustees of the Trust, in July 2002. The Authority considered that the home orchard was, at that time, “still too young to
bear crops”.[20]
[20] Ibid, at para [4].
[26] Judge Barber accepted that, on 20 September 2002, the trustees of the Trust were able, by chance, to purchase a profitable avocado orchard in the vicinity of the home orchard. The Hawken Orchard comprised about 8.93 hectares whereas the home block comprised about 2.4 hectares. The new orchard contained an unpicked crop.
[27] The Authority described the effect of the restructuring as follows:
[9] The effect of the restructuring of 1 November 2002 was that [Dr White] stopped being self-employed in her very profitable private anaesthetic practice and, in effect, stopped receiving an income from that private practice because, instead, she took employment with the newly incorporated [Wharfedale] which took over the running of her private practice. She then provided her services as a professional anaesthetist to the clients of [Wharfedale], performing exactly the same services as she had previously. However, instead of receiving a substantial income commensurate with her skills and exertions, she received a salary of nil from [Wharfedale] in 2003 for 5 months work and of $4,875 in the year ended 31
March 2004 for 12 months work. This was because [Wharfedale] barely made a profit.
[10] The [Commissioner] took the view that through the various restructurings of her business affairs, which involved transferring certain business assets, operations and losses into the specially incorporated company [Wharfedale], the disputant’s overall personal income was significantly reduced and she paid less income tax.
[11] I note that, at one point of the submissions for the [Commissioner], it is put that the tax effect of this arrangement is that, on all the income earned from [Dr White’s] private practice, tax was paid at 33% (the rate then applying to companies and trusts) instead of 39% (the amount then applying to individuals). However, as the facts unfolded, the tax effect of the arrangement seemed to me to be that, while [Dr White]continued to receive her employment income from the Hospital Board as previously, her substantial private practice income as an anaesthetist was recovered from clients by [Wharfedale], which was barely able to remunerate her at all, because its combined business activities barely made a profit.
[28] The Judge’s primary concern seemed to be the effective assignment of Dr White’s income from personal exertions to the company. That, to his mind, provided a basis for making a finding of a tax avoidance arrangement. Judge Barber said:
[23] In my view, the problem for [Dr White] in this case is that the structures implemented from 1 November 2002 used her income in a way which leaves her unremunerated in a manner which is artificial and contrived and has no sensible reality. In effect, the structure has involved an assignment of her professional income as an anaesthetist, which she herself has earned, to a family company where that income has been set-off against losses from the avocado orchard.
[24] There was much evidence to the effect that a significant portion of those losses were contrived by deficient valuations for orchard rental and equipment hireage paid by [Wharfedale] to the family trust, and I shall refer to those only as necessary. I understood that, in the course of the hearing, there were no longer IRD queries about consideration for equipment hireage.
[25] As I have indicated, there are legitimate methods for a taxpayer to off-set, against professional services income, real losses incurred from business activities of that taxpayer, and that could have been legitimately achieved to a substantial degree in this case. However, I am concerned with the facts now before me and there have not been business losses of the disputed off-set against her professional income, but an injection of her personal-exertion professional income into a family company experiencing losses from business activities, so that it did not remunerate [Dr White] as an employee in a fair and commercial manner. (my emphasis)
[29] Although those passages appear to capture the thrust of the Authority’s reasoning, the Judge went on to consider other points raised by counsel. In summary, the Authority:
a) did not resolve the question whether the Commissioner was barred from raising an issue about the adequacy of the orchard rental. However, he made it clear that the level of orchard rental was something that had to be taken into account as a factor, in determining
whether tax avoidance had been established.[21]
[21] Ibid, at para [27].
b)accepted that there was not enough net profit in either the 2002/2003 or 2003/2004 seasons to enable salaries to be allocated to Dr White and her husband for the services they rendered to Wharfedale during those years. Judge Barber accepted that the unprofitability of, particularly, the Hawken Orchard was due to things such as “poor weather, costs, lack of domestic and foreign market supply and demand, and the variability of exchange rates”. He also acknowledged that the poor result for the 2002/2003 crop was “unexpected” and affected the interests of the Trust, rather than
Wharfedale.[22]
[22] Ibid, at para [31]-[33].
c) regarded the orchard rental as “probably fixed ... a little bit high”, while acknowledging that there was nothing “artificial or contrived about fixing that ... rent”. He accepted that only with the benefit of hindsight could it be said that the rent might have been “a bit liberal in favour of the family trust and fixed contrary to industry practice of shared net income”. Having said that, the Authority put little or no
weight on the point in reaching its conclusions.[23]
[23] Ibid, at para [57]. See also para [102]
d)regarded four factors as central to its conclusion that a “tax avoidance arrangement” existed:
i) The transfer of Dr White’s anaesthetist business to
Wharfedale;
ii)Wharfedale offsetting losses from the orchard business against profits from the anaesthetic business;
iii)Dr White carrying out anaesthetist services for Wharfedale for no consideration in 2003 and much less in 2004 than she had previously been paid; and
iv)Wharfedale’s failure to remunerate Dr White adequately for the services she provided as an anaesthetist, “due to insufficient company funds”.[24]
[24] Ibid, at para [80].
