August 2009
Contents:
The Commissioner of Inland Revenue on behalf of Inland Revenue ("IRD") and Solicitor General as chief executive of the Crown Law office ("Crown Law") have recently signed and released to interested parties a protocol that clarifies the nature of the relationship between the two agencies as it relates to the running of tax litigation and the interpretation of the tax laws. The issue is a significant one, because although the IRD has its own tax technical expertise, the Solicitor General and Crown Law have an overarching responsibility to ensure that Government (including the IRD) is conducted according to law.
For taxpayers, the question of "who calls the shots" is important because in assessing and managing tax risk, taxpayers need to consider not only the letter of the law, but also the way in which it is interpreted in practice. Those with experience in dealing with both the IRD and Crown Law on tax matters, will know that the two agencies can often have quite different perspectives on how tax laws are administered, and should be interpreted.
An example is the reliance placed on IRD interpretation statements and other guidance. The Finance and Expenditure Select Committee in its recent report on the Taxation (International Taxation, Life Insurance and Remedial Matters) Bill, emphasised the importance of providing clear guidance to taxpayers on the meaning of otherwise uncertain legislative provisions. The Committee recorded IRD's assurance that it "would publish a special report explaining some of the new rules introduced by this bill as soon as practicable after the bill is passed, and that this information would also be set out in a Tax Information Bulletin by the end of this year". There is no doubt taxpayers do rely on such guidance. However, in the litigation context, the IRD (through Crown Law) has argued on a number of occasions that such statements cannot be relied upon by taxpayers. In one case, the Supreme Court accepted that IRD guidance issued to taxpayers was wrong, may have misled taxpayers, but that that in no way affected the correct legal position, which is to be determined on the basis of the legislation. The Supreme Court's conclusion was no doubt correct as a legal matter, but that is of little comfort to taxpayers who routinely rely on such guidance.
The recently concluded protocol records that Crown Law's position entails two particular responsibilities. First, the responsibility for the conduct of all of the Crown's litigation (including through the IRD) rests with Crown Law. Second, as the protocol states, Crown Law "provides the authoritative view of what the Crown considers the law to be". This, of course, includes tax laws.
In respect of tax administration specifically, the protocol includes the following elements:
- If a legal issue is the subject of significant dispute in litigation, and is due to be the subject of an IRD interpretative statement, statement of position, binding ruling or Adjudication report, the IRD will consult with Crown Law on the issue, and if necessary, obtain Crown Law's formal advice before issuing the statement in question. The decision as to how to apply Crown Law's advice to the statement in question rests with the IRD.
- Crown Law is ultimately responsible for the conduct of litigation in the Commissioner of Inland Revenue's name. In the event of disagreement between Crown Law and the IRD over the conduct of litigation, there is to be consultation, and an escalation process within both organisations. But if the disagreement is not resolved as a result of those processes, the Solicitor-General will have the final decision.
- Crown Law is responsible for selecting counsel to represent the IRD, although the IRD's views will be taken into account.
- Counsel appointed by the Solicitor-General and Crown Law will be responsible for what legal arguments are put to the Court in tax litigation, subject to the views of the Solicitor-General. Counsel will ensure that proposed submissions are fully discussed with the IRD, whose views on the proposed submission will be carefully considered and followed unless there are good reasons for not doing so. In the event of a dispute about proposed submissions, that dispute will ultimately be resolved by the Solicitor-General if the dispute is unable to be resolved through dialogue between Crown Law and IRD.
- Settlement of tax litigation will be the joint responsibility of the Solicitor-General/Crown Law and the IRD. However, if agreement cannot be reached, the Solicitor-General will resolve the issue.
