Overview of Income Tax Act of New Zealand
Section BG 1 of the Income Tax Act, 2007 of New Zealand deals with the general anti-avoidance provisions explained in the Act. Whereas Section GA 1 of the cited Act gives the Commissioner power to make adjustments after the application of s BG 1. These two legal provisions broadly outline the legal stand which the Commissioner can take on tax avoidance in New Zealand. They also outline the approach which the Commissioners have been adopting towards implementing the Anti-avoidance regulations in New Zealand.
Application of s BG 1 is usually considered only after determining if other provisions under the Act are applicable or not. To evaluate this arrangement, a specific provision is interpreted in accordance to its purpose as defined under s 5(1) of the Interpretation Act, 1999. Hence, s BG 1 can only be considered as applicable in view of the whole arrangement after circumventing other specific provisions and discarding them.
Interpretation of these sections was set as a procedure by the New Zealand Supreme Court in the case of Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2 NZLR 289. Through this judgment, the Supreme Court indicated its intention in settling the approach to be followed in establishing the relationship between s BG 1 and rest of the Income Tax Act, 2007.
The issue being considered in this paper is the general anti-avoidance provisions contained in the Income Tax Act, 2007 under ss BG 1 and GA 1 and the relevant terms as defined in s YA 1 of the Act. There are still cases where matters on tax avoidance are referred to the predecessors of ss BG 1 and GA 1, notably:
108 of the Land and Income Tax Act, 1954;
99 of the Income Tax Act, 1976;
BG 1 and GB 1 of the Income Tax Act, 1994;
and ss BG 1 and GB 1 of the Income Tax Act, 2004.
BG 1 of the Income Tax Act, 2007.
GA 1 of the Income Tax Act, 2007.
YA 1 of the Income Tax Act, 2007.
Elmiger v Commissioner of Inland Revenue [1966] NZLR 683 (SC) at 687–688.
W T Ramsay Ltd v Inland Revenue Commissioners [1982] AC 300 (HL).
Furniss (Inspector of Taxes) v Dawson [1984] AC 474 (HL).
Challenge Corporation Ltd v Commissioner of Inland Revenue [1986] 2 NZLR 513 at 555 (PC).
Miller v Commissioner of Inland Revenue [1999] 1 NZLR 275 (CA).
Interpretation of Sections BG 1 and GA 1
Commerce Commission v Fonterra Co-operative Group Ltd [2007] NZSC 36, [2007] 3 NZLR 767.
Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2 NZLR 289.
Penny v Commissioner of Inland Revenue [2011] NZSC 95, [2012] 1 NZLR 433.
- Section BG 1 has always been applied by the tax authorities for creating situations to void the whole arrangement. This is because the language used in framing s BG 1 does not allow any scope for apportionment, hence all tax outcomes of the whole arrangement, including all the legitimate outcomes, are treated as void. The law leaves no scope, under s BG 1, for the applicant to leave in place even a part of the tax avoidance arrangement. The final effect of s BG 1(1) thus becomes that a tax avoidance arrangement becomes void right from the beginning of the arrangement.
- Section BG 1 is in itself an annihilating provision. It has no provision of itself to create a tax liability. In order to complete an assessment, the Commissioner has to apply s 113 of the Tax Administration Act, 1994after completing the process of voiding.
- Legal circles have pointed out on many occasions this drawback. It has been argued that if the voiding of an arrangement, by using s BG 1, has been successfully implemented to counteract the tax advantages which the applicant could have availed, (and the section does no more than that) then there would be no need for the Commissioner to apply s GA 1. But this does not happen in practice. The main point to be noted is that if voiding has not been able to appropriately counteract tax avoidance by the applicant or the voiding has been able to remove legitimate outcomes which the applicant could have gained or if there still are consequential adjustments which are required to be made, the Commissioner has to resort to the application of s GA 1.
- The legal fraternity has been repeatedly saying that Sections BG 1 and GA 1 are giving undue powers to the Commissioner which are used to counteract a tax advantage. This takes place because of the combination created by the effect of s BG 1 and the application of s GA 1.
Before proceeding further with the arguments, it is pertinent to fully understand the various important legal terms used in the context of anti-avoidance doctrine and their exact meanings when used in legal matters.
- Arrangementin fact means an agreement or a contract or plan or an understanding, irrespective of whether it is enforceable or unenforceable, and shall include all steps and transactions through which it is carried by the applicant into effect.
