Articles - BVO - Blackmore Virtue & Owens - articles TaxFiling

By: Bvo  05-Apr-2012
Keywords: Accounting, Property Management, Accountants

The Inland Revenue has been rather successful of late in recent tax avoidance cases. In the past two months, three Taxation Review Authority Decisions ("TRA") have been released involving small business taxpayers in which the Commissioner has alleged tax avoidance. So far, the Commissioner is ahead of the "game" leading 2-1.

The facts of each case differ but the Commissioner's arguments have been similar. In brief, he has argued that:

  • the arrangement in question cannot be explained in terms of ordinary commercial purposes and can be explained only in terms of a concocted series of steps aimed at obtaining a tax benefit;
  • the mechanism used to achieve the results was contrived and artificial and lacked economic substance; and
  • the 2008 decision in Ben Nevi Forestry Ventures & Others v CIR was effectively that transactions that are tax driven tend to be artificial and contrived as they are not focused on the commercial realities. If the taxpayer uses a specific provision in the Income Tax Act in an arrangement that has no commercial purpose, Parliament would not have contemplated such a use.

Following the High Court Decisions late last year on tax avoidance (Penny & Hooper, BNZ Investments Ltd and Westpac Banking Corporation Limited) there has been considerable interest in how the lower courts apply the Supreme Courts decision in Ben Nevis, particularly how the courts would apply the Parliamentary contemplation test that forms a central plank of that decision.

In one case, TRA No. 03/08, Decision No. 3/2010, the facts were a property developer received a series of loans (mostly from trusts) over a 12 year period, while at the same time drawing only a small salary. The trading entities themselves operated in a way that virtually no tax was payable, as the income from one project was generally offset by the costs of the next project.

In one case, TRA No. 03/08, Decision No. 3/2010, the facts were a property developer received a series of loans (mostly from trusts) over a 12 year period, while at the same time drawing only a small salary. The trading entities themselves operated in a way that virtually no tax was payable, as the income from one project was generally offset by the costs of the next project.

Notwithstanding that the underlying trading entities did not derive taxable income; the TRA found that the receipt of the loans by the taxpayer and held on "loose" terms, rather than a salary, amounted to tax avoidance.

The taxpayer had repaid part of the loans out of capital distributions from the entities. On this point the TRA commented that the Commissioner was generous only assessing the net balance of the loans. The TRA also determined that a penalty for adopting an abusive tax position (100% of the tax shortfall being the base position) should be applied.

So what does this decision mean for taxpayers and tax advisors? There are a number of aspects in the fact pattern that are very common in the Small to Medium Enterprise (SME) context:

  • the non-payment of salaries to "owners" in the absence of taxable income in the trading entity
  • drawing and living on capital gain amounts
  • the use of current accounts within family structures to transfer money
  • the use of journal entries to record movements in current accounts

Tax practitioners and other interested parties are awaiting the Court of Appeal decision of Penny and Hooper which will hopefully provide some certainty around how "owner/operator" businesses (which make up the majority of NZ businesses) can operate and where the avoidance boundary arises rather than the current lottery of retrospective avoidance legislation.

So in the meantime…
Tax avoidance is no longer the domain of the largest corporates with complicated financial structures; these recent cases indicate that the avoidance question is becoming more mainstream amongst the SME market.

Practitioners and taxpayers in the SME market must reassess the filing position traditionally adopted in light of the apparent shift in the tax avoidance boundary.

Understanding the potential risks and shifting boundaries as to what is an 'acceptable' tax position is paramount. Remember it is not if you will be audited, but rather when.

Please contact us if you have entered into any transactions during the year or if you are unsure of the tax position taken in earlier income years is robust to withstand such Inland Revenue scrutiny.

Keywords: Accountants, Accounting, Business Planning, Litigation Support, Property Management, Tax Advice, Taxation, Valuations

Other news and updates from Bvo

05-Apr-2012

Articles - BVO - Blackmore Virtue & Owens - articles

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