Contents:
SUPREME COURT OF CANADA'S LATEST DECISION ON TAX AVOIDANCE |
March 2009
Contents:
Court of appeal rejects taxpayer's claim that Inland Revenue acted inconsistently with prior binding ruling
Westpac Banking Corporation v CIR
In Westpac Banking Corporation v CIR [2009] NZCA 24 the Court of Appeal dismissed Westpac's appeal against the High Court's decision to strike out the administrative law grounds of its challenges against the Commissioner's assessments.
Westpac is one of many banks involved in litigation with the Commissioner in relation to structured finance transactions generally in the form of sale and repurchase (or "repo") transactions. On 19 January 2001 Westpac obtained a binding ruling on the proposed tax treatment of one of its transactions, the First Data transaction, relevantly confirming that section BG 1 of the Income Tax Act 1994 (the general anti-avoidance provision in force at that time) did not apply. In September 2004, however, the Commissioner issued amended assessments in relation to Westpac's nine other repo transactions.
In challenge proceedings under Part VIIIA of the Tax Administration Act 1994 ("TAA"), Westpac challenged the correctness of the amended assessments, and also challenged their validity on administrative law grounds. The strike-out application before the Court was concerned only with the Commissioner's application to strike out Westpac's administrative law arguments.
The essence of Westpac's administrative law arguments was that the approach to tax-avoidance law applied by the Commissioner in the First Data ruling was not applied in making assessments in relation to Westpac's other repo transactions and that, although the inconsistency was apparent to Inland Revenue officers who assessed Westpac, they did not adequately resolve the inconsistency through Inland Revenue's internal escalation process before issuing the assessments. Westpac argued that the Commissioner should be required to apply the same view of the tax law to each of its repo transactions, especially given the failure of Inland Revenue officers to adequately resolve their inconsistent views.
In relation to Westpac's administrative law arguments, the Court stated that sections 109 and 114 of the TAA:
provide what might be thought to be a particularly inauspicious statutory context for judicial review (ie outside the challenge process provided for by the Tax Administration Act).
Section 109 provides that a "disputable decision" (including an assessment) may not be disputed outside of a challenge proceeding under Part VIIIA of the TAA. Section 114 provides that assessments made by the Commissioner are not invalidated through the Commissioner's failure to comply with the Inland Revenue Acts.
With respect, the Court's references to section 109, and to an Australian High Court case on the corresponding Australian provisions (Commissioner of Taxation v Futuris Corporation Limited (2008) 247 ALR 605), suggest that the Court mistakenly assumed that Westpac's administrative law arguments were made in the context of a judicial review application under the Judicature Amendment Act 1972. However, as the strike-out application before the Court related to Part VIIIA challenge proceedings, section 109 should not have posed a barrier to disputing the decision. While the Australian High Court in Futuris was focused on a judicial review application rather than (the Australian equivalent to) challenge proceedings under Part VIIIA of the TAA, certain comments in that case suggest that section 114 should also not apply in challenge proceedings (see for example paragraph 451).
Based on the Court's apparent assumption that Westpac had brought judicial review proceedings, which led it to hold that sections 109 and 114 applied to Westpac's judicial review application, the Court held that Westpac's administrative law arguments could succeed only if there were "exceptional circumstances" that could justify judicial review. Citing Futuris, the Court stated that exceptional circumstances exist only where "what purports to be an assessment is not an assessment" and in cases of "conscious maladministration". For the reasons outlined above, we believe that this test is too strict, particularly in relation to administrative law arguments raised in the context of challenge proceedings.
In its discussion on the availability of judicial review, the Court also considered whether the Commissioner could be bound to give effect to taxpayers' legitimate expectations. Westpac argued that the Commissioner could be bound to give effect to a legitimate expectation based on care and management provisions added to the TAA in 1995 (allowing the Commissioner to collect a reduced amount of tax if that would protect the integrity of the tax system, or increase revenue collected overall). In UK case law, similar provisions have resulted in the UK Commissioner being bound to give effect to taxpayers' legitimate expectations. In a clear departure from the UK case law, the Court indicated that the added legislative context of the statutory binding rulings process (added to the TAA at the same time as the care and management provisions) meant the Commissioner may only be bound through the binding rulings process.
Based on the Court's apparent treatment of the case as a judicial review application separate from challenge proceedings and view that the Commissioner could be bound only through the binding rulings process, the Court dismissed Westpac's appeal, and its administrative law arguments were struck out.