[30] It is clear that Judge Barber placed great weight on the fact that it was “not credible nor commercially acceptable, that an experienced anaesthetist like [Dr White] would work for a company for virtually nothing”.[25] He considered that the effect of the arrangement was to enable Dr White “to reduce the amount of tax she was paying on the income she generated from performing anaesthetic services in her private capacity” by (it seems) illegitimately setting off her income against losses incurred by the unprofitable avocado orchard businesses.[26]
[25] Ibid, at para [87].
[26] Ibid, at paras [89] and [90].
[31] The Judge regarded the reduction in income tax as a “not merely incidental” purpose of the arrangement and held that the tax avoidance provisions were engaged. Consistently with what is said earlier in his decision, the Judge’s concluding comments on tax avoidance state:
[103] ..., it is commercially unrealistic and artificial for a senior anaesthetist to work for a company without remuneration. The technique adopted for or by the disputant anaesthetist avoided significant income tax for her under a structure which I find to be a tax avoidance arrangement.
Was the reasonableness of the orchard rental properly in issue?
[32] Mrs Hinde submits that s 138G of the Tax Administration Act 1994 applies. That section limits the live issues on an appeal to the Taxation Review Authority to facts, evidence and propositions of law disclosed in the Commissioner’s and the disputant’s statements of position, respectively.[27] The Authority’s discretion to allow additional challenges involving facts, evidence and propositions of law is circumscribed.[28]
[27] Tax Administration Act 1994, s 138G(1).
[28] Ibid, s 138G(2).
[33] I do not consider it necessary to resolve this issue. While I accept that Dr White was put to extra cost in instructing valuers at a late stage, given the conclusions on this issue expressed by the Authority, no substantive prejudice has been suffered. The Authority made it clear that it was not giving any weight to the level of the orchard rentals, when determining whether there had been a tax
avoidance scheme.[29]
[29] Case Z24 (2010) 24 NZTC 14, 354 (NZ TRA) at paras [57] and [102]. See also para [29](a) and (c) above.
[34] A similar point was raised in Commissioner of Inland Revenue v Penny,[30] in relation to attempts by the Commissioner to widen the scope of the alleged “arrangement”. In the Court of Appeal, Randerson J accepted a submission that only an outline of the facts and evidence had to be put into the Commissioner’s statement of position, while acknowledging that care must be taken to ensure the scope of any alleged “arrangement” is not widened.[31] Neither Hammond J nor Ellen France J expressed a different view on this point.
[30] Commissioner of Inland Revenue v Penny [2010] NZCA 231
[31] Ibid, at paras [82]-[85].
[35] In Penny, as in this case, the evidence on valuation was taken into account in determining whether the alleged “arrangement” was contrived or artificial. Because Judge Barber held that the rent paidt was neither, the point is, in my view, moot.[32]
[32] Case Z24 (2010) 24 NZTC 14,354 (NZ TRA) at para [57]; see also para [29](c) above.
.
Was there a “tax avoidance arrangement”?
(a) Definitional issues
[36] Section BG 1 of the Act provided:
Avoidance arrangement void
(1) A tax avoidance arrangement is void as against the Commissioner for income tax purposes.
Reconstruction
(2) Under Part G (Avoidance and non-market transactions), the Commissioner may counteract a tax advantage that a person has obtained from or under a tax avoidance arrangement.
[37] The definitions of “arrangement”, “tax avoidance” and “tax avoidance arrangement” were in s OB 1 of the Act:
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 . . .
(b) How do the anti-avoidance provisions work?
[38] The scope of the general anti-avoidance provisions was considered by the Supreme Court in Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue.[33] In particular, the Court considered the relationship of those rules with specific provisions of the Act, on which a taxpayer might rely to structure his or her tax affairs. The leading judgment was delivered by Tipping and McGrath JJ, on behalf of themselves and Gault J (the majority). A separate judgment, concurring in the result, was delivered by Elias CJ and Anderson J.
[33] Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2009] 2 NZLR 289 (SC).
[39] The majority traced the history of anti-avoidance provisions in New Zealand tax legislation back to 1878.[34] Their Honours observed that the Commissioner began actively to enforce the anti-avoidance provisions during the 1960s, when s 108 of the Land and Income Tax Act 1954 was in force. The way in which that provision (and its companion provisions in Australian legislation) had been interpreted was discussed.[35] The majority pointed out that changes were made to the anti-avoidance provisions in 1974, to address concerns expressed in the earlier decisions.[36]
[34] Ibid at para [71]. The first such provision was contained in s 62 of the Land Tax Act 1878.
[35] Ibid at paras [72]-[79].
[36] Those cases were: Newton v Commissioner of Taxation of the Commonwealth of Australia [1958] AC 450 (PC), Elmiger v Commissioner of Inland Revenue [1966] NZLR 683 (SC), Mangin v Commissioner of Inland Revenue [1971] NZLR 591 (PC) and Commissioner of Inland Revenue v Gerard [1974] 2 NZLR 279 (CA).
