|
|
Home
| Databases
| WorldLII
| Search
| Feedback
Court of Appeal of New Zealand |
Last Updated: 13 December 2011
|
IN THE COURT OF APPEAL OF NEW ZEALAND
|
CA 147/00
|
|
|
BETWEEN
|
THE COMMISSIONER OF INLAND REVENUE
|
|
|
|
Appellant
|
|
|
AND
|
BNZ INVESTMENTS LIMITED
|
|
|
|
Respondent
|
|
Hearing:
|
13, 14, 15 and 16 November 2000
|
|
|
|
|
Coram:
|
Richardson P
Thomas J Keith J Blanchard J Tipping J |
|
|
|
|
Appearances:
|
J G Fogarty QC, J H Coleman and V L Heine for Appellant
A R Galbraith QC, G J Harley and G S Jansen for Respondent |
|
|
|
|
Judgment:
|
22 May 2001
|
|
JUDGMENTS OF THE COURT
|
Judgments
Para No
Richardson P, Keith and Tipping JJ [1] - [58]
Thomas J [59] - [167]
Blanchard J [168] - [183]
RICHARDSON P, KEITH AND TIPPING JJ
(DELIVERED BY RICHARDSON
P)
Table of Contents
Para No
Introduction [1]
The statutory provisions [5]
The facts [7]
The one arrangement issue: the rival arguments
in the High
Court [17]
McGechan J's conclusions [21]
Discussion: factual findings [30]
Arrangement: analysis of s99 [38]
Arrangement: conclusions [49]
Result [58]
Introduction
[1] The question for decision is whether 9 redeemable preference share (RPS) investments made by BNZ Investments Limited (BNZI) in the 1989 and 1990 tax years were affected by the anti-avoidance provisions of s99 of the Income Tax Act 1976.
[2] In each instance the Bank of New Zealand (BNZ) borrowed and funded BNZI, its wholly owned subsidiary, to subscribe for RPS in companies provided for that purpose by Capital Markets Limited (CML), a member of the Fay Richwhite Group. Those investments by BNZI provided a return in the form of dividends from the date of issue of the particular RPS until the date of maturity between 9 months and 3 years later depending on the particular investment. CML utilised the proceeds in complex off-shore transactions which placed the funds in off-shore interest bearing deposits. Dividends on the RPS were at rates negotiated between BNZ for BNZI and CML on the basis that no allowance was required for New Zealand tax on downstream income and that the dividends paid on the RPS would be exempt income as inter-company dividends in the hands of BNZI.
[3] Following a 16 day hearing in the High Court, McGechan J, in a judgment delivered on 10 July 2000 and reported at (2000) 19 NZTC 15,732, held in favour of BNZI and against the Commissioner of Inland Revenue. He held first that on the proper application of s99 the downstream transactions were not part of the arrangement entered into affecting BNZI; second, had there been a single composite arrangement including downstream transactions, those cases where mandatory convertible notes had been employed downstream by CML (the MCN transactions) did not have the requisite purpose or effect of tax avoidance within s99(2) but other cases described as Alasdair/Fenstanton transactions which employed s195 debentures at the equivalent point would be caught by s99(2); and third, had there been a tax avoidance arrangement within s99(2), the adjustments made by the Commissioner relying on s99(3) would have been excessive and should have been limited to assessing the increment in RPS dividends received by BNZI attributable to tax avoidance by entities downstream.
[4] The Commissioner appeals and BNZI cross-appeals against the Judge's purpose or effect finding in respect of the Alasdair/Fenstanton transactions.
The statutory provisions
[5] At the material times s63(2) relevantly provided that "dividends derived by any company that is resident in New Zealand ... from companies ... shall be exempt from income tax in New Zealand". That exemption from income tax was substantially affected as from 30 July 1991 (and so not affecting the dividends the subject of the Commissioner's assessments) by s63(2C) which excluded the application of s63(2) where the dividend was payable in respect of a fixed rate share as defined in very broad terms in s63(2D). That definition of "fixed rate" included a rate determined by "a fixed relationship to economic, commodity, industrial or financial indices or to banking rates or general commercial rates of interest", or adjusted by a fixed relationship to a rate of income tax or where, having regard to various specified factors, the Commissioner considered "the payment of dividends in respect of the share is equivalent to the payment of interest in respect of money lent".
[6] The immediately relevant provisions of s99 read:
(1) For the purposes of this section--
"Arrangement" means any contract, agreement, plan, or understanding (whether enforceable or unenforceable) including all steps and transactions by which it is carried into effect:
"Liability" includes a potential or prospective liability in respect of future income:
"Tax avoidance" includes--
(a) Directly or indirectly altering the incidence of any income tax:
(b) Directly or indirectly relieving any person from liability to pay income tax:
(c) Directly or indirectly avoiding, reducing, or postponing any liability to income tax.