The Court's reasoning that the Commissioner can be bound only under the binding rulings regime (and not by legitimate expectations) is incongruous with previous decisions allowing the Commissioner to settle disputes with taxpayers and, perhaps to a lesser extent, with the Commissioner's practice of publishing his interpretation of tax laws (other than in binding rulings). These matters were not addressed in the Court's judgment. In terms of sections 6 and 6A of the TAA, it is questionable whether preventing the Commissioner from binding himself outside the binding rulings process will protect the integrity of the tax system, or enhance the Commissioner's ability to collect the highest net revenue over time (having regard to the resources available to him, the importance of promoting voluntary compliance, and the compliance costs incurred by taxpayers).
In addition, the Court commented that "advertent departures from departmental procedures can hardly be exceptional (...in the sense of being rare)" and consequently were not susceptible to judicial review. As well as being concerning to taxpayers, we believe this approach should be concerning to the Commissioner who rightly will expect his officers to apply Departmental policy.
Finally, this and other recent decisions of the courts concerning taxpayers' reliance on Inland Revenue's processes and stated policies sends an important signal to those participating in the tax policy process. While there may be advantages in leaving questions of process and interpretation to be dealt with by way of Departmental policy, taxpayers clearly cannot rely on those processes or policies being enforced when it really counts. To protect taxpayers' interests in seeing the tax system applied consistently and with due process, those policies and processes may need to be legislated for, resulting regrettably in more detailed tax legislation, but better ensuring that processes and policies are consistently followed.
To view a copy of the case please click here.
1 The Futuris judgment is available at http://www.austlii.edu.au/au/cases/cth/HCA/2008/32.html.
In Chesterfield Preschools Ltd v CIR (2008-409-000722, Christchurch Registry, 25 November 2008, Fogarty J) the High Court upheld the taxpayers' second application for judicial review in respect of GST input tax refunds that had been withheld since the early 1990s. The proceedings related to assurances by Inland Revenue officers that GST refunds which had been withheld would be applied against GST owed by related entities in the periods the refunds were initially claimed. As a result of the refunds being delayed, the taxpayer had incurred substantial penalties and interest.
Broadly, the Court reviewed two aspects to the Commissioner's decision making. First his decision to refuse certain input tax claims on the basis they resulted from a "sham", and secondly the Commissioner's refusal to apply GST refunds against GST liabilities for the periods in which they were claimed, or exercise his discretion to remit penalties. In relation to the sham question, the Commissioner considered there was a sham based on his finding that the taxpayer was not credible. The Court held that this was a misapplication of the sham test, as a sham involves a finding of dishonesty rather than a lack of credibility. The parties were given a month to settle the sham issue, or the matter would be set down for a hearing in the High Court.
In relation to the exercise of the Commissioner's discretions in respect of penalties, the Court redirected the Commissioner to exercise his discretions (including under sections 6 and 6A of the Tax Administration Act 1994) in compliance with the Court's previous directions, to ensure that penalties imposed on the taxpayers were proportionate to the breaches of the taxpayers' tax obligations (in accordance with legislation which applied prior to 1997 when the taxpayers failed to pay the core tax in dispute). The Court had in the first judicial review application specifically directed the Commissioner to backdate applications, disregard time bars, apply refunds to the best fiscal advantage of the taxpayers, and remit penalties that had arisen while litigation was proceeding. The Court stated that the Commissioner's obligations in this respect arose from the past conduct of his officers.
The Court was critical of the Commissioner's narrow view of its previous judgment from the taxpayers' first judicial review application, and his failure to follow the Court's directions. The Court stated that "officers of the Inland Revenue Department found the [previous] judgment to be wholly inconsistent with the Commissioner's policies in the administration of the Act, and were not ready or able to adapt."
To view a copy of the case please click here.
In Peace and Glory Society Ltd (in liq) v Samsa (CIV-2007-404-000700, HC Auckland, 2 December 2008, Hugh Williams J) liquidators alleged that the sole director and shareholder of the company should be held personally liable for the company's debts because he had breached his director duties regarding a GST debt.
The company had purchased a property for $350,000, claiming a refund for the GST portion of the purchase price. However, after spending at least $125,000 on renovations, the company ran out of money and the renovations were not completed. As the likely sale price would have been insufficient to cover the company's indebtedness, the director decided to refinance.