[40] The new s 108 was designed to clarify the types of transactions the section was intended to cover, extending the definition of tax avoidance to a wider range of tax advantages.[37] However, the 1974 amendments did not explicitly address the relationship between allowing tax concessions for specified arrangements and the general anti-avoidance provisions which operated to strike down those arrangements that had a purpose of tax avoidance that was not merely incidental.
[37] Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2009] 2 NZLR 289 (SC) at paras [80]-[83].
[41] The 1974 amendments were considered by the Court of Appeal and Privy
Council in Challenge Corporation Ltd v Commissioner of Inland Revenue.[38] The
Privy Council held that a tax avoidance arrangement was one in which a taxpayer derived a tax advantage from a transaction without suffering a reduction in income, loss or expenditure of a type that Parliament intended those qualifying for a reduction in tax liability to suffer.[39] In later cases, that approach was applied by both the Court of Appeal and the Privy Council.[40]
[38] Challenge Corporation Ltd v Commissioner of Inland Revenue [1986] 2 NZLR 513 (HC), (CA) and (PC).
[39] Ibid, at 561 (PC).
[40] Commissioner of Inland Revenue v BNZ Investments Ltd [2002] 1 NZLR 450 (CA), Dandelion Investments Ltd v Commissioner of Inland Revenue [2003] 1 NZLR 600 (CA), Miller v Commissioner of Inland Revenue [2001] 3 NZLR 316 (PC) and Peterson v Commissioner ofInland Revenue [2006] 3 NZLR 433 (PC).
[42] In Commissioner of Inland Revenue v Auckland Harbour Board, the Privy Council described the avoidance provisions as a “long stop for the Revenue" in tax avoidance cases.[41] The majority considered that view continued “uncertainty about the relationship of the general anti-avoidance provision with specific provisions”, making it “desirable for [the Supreme Court] to settle the approach which should be applied in New Zealand”.[42]
[41] Commissioner of Inland Revenue v Auckland Harbour Board [2001] 3 NZLR 289 (PC) at para [11]. While Auckland Harbour Board dealt with an assessment by the Commissioner on the basis of a “non market disposition”, the Privy Council, at para [11], regarded that provision as having a “similar” function to the general anti-avoidance provisions.
[42] Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2009] 2 NZLR 289 (SC) at para [100].
[43] The majority then undertook a detailed discussion of the way in which the general anti-avoidance provisions should be reconciled with specific sections of the Act. They considered that “Parliament’s overall purpose is best served by construing specific tax provisions and the general anti-avoidance provision so as to give
appropriate effect to each”.[43] Tipping, McGrath and Gault JJ held that:
[43] Ibid, at para [103].
a) those provisions were “meant to work in tandem”;[44]
[44] Ibid.
b) neither should be regarded as overriding;[45]
[45] Ibid.
c) the general anti-avoidance regime was designed to be the principal vehicle by which tax avoidance was addressed, while individual specific provisions had a focus determined primarily by their ordinary
meaning, as established through their text in the light of their specific purpose.[46]
[46] Ibid. See also s AA3 of the Act and s 5 of the Interpretation Act 1999.
[44] The majority considered that “Parliament must have envisaged that the way a specific provision was deployed would, in some circumstances, cross the line and turn what might otherwise have been a permissible arrangement into a tax avoidance arrangement”.47 They observed that, even if all steps in an “arrangement” were “unobjectionable in themselves, their combination may give rise to a tax avoidance arrangement”.48
[45] In summarising their conclusions, the majority said:49
[106] Put at the highest level of generality, a specific provision is designed to give the taxpayer a tax advantage if its use falls within its ordinary meaning. That will be a permissible tax advantage. The general provision is designed to avoid the fiscal effect of tax avoidance arrangements having a more than merely incidental purpose or effect of tax avoidance. Its function is to prevent uses of the specific provisions which fall outside their intended scope in the overall scheme of the Act. Such uses give rise to an impermissible tax advantage which the Commissioner may counteract. The general anti-avoidance provision and its associated reconstruction power provide explicit authority for the Commissioner and New Zealand courts to avoid what has been done and to reconstruct tax avoidance arrangements.
[46] In using the rubrics “permissible” and “impermissible”, the majority intentionally discarded the distinction drawn by the Privy Council, between “tax avoidance” and “tax mitigation”, in Challenge Corporation Ltd v Commissioner of Inland Revenue.50 The majority considered the latter approach was “conclusory and unhelpful.51 In my view, the change in terminology signals a need to scrutinise a
47 Ibid, at para [104].
48 Ibid, at para [105].
49 Ibid, at para [106].
50 Challenge Corporation Ltd v Commissioner of Inland Revenue [1986] 2 NZLR 513 (PC) at 561 (Lord Templeman, on behalf of himself, Lord Keith of Kinkel, Lord Brightman and Lord Goff
of Chieveley) and 566 (Lord Oliver of Aylmerton). Lord Templeman defined “tax mitigation” as the taxpayer’s freedom to mitigate his or her liability to pay tax and “tax avoidance”, by which a tax advantage is derived from an arrangement when the taxpayer reduces the liability to tax without involving himself or herself in the loss or expenditure entitling him or her to that reduction. Lord Oliver took the view that the general tax avoidance provisions were not
intended to cover transactions authorised expressly by other provisions of the relevant statute.