- Tax Avoidancedeals with situations which:
- directly or indirectly help the applicant in altering the incidence of any kind of income tax;
- directly or indirectly helps the applicant to be relieved from the liability of paying income tax, including from a potential or a prospective liability of income tax in future;
- directly or indirectly helps the applicant in reducing, avoiding or postponing any income tax liability or from any potential or prospective income tax liability in the future.
- Tax Avoidance Arrangement, is in fact the culmination of the first two terminologies discussed at 5 and 6 and describes any arrangement, whether entered into by the person affected because of the arrangement or by any another person, who directly or indirectly:
- has tax avoidance as its purpose or effect;
- or has tax avoidance as one of its purposes or effects;
- whether or not any other purpose or effect is refer-able to ordinary business or family dealings, provided the tax avoidance purpose or effect is not merely an incidental one.
- As stated above, s BG 1 has powers to void any tax avoidance arrangement. Technically, an “arrangement” is defined as and includes a formal, legally-enforceable contract through certain informal, unenforceable understandings.
- Hence, an “arrangement” shall:
- include “all steps and transactions by which it is carried into effect”;
- include unilateral arrangements;
- comprise two or more documents or transactions together if they are forming part of a single “agreement, contract, plan or understanding”;
- include all steps or transactions which are carried out or brought into effect by the applicant even outside of New Zealand.
- The definition also implies that a taxpayer shall be considered party to an “arrangement” even if it did not know the details of the arrangement and the way it would be carried out.
- Hence, before taking any decision, it becomes important for the law makers to understand the arrangement fully, to take into account all the pertinent and relevant facts and the information related to the arrangement. This should also include understanding of the private, commercial and any other objectives of the arrangement, including those of tax.
- To determining and establish whether there existed a tax avoidance arrangement and this should involve the consideration of various factors, including the:
- manner in which the arrangement is carried out;
- role of all relevant parties and their relationships;
- economic and commercial effect of documents and transactions;
- duration of the arrangement;
- nature and extent of the financial consequences;
- The relevance of all these factors will depend on the provisions used by the lawmakers or circumvented and also what facts, features and attributes are required under the Act as a whole.
Based on the above discussed points, the important question is – Does the arrangement, when viewed in a commercially and economically realistic way, makes use of (or circumvents) the relevant provisions in a manner which is consistent with the purpose set out by the Parliament? In this context, it is necessary to exercise judgement as to whether any of the requisite facts, features and attributes are absent or present to the degree sufficient for enforcing the Act.
Even in cases where an arrangement, which is complex or unusual and creates or produces such tax results which can be considered as undesirable from the perspective of the policy, it may not exactly be a tax avoidance arrangement. Taxpayers have the liberty of structuring their financial arrangements to get them the best tax advantages, provided, of course, that the use of such provisions has been made in accordance with what the Parliament had contemplated when enacting the provisions. However, it is also a fact that merely a literal compliance with the legal provisions is not sufficient for establishing that the use has been made within the Parliament’s contemplation.
The Predication Test In this respect, Lord Denning outlined in the case of Newtonwhat has now become known as the predication test. Under this test, his Lordship ruled that an arrangement may not be considered as a tax avoidance arrangement if it can be explained as an ordinary business or a family dealing. Lord Denning said, and I quote:
“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.” Unquote.
Legal Terms Used in Anti-Avoidance Doctrine
This test has limited the anti-avoidance provision to such arrangements which have the sole or principal purpose to effect a tax avoidance. In Challenge,the Privy Council had ruled that the relevant purpose of tax avoidance had to be the sole or at least principal purpose of an existing arrangement and this was instrumental in overturning the view of Woodhouse J in Miller). Consequently, amendments were carried out in s 108, (which is a predecessor to s BG 1) by introducing s 9 of the Land and Income Tax Amendment Act (No 2) of 1974 for countering this restrictive manner in which s 108 was being applied. This amendment opened a way towards clarifying that such arrangements which have a more than “merely incidental purpose or effect” of tax avoidance should be considered as tax avoidance arrangements, whether or not, such purposes or effects are refer-able to an ordinary business or some family dealings.