The release of the protocol is a welcome development in improving taxpayers' understanding of the IRD's and Crown Law's respective roles. That Crown Law "calls the shots" on running tax litigation will be of no surprise to most taxpayers and their advisors. What is less clear is what that means outside of the litigation context. The fact the Solicitor General and Crown Law "provide the authoritative view of what the Crown considers the law to be", and have the final say on what legal arguments are made in tax litigation, may mean that on uncertain matters Crown Law has a significant role in interpreting the tax laws, even outside the litigation context. Taxpayers and their advisors need to be aware of this in deciding how much comfort to draw from the IRD's previous acceptance of a particular interpretation which may not reflect the strict legal position, especially on issues where the tax at stake is potentially significant.
High Court gives judgment on application of section BG 1 to structured finance transactions in BNZ Investments Limited & Ors v CIR (CIV-2004-485-1059, Wellington High Court, 15 July 2009)
The BNZ Group entered into nine cross-border sale and repurchase (or "repo") transactions with large UK and US based financial institutions. Three of the transactions were subject to favourable binding rulings from Inland Revenue. The case concerned the other six transactions, which were not the subject of binding rulings.
The returns from those other six transactions were either exempt under the conduit regime (in the case of five of the transactions) or fully tax relieved under the foreign tax credit regime (in the case of the other transaction) - a function of the fact that funding was provided by way of repo over fixed rate shares or trust interests, and not by way of loan. BNZ could nonetheless deduct its costs associated with each transaction, because the costs in question were interest expenditure (or deemed to be interest expenditure). Interest expenditure incurred by a company is deemed to be deductible whether or not the expenditure relates to assessable income. Inland Revenue contended that the transactions were tax avoidance arrangements, principally on the basis that absent the particular tax treatment (tax relieved income, and deductible expenditure) the transactions would not have been commercially viable.
Wild J noted that cross-border repos structured so as to result in a tax arbitrage between two jurisdictions were "well established" and "mainstream" (paragraph [517]). He also accepted that BNZ's transactions "had the same core characteristic as the domestic RPS transactions that New Zealand banks commonly invested in through the 1980s and early 1990s" (paragraph [244]).
Nonetheless, Wild J concluded that the transactions were tax avoidance arrangements, for reasons which he summarised in order of importance at paragraph [526]:
- The BNZ transactions had the purpose or effect (that was not merely incidental) of substantially altering the incidence of tax for BNZ.
- Aside from the tax benefits, "the transactions had no commercial purpose or rationale".
- The foreign tax credit claimed by BNZ in respect of its first transaction was not within the scheme and purpose of the foreign tax credit regime, nor could BNZ act as a "conduit" in the manner contemplated by the conduit regime.
- Elements of the transactions were contrived to increase the tax benefits, and the process by which certain rates were set was not normal commercial practice.
- BNZ suffered no risk from the transactions aside from tax risks, but earned returns disproportionate to those risks.
Wild J's decision is the second decision of the High Court on section BG 1, following the two Supreme Court decisions on tax avoidance late last year (Ben Nevis in the income tax context, and Glenharrow Holdings in the GST context). Wild J considered that Ben Nevis required him to decide: "had Parliament foreseen transactions of this type when enacting the specific provisions deployed in the transactions, would it have viewed them as within the scheme and purpose of those specific provisions?" (paragraph [135]). Essentially, Wild J decided that Parliament would not have "approved" of transactions which, aside from the tax benefits, would not have been commercially viable.
In the other High Court decision to have applied Ben Nevis so far (Penny and Hooper v CIR, summarised in the April 2009 Tax Law Update (click here for a copy)), a different Judge took a different approach, concluding that in applying section BG 1, the Court must seek to ascertain Parliament's purpose from the scheme of the Act viewed objectively, and not (as the Judge in that case put it) by way of "an intuitive subjective impression of the morality" of the arrangement in question. In that case, the Court found in favour of the taxpayer. Both Penny and Hooper and the BNZ Investments decision have been appealed to the Court of Appeal, although neither appeal is expected to be heard until next year.
In the meantime, a case involving transactions similar to those considered in BNZ Investments, entered into by Westpac, has recently concluded before Harrison J in the High Court at Auckland. Judgment in that case is expected later this year.