51 Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2009] 2 NZLR 289 (SC) at para [95].
particular transaction to ascertain whether its purpose fell inside or outside of the intended scope of a specific provision that confers a tax advantage.52
[47] The majority articulated a number of factors that a Court could take into account in determining whether tax avoidance existed, on the facts of a particular case:53
a) The manner in which the arrangement is carried out.
b)The role of relevant parties and any relationship they may have with the taxpayer.
c) The economic and commercial effect of documents and transactions, measured against the actual fiscal consequences of implementation of the arrangement.
d)Whether the taxpayer gains the benefit of a specific provision “in an artificial or contrived way”.
[48] The majority thought first instance judges should consider the use made of specific provisions in the Act “in the light of the commercial reality and economic effect” of their use and, in doing so, were “not limited to purely legal considerations”.54
[49] Elias CJ and Anderson J agreed with the majority that the scheme in issue was a tax avoidance arrangement, as defined. They wrote separately to express some reservations on aspects of the majority’s reasoning that was not essential to the result in the particular case. As I am bound by the majority judgment, it is unnecessary for me to discuss the issues raised by Elias CJ and Anderson J.
52 Note, however, that the term “purpose or effect” (in the definition “tax avoidance arrangement” in s OB 1 of the Act) should not be equated to motive: see Glenharrow Holdings Ltd v Commissioner of Inland Revenue [2009] 2 NZLR 359 (SC) at paras [36] and [37]. See also paras [50] and [51] below.
53 Ibid, at paras [108] and [109].
54 Ibid, at para [109].
[50] On the same day that judgment was delivered in Ben Nevis, the Supreme Court ruled on the application of general anti-avoidance provisions in the Goods and Services Tax Act 1985 in Glenharrow Holdings Ltd v Commissioner of Inland Revenue.55 There was only one change in the composition of the Court between the two cases: while Gault J was a member of the Court in Ben Nevis, Blanchard J sat in Glenharrow.
[51] The unanimous judgment of the Glenharrow Court was given by Blanchard J. His focus was on s 76 of the Goods and Services Tax Act, the comparable provision to s BG 1. The Court held that s 76 required an examination of the purpose or effect of the arrangement;56 in saying that, the term “purpose or effect” was not equated to motive, but rather the end result sought to be achieved.57
Therefore, the anti-avoidance provision must be seen as being aimed at the objective purpose of the arrangement, not the purpose of the parties.58
[52] At first sight, a Court’s inability to focus on the parties’ intention seems counter-intuitive. For example, in this case, the Authority accepted that Dr White had no intention to avoid tax. Notwithstanding that finding, the Commissioner contended (and the Authority accepted) that, objectively assessed, the “arrangement”
amounted to tax avoidance.59 However, some helpful elaboration, in the context of
an arrangement which has tax avoidance as only one of its effects,60 can be found in Woodhouse P’s judgment (in the Court of Appeal) in Challenge Corporation Ltd v Commissioner of Inland Revenue.61 Woodhouse P said:62
As a matter of construction I think the phrase "merely incidental purpose or effect" in the context of s 99 points to something which is necessarily linked and without contrivance to some other purpose or effect so that it can be regarded as a natural concomitant. Many taxpayers when considering a
55 Glenharrow Holdings Ltd v Commissioner of Inland Revenue [2009] 2 NZLR 359 (SC).
56 Ibid, at para [36].
57 Ibid, at para [37], applying Newton v Commissioner of Taxation for the Commonwealth of
Australia [1958] AC 450 (PC) at 465.
58 Glenharrow Holdings Ltd v Commissioner of Inland Revenue [2009] 2 NZLR 359 (SC) at para
[38], applying Ashton v Commissioner of Inland Revenue [1975] 2 NZLR 717 (PC) at 722.
59 See paras [21] and [28](d) above.
60 See (b) of the definition of “tax avoidance arrangement” in s OB 1 of the Act, set out at para [37]
above.
61 Challenge Corporation Ltd v Commissioner of Inland Revenue [1986] 2 NZLR 513 (CA) at 532-
534. See para (b) of the definition of “tax avoidance” in s OB 1, the comparator provision to that discussed by Woodhouse P.