The director personally raised a loan and purchased the property from the company for $395,000, a valuation accepted by Inland Revenue. As a result, the company owed Inland Revenue approximately $44,000 of GST from the sale of the property and had no assets with which to pay this amount. The director offered $30,000 to settle the GST debt, but Inland Revenue rejected this offer and assessed the company for the full amount of GST.
In relation to the sale of the property and the company's inability to satisfy the resulting GST debt, the Court rejected the liquidator's allegation that the director breached his director duties. Instead, the Court found that he had taken the "least unattractive" of the options available to him, and that it had not been demonstrated that a reasonable director in the same circumstances would not have made the same choice.
Although the Court accepted that the company's accounting records did not satisfy section 194 of the Companies Act 1993, the Court found that in the circumstances the director was sufficiently aware of the company's position that his failure to comply with section 194 did not cause the company's insolvency.
To view a copy of the case please click here.
In Avowal Administrative Attorneys Limited & Ors v District Court at North Shore & Anor (CIV 2006-404-007264, HC Auckland, 22 December 2008, Venning J) the applicants brought judicial review proceedings challenging the legality of four tax raids executed by the Commissioner of Inland Revenue. The tax raids were part of a coordinated investigation with the Australian Tax Office in which a number of hard drives were copied or seized for copying. The proceedings challenged the Commissioner's exercise of his power to copy, or remove for copying, books and documents under sections 16 and 16B of the Tax Administration Act 1994.
The Court rejected an argument by the taxpayers that computer hard drives were not "books or documents" to which section 16 and 16B could apply.
The Court held that, as a general principle, the Commissioner was required to conduct a relevance search to determine whether computer hard drives contained relevant information before copying or removing them. For this purpose, a key word search was sufficient. If the Commissioner did not conduct a relevance search, then the copying or removing the hard drives was illegal. However, this general principle was subject to exceptions where the taxpayer claimed privilege or the hard drives were encrypted.
Where the taxpayer claimed privilege over the entire contents of a hard drive, the Commissioner was not required to conduct a relevance search. He could copy or remove the hard drive (which would be sealed) and the taxpayer's privilege claims over documents on the hard drive would be determined later. The Court also indicated that the Commissioner may be entitled to conduct a relevance search even if a taxpayer had claimed privilege, although recognising that in practice he would be brave to adopt this approach in the face of a taxpayer claiming privilege.
Where a computer hard drive was encrypted, the Commissioner could copy the hard drive without conducting a relevance search if it was reasonable to believe that it may contain relevant information.
To view a copy of the case please click here.
In Travis Trust v Charities Commission CIV-2008-485-1689 (Joseph Williams J, Wellington High Court) Williams J upheld the decision of the Charities Commission in declining the Travis Trust's application to register as a charitable entity under the Charities Act 2005 ("Act"). This is the first case in which a court has considered the meaning of "charitable purpose" and "public benefit" under the Act.
Williams J found that the Travis Trust had the purpose of supporting a single horse race run by the Cambridge Jockey Club, or, at its widest, the purpose of supporting the Cambridge Jockey Club's annual calendar of three meetings through sponsorship of one of the club's headline races.
Williams J thought section 5(1) of the Act simply codified the two common law requirements that a charity must have a charitable purpose and be for the benefit of the public. He found that the Travis Trust failed to satisfy either requirement. First, case law established that the promotion of a horse race is not a charitable purpose in and of itself, nor is the promotion of horse racing generally. Some "deeper purpose", such as the promotion of health, education or perhaps animal welfare, is needed before a trust to promote racing could be charitable. Second, as the Cambridge Jockey Club was a private club, the Travis Trust did not benefit a sufficient section of the public. Downstream benefits that may accrue to the racing industry or the racing public were too remote to be part of the Travis Trust's purpose.
To view a copy of the case please click here.
In FCT v Sydney Refractive Surgery Centre Pty Ltd 2008 ATC 20-081 the Full Federal Court of Australia found that compensatory damages for defamation received by Sydney Refractive Surgery Pty Ltd ("SRSC") were not "income according to ordinary concepts". The damages were awarded after allegations of unethical behaviour broadcast on several television programmes were found to be defamatory. The damages were calculated solely by reference to SRSC's lost profits.
The Commissioner argued that, unlike a natural person, a company does not have feelings, and therefore a defamation award to a company cannot be compensation for hurt feelings - only for financial losses. The Commissioner then argued that this proposition, when coupled with the fact the award was calculated by reference to lost profits, meant that the award was income rather than capital in nature.
