Decision date: 6 November 2013
Case: TRA 11/10
Act(s): Income Tax Act 2004, Tax Administration Act 1994
Keywords: Tax avoidance, misappropriation, abusive tax position
The arrangement did not meet the requirements of sections DC 5, DA 1 DB 6 or DB 7 of the Income Tax Act 2004. The arrangement was also a tax avoidance arrangement and the shortfall penalty for taking an abusive tax position was appropriately applied by the Commissioner of Inland Revenue ("the Commissioner"). Further, the requirements for a deduction under section DB33 were not satisfied.
In the income tax years ended 31 March 2004 to 31 March 2006, the disputant participated in an arrangement which purported to constitute an employee indemnity fund ("the EEF") for the benefit of the disputant's employees.
Ultimately, the disputant claimed deductions in the relevant income years for contributions, fees, insurance and interest paid under the EEF. The Commissioner reversed the deductions and assessed the disputant for shortfall penalties.
In an earlier proceeding (Case 8 (2012) 25 NZTC 15,824) the disputant argued that the promoters of the EEF had defrauded them and that where there is such a fraud there can be no tax avoidance.
On 11 September 2012, the Taxation Review Authority ("TRA") gave a threshold decision on this point, confirming that fraud on the disputant did not preclude the tax avoidance provisions from applying to the arrangement.
The hearing for the substantive matters in dispute proceeded on 6 May 2013.
The TRA held that the EEF did not meet the requirements of section DC 5. In particular, the contributions to the EEF were not set aside or paid to provide individual personal benefits to employees of the disputant and that the EEF was not established in a way that fully secured the rights of employees to receive the benefits.
Rather, the TRA considered the EEF appeared to be more in the nature of an insurance policy for the disputant (as the employer) in the event that it was unable to meet employment-related costs. In any event, any benefits that could be regarded as personal to the employees appeared to be benefits the employees were already entitled to pursuant to statute and/or their employment contracts. Further, the funds the disputant purportedly set aside to provide individual personal benefits to the employees were no more than book entries and/or were not accessible by the employees.
Section DA 1
The TRA found that it may have been arguable that any expenditure incurred that was directly related to the risk factors identified in the EEF would have had the requisite nexus with the disputant's income-earning business.
However, the TRA considered that because the expenses claimed related to the EEF and not the risk categories themselves, the expenditure was one step removed from actual expenditure on the risk factors. Further, the EEF was more akin to setting aside money as a contingency fund for the benefit of the disputant, rather than as a redundancy fund for employees. In addition, the EEF did not deplete over time, no claims were made and no bonuses paid to employees.
The TRA considered that the expenditure was capital in nature because the contributions were an attempt to establish the nucleus of a fund that was an identifiable asset of an enduring nature; employee benefits did not accrue from the establishment of the EEF; and the disputant's director had confirmed that he saw the arrangement as a retirement fund for his own benefit.
The TRA considered that there was no evidence that established that any of the purported interest payments were, in fact, payments of interest in relation to the loan.
The TRA concluded that the arrangement had a purpose or effect of tax avoidance. Further, the TRA considered that no evidence existed that supported the disputant's purported purpose of creating a pool of money to meet future employment-related costs.
The TRA considered that the arrangement was artificial, contrived and something of a pretence; it was commercially unusual and there were no economic consequences incurred by the disputant. Ultimately, when viewed in a commercially realistic way, the tax avoidance purpose was pursued as a goal in itself and was therefore not merely incidental.
The disputant alleged that the arrangement was a fraud on it by the promoters but the TRA again confirmed that was irrelevant to determining whether or not section BG 1 applies. In any event, the TRA stated that the reasons the disputant gave in support of fraud allegations also supported a finding of tax avoidance.
The TRA confirmed that the reconstruction carried out by the Commissioner was an appropriate exercise of section GB 1.
The TRA considered that, when viewed objectively, the positions taken were not about as likely as not to be correct.
Further, the TRA considered that the positions taken were in relation to an arrangement that had a dominant purpose of tax avoidance and accordingly, the Commissioner acted appropriately and correctly in imposing an abusive tax position shortfall penalty under section141D.
The disputant asserted, on the basis of its allegations of fraud, it was entitled to deductions under section DB 33 for misappropriation.
The TRA considered that proof of fraud by the promoters was not relevant for the purposes of section DB 33. The TRA concluded that the disputants had failed to prove that property had been misappropriated in the course of the disputant's business by a person rendering services to the disputant.