62 Ibid, at 533-534.
course of action are likely to appreciate and welcome an opportunity provided by the Act for achieving some tax benefit as an aspect of it. But this should not bring the transaction or transactions almost automatically within the avoidance provisions of s 99. By itself conscious recognition and acceptance that a commercial transaction will be accompanied by a degree of tax relief is not the issue. Already I have mentioned the example put forward in this case of goods manufactured in New Zealand and sold overseas in the knowledge that surrounding costs were likely to be assisted by a tax saving which would not be applicable in the case of internal sales. But it could hardly be said in such a case that the trading had been pursued to gain the tax advantage as an end in itself. Conventional exporters do not trade to save tax but to achieve profits. To put the point in another way, among the cost factors to be taken into account one of them, to a greater or lesser extent, would sensibly and properly be the tax factor. So regarded, the tax saving purpose intended as a support to the operation could in the ordinary course no more be labelled an end in itself than the purpose of avoiding or minimising any other cost likely to affect the operation. In other words in the usual case the associated tax purpose ought not to be and in my opinion would not be regarded as more than a "merely incidental purpose". (my emphasis)
On that approach, it follows that evidence of a subjective nature from the taxpayer and others may assist the Court in determining issues of avoidance. However, its use must be restricted to providing the context in which the arrangement was brought into being, in order to assist the Court to understand any genuine commercial
arrangements involved.63
(c) The impact of Commissioner of Inland Revenue v Penny
[53] In Penny v Commissioner of Inland Revenue,64 MacKenzie J found in favour of two surgeons who had established companies of the type used by Dr White and had paid to themselves salaries that the Commissioner considered to be artificially low. In Commissioner of Inland Revenue v Penny65 the High Court judgment was reversed, by a majority.66
[54] At the time of argument of this appeal, the Court of Appeal’s judgment in Penny remained reserved. After delivery of that judgment on 4 June 2010, counsel were provided with an opportunity to make further submissions on its application to
63 See Westpac Banking Corporation v Commissioner of Inland Revenue (2009) 24 NZTC 23,834 (HC) at para [44].
64 Penny v Commissioner of Inland Revenue [2009] 3 NZLR 523 (HC).
65 Commissioner of Inland Revenue v Penny [2010] NZCA 231.
66 Hammond and Randerson JJ, Ellen France J dissenting.
the present case. I have received and considered submissions from counsel on that topic.
[55] In contrast to the present case, companies operated by two surgeons, Mr
Hooper and Mr Penny, did have sufficient money to pay salaries. While, during the
1999 and 2000 tax years Mr Hooper and Mr Penny returned income of $650,000 and
$302,000, after the companies were incorporated and they became employed by them, their income reduced to $120,000 and (in round terms) $110,000 respectively. Both Mr Hooper and Mr Penny accepted that the salaries paid by the respective companies were not commercially realistic and that they would not have entered into a similar arrangement with an unrelated party. Like Dr White, both Mr Hooper and Mr Penny cited the possibility of exposure to litigation not covered by accident compensation legislation as the reason for the new financial structures.
[56] The principal judgment in the Court of Appeal was delivered by Randerson J. After reviewing both Ben Nevis and Glenharrow, the Judge considered the Commissioner’s contention that a tax avoidance arrangement existed. He found that one of the effects of the arrangement was to alter the incidence of the taxpayers’ personal income from the top personal marginal tax rate of 39 cents in the dollar to
the company tax rate of 33 cents.67 The Commissioner’s view was that the
difference of 6 cents in the dollar between company and personal tax rates was avoided, to the extent that the salaries allocated were set at commercially unrealistic levels. Viewed as a whole, Randerson J accepted the Commissioner’s position that the “arrangement” was “artificial, contrived and beyond Parliamentary contemplation as a legitimate business arrangement”.68
[57] The case for Mr Hooper and Mr Penny rested on the company/trust structure that they put in place as “a legitimate and accepted means of conducting business” of which they had “taken advantage” to use the differential tax structure in their favour.69
67 Commissioner of Inland Revenue v Penny [2010] NZCA 231 at [86].
68 Ibid.
69 Ibid, at para [87].
[58] Randerson J placed some emphasis on Hadlee v Commissioner of Inland Revenue.70 In Hadlee, the High Court, Court of Appeal and Privy Council all held that, despite the assignment of a portion of partnership income by the objector to a trust whose beneficiaries comprised members of his family, the income that Mr Hadlee received from the partnership “was all derived by him for tax purposes and that, in any event, the assignment and associated arrangements constituted tax avoidance”.71
[59] In finding that the arrangements constituted tax avoidance, Randerson J said:
[113] There are two striking features of the arrangements adopted by both respondents. The first is that each had been conducting their respective practices as orthopaedic surgeons on their own account and then chose to incorporate their practices. In Mr Hooper’s case, that occurred in 2000, coinciding with the increase in the top personal tax rate. Mr Penny’s company was incorporated earlier in 1997. There is, and could be, no valid criticism of the adoption of the corporate vehicle as such. But it is the combination of that fact with the second striking feature which I consider to be significant. In each case, the net income before tax each respondent was receiving was dramatically reduced from the year 2000 onwards – in Mr Hooper’s case from about $650,000 to $120,000 per annum and in Mr Penny’s case from $302,000 to $125,000 and then to $100,000 thereafter. Their reduced salaries in the company structure represented approximately
16 per cent and 33 per cent respectively of the net pre-tax income they previously enjoyed.