The Court dismissed the Commissioner's appeal, holding that an award for defamation of a company compensates the company for loss of its earning ability (being a reduction in its ability to induce customers to do business with it), which is the loss of a capital asset. Therefore, the award was a capital receipt. This character of a receipt does not change according to the manner in which the compensation is measured.
To view a copy of the case please click here.
In Hance & Anor v FCT [2008] FCAFC 196 the Full Federal Court of Australia considered the minimum requirements for "carrying on a business". The taxpayers proposed to sub-lease almond lots from AIMA Limited ("AIMA") and then engage AIMA to manage the lots and to harvest and sell the almonds harvested on their behalf. The taxpayers sought a private ruling concerning the tax treatment of income and outgoings in connection with the proposed arrangement. The Commissioner ruled that the expenses were non-deductible capital expenditure as the taxpayers' investment comprised a capital asset rather than a business.
The Court overturned the Australian Commissioner of Taxation's ruling that the taxpayers were not carrying on a business and allowed their appeal. The Court concluded that the continuation of the operation by the taxpayers over an extended period of time, the repetitive nature of the work involved in farming each almond lot (to be paid for on a regular basis) and the return in the form of proceeds from almond crops (to be received seasonally) all suggested a business would be carried on. The Commissioner's argument that the taxpayers would not be carrying on a business because they had delegated all their management functions to AIMA was dismissed on the basis that persons who undertake businesses are entitled to delegate functions to others, and the taxpayers would still be required to ensure that AIMA performs its obligations in an appropriate and economical way.
To view a copy of the case please click here.
In Lipson v. Canada [2009] SCC 1 the Supreme Court of Canada discussed the concept of "abusive tax avoidance" in Canada's general anti-avoidance provision. In this case the taxpayer's wife borrowed $562,500 under a personal loan ("personal loan"), which she used to acquire shares from her husband. Her husband used the $562,500 to fund the purchase of a house under an agreement the pair had previously entered into. The next day the pair borrowed $562,500 secured by a mortgage ("house loan") over the house which they used to repay the wife's personal loan.
The tax effects of this these transactions considered by the Supreme Court were as follows.
The taxpayer's wife would have been entitled to interest deductions on her personal loan if it had not been repaid (the loan was used to acquire income producing shares), and another tax rule permitted her to claim interest deductions on the house loan because it was used to refinance her personal loan.
A specific anti-avoidance rule then attributed to the husband any income or loss in respect of his wife's shares. Ironically, the purpose of this rule was to prevent non-arm's length parties such as spouses obtaining tax benefits by transferring property between themselves.
Subject to the general anti-avoidance provision, these transactions had the effect that the husband was deemed to derive income from his wife's shares against which he could claim an interest deduction in respect of the house loan. The interest deduction resulted in a reduction of the husband's income, as against a scenario where the pair simply borrowed money and used it to pay for the house.
The taxpayer conceded that the series of transactions involved avoidance transactions resulting in a tax benefit. However, the arrangement would only breach the Canadian general anti-avoidance rule if it resulted in "abusive tax avoidance", defined as "abuse and misuse" of the relevant provisions. The majority of the Court (4 of 7) held that "abuse and misuse" must be determined in relation to particular provisions and that individual tax benefits must be analysed separately (although in the context of the entire series of transactions and bearing in mind that each step may have an impact on the others), and occurs only where it is determined that the result of a transaction frustrates the object, spirit and purpose of one or more of the relevant provisions (similar to the judicial approach to New Zealand's general anti-avoidance provision).
The majority held that the purpose of the attribution rule was frustrated when the taxpayer used it to reduce his income from the shares, and noted in this regard that it was a specific anti-avoidance rule being used to facilitate tax avoidance. On that basis the Court held that the general anti-avoidance rule applied to deny the tax benefit of interest deductions otherwise obtained by the taxpayer.
To view a copy of the case please click here.
The Taxation (Business Tax Measures) Bill ("Bill") was introduced into Parliament on 10 February 2009. It contains measures aimed at easing the impact of taxes on small and medium sized businesses' cash flows, and reducing business tax compliance costs. Revenue Minister Peter Dunne says these measures are an important step towards helping smaller business deal with the current economic pressures.
The use of money interest rate has also been reduced from 14.24% to 9.73% for taxpayers and from 6.66% to 4.23% for the Commissioner of Inland Revenue with effect from 1 March 2009. The rate of interest that applies for FBT purposes on employment related loans has been reduced from 10.90% to 8.05%.
To view a copy of the Bill please click here.
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