In general, the anti-avoidance provisions proscribe those arrangements which use the Act in such a way that the Parliament had not contemplated. Although the taxpayers have the freedom to structure their financial arrangements while using those structures which have been recognised by the Act, an arrangement can be declared a tax avoidance arrangement if the applicant’s structures are based on provisions which are outside of the Parliament’s contemplation. Consider for example, that a taxpayer has chosen to sell or lease an asset and he has different tax consequences from that choice. Now, if the taxpayer has structured such an arrangement so as to use the lease provisions but on taking into consideration the commercial and economic conditions of the arrangement, that the arrangement is actually a sale, then the provisions used by the applicant shall be considered to be outside the Parliament’s contemplation.
Conclusion
The judgment given by the New Zealand Supreme court in the case of Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2 NZLR 289 has since been acknowledged in subsequent judicial decisions on the same topic. Many subsequent judgments did acknowledge that the Ben Nevis approach is the most appropriate approach for applying s BG 1 in matters related to anti-avoidance. Another landmark decision on anti-avoidance issue was given by the Supreme Court in the case Penny v Commissioner of Inland Revenue [2011] NZSC 95, [2012] 1 NZLR 433, popularly referred to as Penny & Hooper in the legal circles. Accordingly, all the subsequent Commissioners consider that these judgments reflect the true essence of the law in cases related to anti-avoidance.
Criteria for Determining Tax Avoidance Arrangements
Under PART-C: APPLICATION of this paper, legal application of the term Arrangement has been discussed. It has also been detailed how s BG 1 becomes eligible when an arrangement is proven showing that the defendant in an anti-avoidance lawsuit was doing so with intent and knowledge. However, there have come to light certain lawsuits where the defendant was unaware of the arrangement and still was implicated because of s BG 1. In the contention of this paper, this lawsuit seems to be a case where Mr. Nathan was unaware of the legality of the term arrangement and had no intention of creating a situation of anti-avoidance of tax. His only contention was to safeguard the financial rights of his family members in a legal way and hence he created a family trust to which he entrusted all the financial responsibilities and legal rights of the trustees with respect to the asset that he created and also with regard to the income which this asset would be generating in the future.
Based on the above arguments, the taxpayers had requested in Ben Nevis that courts should recognise the use of choices in the Act. The court said, and I quote:
“The appellants made a sustained plea that the courts should not deprive commercial and other parties of tax beneficial choices. On the approach we have set out, taxpayers have the freedom to structure transactions to their best tax advantage. They may utilise available tax incentives in whatever way the applicable legislative text, read in the light of its context and purpose, permits. They cannot, however, do so in a way that is proscribed by the general anti-avoidance provision. Unquote.
The New Zealand Supreme Court in Penny (SC) had said that while the taxpayers should have the choice to transfer the assets owned by their businesses to trusts or companies owned by their family trusts, provided there were no other aspects of the arrangement which meant it was a tax avoidance arrangement. The economic and commercial reality of an arrangement, when considered as a whole, should be that the taxpayer received the full benefits of the income provided it was derived effectively.
Enonchong, N. D. Undue Influence and Unconscionable Dealing (Sweet & Maxwell 2006)
Mayer, D.N. Liberty to Contract: Rediscovering a Lost Constitutional Right (Cato Institute 2011)
Poole, J. Contract Law (OUP 2008)
Trebilcock, M.J. The Limits of Freedom of Contract (HUP 1993)
Allcard v Skinner [1887] LR 36 ChD 145
Barton v Armstrong [1976] 1 AC 104
Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2 NZLR 289.
Challenge Corporation Ltd v Commissioner of Inland Revenue [1986] 2 NZLR 513 at 555 (PC).
Commerce Commission v Fonterra Co-operative Group Ltd [2007] NZSC 36, [2007] 3
NZLR 767.
CTN Cash And Carry Ltd v Gallagher Ltd [1994] 3 All ER 714
Dimskal Shipping Co SA v International Transport Workers’ Federation, The Evia Luck [1991] 4 All ER 871
Elmiger v Commissioner of Inland Revenue [1966] NZLR 683 (SC) at 687–688.
Fisher v Bell [1961] 1 QB 394
Furniss (Inspector of Taxes) v Dawson [1984] AC 474 (HL).
Occidental Worldwide investment Corporation v Skibs A/S Avanti, the Siboen and the
Sibotre [1976] 1 Lloyd’s Rep 293
Miller v Commissioner of Inland Revenue [1999] 1 NZLR 275 (CA).
Penny v Commissioner of Inland Revenue [2011] NZSC 95, [2012] 1 NZLR 433.
W T Ramsay Ltd v Inland Revenue Commissioners [1982] AC 300 (HL).
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