[114] Both respondents accepted without hesitation that these salaries were at levels substantially below what could have been expected if they had been employed independently at arms-length. On Mr Lyne’s evidence, Mr Hooper’s salary should have been, on average, about $558,000 (compare the
$120,000 he was actually paid) and Mr Penny’s should have been $633,000 (compare the $100,000 he was actually paid).
[60] Having said that, Randerson J sought to minimise the precedent value of the finding he had made. His Honour was conscious of the “practical consequences” that could result from his decision, “including the uncertainty which may be created for the Commissioner as well as for taxpayers and their advisers”.72 Randerson J said:
[126] It will be a matter of assessing all the circumstances including the extent and nature of any element of artificiality or contrivance in order to
70 Hadlee v Commissioner of Inland Revenue [1989] 2 NZLR 447 (HC); [1991] 3 NZLR 517 (CA); [1993] 2 NZLR 385 (PC).
71 Commissioner of Inland Revenue v Penny [2010] NZCA 231 at para [101].
72 Ibid, at para [125].
determine whether any particular arrangement is within or outside the contemplation of Parliament in enacting the tax legislation. Where there are legitimate reasons such as those discussed at [98] above for adopting a salary markedly below commercial levels, a challenge by the Commissioner may be unlikely to succeed. Nor would I expect the Commissioner to interfere in marginal circumstances. The difference here is that salaries were adopted at levels so far below ordinary commercial expectations that, in the absence of legitimate reasons for doing so, there is a strong implication of tax avoidance. (my emphasis)
[61] Hammond J agreed with the result reached by Randerson J, substantially for the reasons he gave.73 The Judge explained, on the facts of Penny, that the Ben Nevis test should be applied as follows:
[137] . . .. The first inquiry is as to the application of the specific rules: “...the use made of the specific provision [must be] within its intended scope”. If it is not, that is the end of the inquiry at that point.
[138] But if the use is within the specific provision, the second question arises: whether the taxpayers’ “use of the specific provision viewed in the light of the arrangement as a whole” is lawful:
If ... it is apparent that the taxpayer has used [the] specific provision, and thereby altered the incidence of income tax, in a way which cannot have been within the contemplation and purposes of Parliament when it enacted the provision, the arrangement will be a tax avoidance arrangement.
...
[140] The third limb of Ben Nevis, or perhaps more accurately a gloss on the second limb, is that “[t]he general anti-avoidance provision does not confine a court as to the matters which may be taken into account when considering whether a tax avoidance arrangement exists”. As the Supreme Court said, the way in which the arrangement is stitched together and the effect of it in economic and commercial terms may also be significant. A combination of various elements may well be critical; in particular, the structuring of an arrangement so that the taxpayer gains the benefit of the specific provision in an artificial or contrived way.
[141] The significance of this, in terms of juridical technique, is that the approach is not a particularistic one; in an avoidance case matters are to be approached in a more “rounded” way which is intended to give full effect to the overall legislative taxation scheme and purpose. (my emphasis)
[62] Hammond J’s reasons for regarding the transactions as tax avoidance were summarised as follows:
73 Ibid, at para [133].
[157] But in this case, the intertwined economic and commercial effects of what was done, in their proper legislative context, seem to me to be as follows:
(i)Income derived from personal exertion should belong in its appropriate taxation band – here the highest band – in a graduated personal tax scheme. It should not be inappropriately diverted away.
(ii) These doctors were in the top personal tax rate as a result of their personal skill and exertion.
(iii) When Parliament increased the top tax to 39 per cent the doctors deliberately took themselves out of that category by interposing a company/trust structure.
(iv) Very significantly, they retained control over the whole of the income generated (notwithstanding the company/trust structure).
(v) They then applied the income so earned for the benefit of themselves and their families.
(vi) Their salaries were fixed at artificially low levels which did not on any view of the matter conform with anything approaching economic reality.
[63] Ellen France J reached a contrary conclusion. She began with the proposition “that not all arrangements which produce a tax advantage will constitute tax avoidance”.74 Her Honour regarded that proposition as “the corollary of the freedom taxpayers have to structure their tax affairs in the most tax effective way”. The Judge considered that, while the arrangements into which Messrs Penny and Hooper entered did produce tax advantages, they did not amount to tax avoidance.75
[64] Ellen France J considered that the arrangements could be classified as of an “everyday” nature.76 She referred to the common usage of separate identities of companies and trusts and characterised what occurred as “acceptable business practice and the opposite of artifice or contrivance”.77 In those circumstances, Ellen France J did not regard the taxpayers as having gained the benefit of specific provisions of the Act in any artificial or contrived way; rather, they had taken
74 Ibid, at para [163].
75 Ibid.
76 Ibid, at para [181].
77 Ibid.
advantage of differences in tax rates “in a way that is within the limits of acceptable commercial practice”.78
(d) Was the Taxation Review Authority right to find “tax avoidance”?
[65] I have concluded that the Authority erred in holding that the transactions into which Dr White entered constituted a “tax avoidance arrangement” for the purposes of s BG 1 of the Act.