To view a copy of the case click here.
In CIR v Trustees in the Mangaheia Trust (CIV 2009-485-000593, Wellington Registry, 29 July 2009) the High Court upheld the TRA's decision that the taxpayers, trustees of two trusts, were allowed to claim GST input tax credits in relation to legal services acquired in the course of protracted litigation of a dispute with the trusts' beneficiaries. Each of the trusts had substantial assets and carried on a taxable activity for which it was GST registered. The assets of the trusts that the legal services were acquired to protect included assets that were not used by the trusts to carry out their taxable activities.
The issue before the Court was whether the legal services were acquired for the principal purpose of making taxable supplies. The High Court rejected the Commissioner's argument that the legal services related to claims made personally against the trustees and were therefore unrelated to the taxable activities of the trusts. The Court held that a restrictive approach is not necessary in assessing the extent of a taxable activity, and that the principal purpose test was satisfied because (as part of the trusts' taxable activities) the trustees had to protect the capital and business assets of the trusts.
To view a copy of the case please click here.
In Radioworks Limited v CIR (CIV 2007-404-005853) and TVWorks Limited v CIR (CIV 2007-404-005854, Auckland High Court, 27 July 2009), the High Court held that an order for general discovery does not cut across the disclosure and evidence exclusion regimes of the Tax Administration Act 1994 ("TAA").
The primary issue before the Court was whether an order for general discovery was appropriate in relation to tax cases. The taxpayers contended that the Commissioner's wide-ranging information gathering powers in section 17 of the TAA rendered general discovery unnecessary and that, in any event, the evidence exclusion rule in section 138G of the TAA limited the parties to the facts, evidence, issues and propositions of law contained in their respective statements of position.
The Court found in favour of the Commissioner finding that the scheme of the TAA does not preclude discovery in the ordinary course. The Court stated that there is no certainty that all relevant information will emerge by use of section 17 of the TAA as the Commissioner will not necessarily know what information the taxpayer holds and exactly what to seek. In addition, the Court drew a distinction between the discovery of evidence and its subsequent admissibility. It was held that, though section 138G may operate to treat evidence as inadmissible, it does not preclude its discovery. Further the Court stated that relevant documents emerging from discovery may fall within a category of documents identified in the statements of position (and hence not fall within the evidence exclusion rule) or may be the subject of an exception to the evidence exclusion rule.
The Court also granted an order for discovery against non-parties in the Commissioner's favour. The non-parties were held to be in possession of documents relevant to the proceedings.
To view a copy of the case please click here.
The Court of Appeal decision in Janus Nominees Limited v Fairhall [2009] NZCA 280 highlights the importance of appropriate tax warranties and undertaking appropriate due diligence where acquiring property by purchasing the shares in a property holding company.
This was an appeal from a High Court decision that the purchasers of shares in a property holding company had been misled for the purposes of section 9 of the Fair Trading Act 1986 ("FTA") that a future sale of the property would be GST exempt. In fact GST was imposed on the subsequent sale of the property from the property holding company to the purchaser's family trust. The purchasers were not aware of the company's previous GST profile as they did not undertake due diligence, and the warranty given by the vendors that the company had "no current liability" for tax was insufficient to extend to a latent GST liability relating to the property. The Court of Appeal found in the vendor's favour ruling that, as the transaction was between sophisticated parties who were independently advised, to impose liability under the FTA would cut deeply into the principle of caveat emptor.
To view a copy of the case please click here.
Bilateral information sharing agreements with Guernsey, Jersey, Isle of Man, the Cook Islands, the British Virgin Islands, the Cayman Islands and Gibraltar
New Zealand tax authorities will be able to request tax records, business books and other tax-related information from more offshore financial centres after New Zealand recently signed seven new Tax Information Exchange Agreements ("TIEAs"). In a media statement the Minister of Revenue stated that the global financial crisis has resulted in a worldwide focus on tax co-operation and an increasing number of offshore financial centres have agreed to adopt the OECD standard for information exchange.