[66] I start from the premise that a “rounded” assessment of what occurred is required,79 in order to determine whether the tax advantages that Dr White gained were “permissible” or “impermissible”.80 Accepting that Dr White’s subjective intentions are not determinative in ascertaining the “effect or purpose”81 of the arrangement,82 it is necessary to look at the nature of the alleged arrangement and how it was carried into effect to determine whether its purpose or effect was to obtain an impermissible tax advantage.83
[67] The relevant (uncontested) findings of fact made by the Authority were:
a) Even though the structure adopted by Dr White and her husband involved payment of $30,000 to each of their children for provision of services to the businesses, the amounts paid were reasonable.84 Allied to that was the Authority’s finding that real losses incurred from the taxpayer’s business activities could have been legitimately off-set against professional services income, at least “to a substantial degree” by other “legitimate methods”.85 The Authority also recorded that a
78 Ibid, at para [184].
79 Ibid, at para [141].
80 Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2009] 2 NZLR 289 (SC) at para [106]. See also para [45] above.
81 Income Tax Act 1994, s OB 1 definition of “tax avoidance arrangement”.
82 Glenharrow Holdings Ltd v Commissioner of Inland Revenue [2009] 2 NZLR 359 (SC) at para
[38], but see also Westpac Banking Corporation v Commissioner of Inland Revenue (2009) 24
NZTC 23,834 (HC) at para [44].
83 Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2009] 2 NZLR 289 (SC) at para [106].
84 Case Z24 (2010) 24 NZTC 14,354 (NZ TRA) at paras [19] and [85](1).
85 Ibid, at para [25].
deliberate decision was made not to use the LAQC regime because “a good profit [was expected] for 2004”.86
b)Dr White and her husband reconstructed their financial affairs to overcome a genuine concern about potential exposure to claims by clients in respect of their separate private professional services/business and, consequentially, to protect their family.87 In doing so, they adopted a legitimate corporate structure approved by the Act.88
c) Dr White and her husband began to put the new structures in place in July 2002, when the home orchard and a motel unit they had owned since 1994 were sold to the trustees of the family trust.89
d)While Dr White was not paid a salary in the 2003 and 2004 tax years, provisional tax was paid based on her previous year’s income. The reason no actual salary was credited was because, due to the unexpected unprofitability of the Hawken Orchard, there was no
money for the tax to be paid.90
e) Wharfedale’s unprofitability arose from factors such as “poor weather, costs, lack of domestic and foreign market supply and demand, and the variability of exchange rates”.91 Payment of orchard expenses absorbed most of the net profit that would otherwise have been achieved, in 2003 by Wharfedale. Similarly, because “nature caused the harvest to reduce by about 25% and the market returns on the reduced crop were lower than expected”, losses were also incurred in the 2004 financial year.92
86 Ibid, at para [33].
87 Ibid, at para [3].
88 Income Tax Act 1994, s OB 2. See paras [21] above and [70] below.
89 Case Z24 (2010) 24 NZTC 14,354 (TRA NZ) at paras [4] and [5]. That was before the Hawken
Orchard was purchased on 20 September 2002.
90 Ibid, at para [32].
91 Ibid, at para [31].
92 Ibid, at para [33].
f) If the crop on the Hawken Orchard had been harvested successfully, there would have been money to credit to Dr White, by way of salary, and income tax would have been paid on that.
[68] It is plain from the Authority’s decision that he concluded that tax avoidance existed primarily because Dr White “used her income in a way which [left] her unremunerated in a manner [that was] artificial and contrived and [had] no sensible reality”.93 The Judge considered that the effect of the structure in assigning her professional income as an anaesthetist to a family company, resulting in her income being set-off against losses from the orchards was problematic.94
[69] Judge Barber accepted there were “legitimate methods for a taxpayer to offset, against professional services, income, real losses incurred from business activities of that taxpayer, and that could have been legitimately achieved to a substantial degree” in the present case.95 His real concern was with “an injection of [Dr White’s] personal/exertion professional income into a family company experiencing losses from business activities so that it did not remunerate [Dr White] as an employee in a fair and commercial manner”.96 My response to that observation is that, at the time the arrangements were entered into, it was not expected that financial losses would be caused from business activities; indeed, the Authority found that as a fact.97 Further, the reason that no money was available for Wharfedale to pay a salary to Dr White was because income had to be diverted to pay real (not contrived) debts. To adopt Woodhouse P’s comments in Challenge Corporation Ltd v Commissioner of Inland Revenue,98 Dr White formed and used a closely held company to obtain a tax advantage in a manner that was not inconsistent with the purpose for which the use of such a company was allowed.99 In arranging her affairs in that way, Dr White did nothing more than obtain the tax advantage that Parliament intended would flow to someone in her position.
93 Ibid, at para [23].
94 Ibid.
95 Ibid, at para [25].
96 Ibid.
97 Ibid, at paras [30] and [31].
98 Challenge Corporation Ltd v Commissioner of Inland Revenue [1986] 2 NZLR 513 (CA) at 533-
534.
99 Income Tax Act 1994, s OB 2 and para [21] above.
[70] The “close company” regime specifically allows small family companies and their shareholders to account for the tax payable on the salary of a shareholder- employee under the provisional tax regime, rather than the PAYE system. The ability of a shareholder-employee to defer receipt of salary until the end of the tax year necessarily means there may be some circumstances in which it will be necessary, in fragile financial circumstances, for the working shareholder to donate his or her time, if funds are not available to pay proper remuneration.
[71] In Penny, the Court of Appeal seems to have accepted that there could be no valid criticism of adoption of a corporate vehicle and use of trusts in a case such as this.100 Unlike Penny, this was not a case in which a reduced salary was deliberately paid. Rather, it was a case in which salary was not paid because the company lacked funds to do so.
[72] In my view, the possibility of unexpected losses that could result in salaries not being paid is expressly contemplated by the ability to use closely held companies to employ individual taxpayers on a provisional tax basis. Additionally, the evidence in this case was that Dr White did continue to pay provisional tax on the basis of income actually received from source. There is no evidence that Dr White would, inevitably, have received no or a minimal salary from the company in the relevant tax years.
[73] The elements of the “tax avoidance arrangement” on which Judge Barber relied101 reveal nothing out of the ordinary. Indeed, they reflect, as Ellen France J put it in Penny, “acceptable business practice and the opposite of artifice or contrivance.”102 As was recognised by the Court of Appeal in Grieve v Commissioner of Inland Revenue:103
It is not for the Courts or the Commissioner to confine the recognition of businesses to those that are always profitable or to do so only as long as they operate at a profit.
100 Commissioner of Inland Revenue v Penny [2010] NZCA 231 at para [113], per Randerson J, with whom neither Hammond J nor Ellen France J appeared to disagree on this point.
101 Summarised at para [29](d)] above.
102 Commissioner of Inland Revenue v Penny [2010] NZCA 231 at para [168].
103 Grieve v Commissioner of Inland Revenue [1984] 1 NZLR 101 (CA) at 110.
Those comments were made in the context of determining the ambit of the word “business” in the Land and Income Tax Act 1954 but they also provide more general insight into the scheme and purpose of the Act.
[74] It seems to me difficult to say that Dr White engaged herself in a tax avoidance arrangement when, at the time the arrangements were put in place, there was a realistic expectation of sufficient profit to pay a salary to Dr White, from which tax would be paid. The primary factor that Judge Barber held contributed to
Wharfedale making losses (the failure of the Hawken Orchard to make a profit)104
was not foreseeable.
[75] The fact that this was the case was evidenced by Dr White continuing to pay her provisional tax on the pre-existing basis. The fact that the company happened to make a loss should not turn an otherwise acceptable business arrangement into one characterised as artificial or a contrivance. While the effect of the arrangement was (for unforeseen reasons) to negate the need for Dr White to pay income tax, its purpose was not to obtain an impermissible tax advantage. In my view, the purpose or effect of the arrangement was not to avoid payment of tax, having regard to the way in which the authorities have defined the words “purpose or effect”, as a
composite phrase.105 Even if that conclusion were wrong, I consider that purpose or
effect was “merely incidental” and therefore falls outside the scope of the definition of tax avoidance.106
[76] Using the approach articulated by Tipping, McGrath and Gault JJ in Ben Nevis107 this was a tax advantage gained through the ability to use Wharfedale to employ Dr White which fell both within s OB 2 and the scheme of the Act as a whole. On that basis it was a “permissible tax advantage”. In this case, the taxpayer relied on the use of a closely held company to employ her and to pay tax on a provisional, rather than PAYE, basis.
104 Summarised at para [29](b) above.
105 Glenharrow Holdings Ltd v Commissioner of Inland Revenue [2009] 2 NZLR 359 (SC) at para
[38].
106 Income Tax Act 1994, s OB 1, para (b) of the definition of “tax avoidance arrangement”; set out at para [37] above.
107 Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2009] 2 NZLR 289 (SC) at para [106].
[77] I add that the additional factors on which the Commissioner relied to establish a tax avoidance arrangement (not accepted by Judge Barber) do not change my view of the way in which the arrangements commenced on 1 November 2002 should be characterised.108
The “reconstruction” issue
[78] In light of my findings on the tax avoidance point, it is unnecessary for me to consider the “reconstruction” issue.
Result
[79] For the reasons given, the appeal is allowed. Dr White has established that the Commissioner’s assessments are wrong, and is entitled to relief.109 I make orders cancelling the 2003 and 2004 income tax assessments assessing Dr White to $34,844 and $95,644 attributed additional income respectively and directing the Commissioner to make an assessment in accordance with the amounts returned by the taxpayer. In case some more detailed expression of the appropriate relief is necessary, leave is reserved to both parties to apply further,110 within 21 days of the date of delivery of this judgment.
[80] There is no reason why costs should not follow the event. Costs are awarded in favour of Dr White on a 2B basis, together with reasonable disbursements, both to
be fixed by the Registrar.
P R Heath J
Delivered at 2.30pm on 12 October 2010
108 See para [21] above.
109 Tax Administration Act 1994, s 138P.
110 Taxation Review Authorities Act 1994, s 26A and High Court Rules r 20.19.
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