The bilateral TIEAs will enable tax authorities to gain access to information about income and assets of taxpayers located in the other jurisdiction. The TIEAs will cover not only information held by banks and other financial institutions but also information on company ownership and on the settlors, trustees and beneficiaries of trusts.
To view copies of the TIEAs please click here.
The Government introduced the Taxation (Consequential Rate Alignment and Remedial Matters) Bill 2009 ("Bill") to align resident withholding tax ("RWT") rates on interest with the current personal and corporate tax rates, and to align the portfolio investment entity ("PIE") prescribed tax rates with the current personal tax rates.
If enacted in its present form, the Bill will align RWT on interest paid to individuals with individual personal tax rates from 1 April 2010. The new RWT rates for individuals will be 12.5%, 21%, 33% and 38% depending on their personal tax rates.
The new default RWT rate for interest payments to individuals who do not notify their correct rate will be 38% for accounts opened from 1 April 2010. There will be a transitional period for existing accounts. Individuals currently on the default rate of 19.5% will be automatically shifted to the rate of 21% from 1 April 2010 and to the default rate of 38% from 1 April 2011 if they do not notify their correct rate.
The RWT rate on interest paid to companies will be reduced from 33% to 30%. The use of the 30% rate will be optional from 1 April 2010 and compulsory from 1 April 2011. However a company can choose a 38% RWT rate.
The RWT rate on dividends remains at 33%, meaning that a company which pays a dividend with imputation credits at a 30/70 ratio will still be required to withhold 3% tax.
The prescribed investor rates for PIEs will be aligned with personal tax rates from 1 April 2010. The new prescribed investor rates for individuals investing in PIEs will be 12.5%, 21% and 30%.
The Bill also contains a number of consequential amendments and unrelated remedial amendments.
To view a copy of the Bill please click here.
An Official Issues Paper, The binding rulings system: legislative issues ("Issues Paper"), was released in July and addresses a number of perceived problems with New Zealand's binding rulings regime. Proposals in the Issues Paper include:
- Recognising that issues on which rulings should be available do sometimes involve questions of fact. This would be achieved by replacing the present general prohibition against rulings on questions of fact with a limited list of factual matters on which the Commissioner cannot rule, or by giving the Commissioner discretion whether or not to rule on questions of fact.
- Steps to reduce the cost of binding rulings. One proposal involves limiting consultation with taxpayers in relation to information required to support their binding ruling applications. This seems undesirable from a taxpayer perspective.
- Enabling the promoter of an arrangement to obtain a binding product ruling where the promoter does not intend to enter into the arrangement being ruled (at the same time giving promoters incentives to provide correct and complete information).
- Clarifying when the Commissioner can refuse to rule on an issue because of a court case or dispute, and the consequences for a ruling on multiple tax types (eg income tax and GST) if it fails as to one tax type.
- Introducing rules to prevent taxpayers who have relied on advice provided by Inland Revenue from being exposed to tax shortfall penalties and use of money interest. It is proposed that the Commissioner will have discretion to determine whether a taxpayer has relied on Inland Revenue's advice.
Submissions on the Issues Paper are due by 28 August 2009.
To view a copy of the Issues Paper please click here.
This publication is included in Russell McVeagh's website on the Internet: www.russellmcveagh.com
The transmission/publication is intended only to provide a summary of the subject covered. It does not purport to be comprehensive or to provide legal advice. No person should act in reliance to any statement contained in this publication without first obtaining specific professional advice. If you require any advice or further information on the subject matter of this newsletter, please contact the partner/solicitor in the firm who normally advises you, or alternatively contact:
TAX CONTACTS:
Fred Ward PARTNER |
Richard Scoular PARTNER |
Campbell Rose PARTNER |
Brendan Brown PARTNER |
Shaun Connolly PARTNER |
|