(2) Every arrangement made or entered into, whether before or after the commencement of this Act, shall be absolutely void as against the Commissioner for income tax purposes if and to the extent that, directly or indirectly,--
(a) Its purpose or effect is tax avoidance; or
(b) Where it has 2 or more purposes or effects, one of its purposes or effects (not being a merely incidental purpose or effect) is tax avoidance, whether or not any other or others of its purposes or effects relate to, or are referable to, ordinary business or family dealings,--
whether or not any person affected by that arrangement is a party thereto.
(3) Where an arrangement is void in accordance with subsection (2) of this section, the assessable income . . . of any person affected by that arrangement shall be adjusted in such manner as the Commissioner considers appropriate so as to counteract any tax advantage obtained by that person from or under that arrangement, and, without limiting the generality of the foregoing provisions of this subsection, the Commissioner may have regard to such income as, in his opinion, either--
(a) That person would have, or might be expected to have, or would in all likelihood have, derived if that arrangement had not been made or entered into; or
(b) That person would have derived if he had been entitled to the benefit of all income, or of such part thereof as the Commissioner considers proper, derived by any other person or persons as a result of that arrangement.
The facts
[7] The primary focus in the judgment and in the argument of the appeal was on the first question, whether the downstream transactions formed part of a single arrangement affecting BNZI. Much of the detail of the agreed statement of facts, the briefs of witnesses and oral evidence and the exhibits and, as well, the narrative in the judgment, is directed at the downstream structures and flows reflected in comprehensive and complex wiring diagrams. The upstream transactions are relatively simple and straightforward. The downstream are anything but. There is a clear line in terms of overt participation on the part of BNZI between upstream and downstream and in considering that first question it is unnecessary to go into all the detail of the downstream transactions. As well, the report in the New Zealand Tax Cases of McGechan J's judgment amply provides any further detail that may facilitate understanding of that question.
[8] It is sufficient then to refer at this point to the broader background of RPS investments, to the Judge's factual narrative, and then to set out his essential findings of fact and law on this branch of the case.
[9] Over a long period company law and the successive statutes have recognised RPS as a conventional equity means of funding companies. The extent of their practical utilisation has necessarily been affected by the commercial climate of the times. McGechan J explains:
From deregulation of financial markets in 1984 RPS financing became commonplace. It carried taxation advantages. An investor could borrow funds to invest in RPS and deduct interest on the borrowings. Dividends on the RPS, when received, would be tax exempt under the then inter-company dividend exception. The dividends were not deductible to the issuer, but if the issuer had tax losses or received only exempt income, that was not significant. There was room for splitting the tax margin, otherwise payable by the investor, between the investor and the issuer to mutual gain. There was one cloud on the horizon in the late 1980's. It was the Commissioner's Public Information Bulletin PIB163 which recorded doubt whether interest on borrowings by the investor for the purpose of such schemes was deductible. The Commissioner's negative viewpoint was widely regarded as wrong, but probably is the genesis of the habitual extension of issuer indemnities to encompass tax aspects.
[12] BNZ, along with many others, entered into RPS on a widespread basis. The receipt of exempt dividends seems to have carried particular attraction in allowing the reduction of the bank's ratio of tax to receipts. By November 1987 the bank held some $500m so invested.
[10] By the late 1980s BNZ and Fay Richwhite, a merchant bank, had a strong working relationship and BNZ was Fay Richwhite's principal banker. However, they were competitors. McGechan J noted (para [13]):
FR in particular kept its affairs so far as possible to itself, appreciating that the bank could move on opportunities of which the bank became aware. The two organisations did not involve themselves in joint ventures. BNZ remained a financier. There was an exception, to some degree, in the form of the Euronational Group. Euronational was a company incorporated in the Cook Islands by FR and Brierley Investments Limited which the BNZ was invited to join as an equal shareholder. It did so, taking up 28% of the capital, and having a Board representative. This reflected a then viewpoint of the BNZ that it should have an offshore banking capacity to match that of competitor banks.
[11] BNZ built up a large RPS portfolio and at the time of these transactions BNZI had entered into some 57 RPS transactions. None of the other transactions is in question. Following an indication to a CML executive by a BNZ executive of the bank's potential interest in undertaking RPS transactions, and following a meeting or meetings, BNZ indicated by letter of 14 July 1988 its willingness in principle to proceed. McGechan J summed up the position in this way (para [17]):
The parameters were up to $100m for up to 3 years at dividend rates to be agreed, with so-called normal indemnities, including within their scope any tax liability in respect of exempt dividends, disallowance of deductions, and taxation of redemption payments. BNZI was to have the benefit of a secured Put Option to cover repayment. Negotiations, particularly as to the bank's margin, dividend rate, securities, and indemnities, and draft documentation followed. The principle was attractive to BNZ. CML had significant bargaining power accordingly. The dividend rate was agreed at the after tax bank bill rate plus 50% of tax savings generated. Securities, to be made available from a pre-approved stable, were blue-chip. Indemnities, under CML pressure, were kept to a point where BNZI would only make a small margin; and arrangements were reached over conduct of objections. It followed the bank could end up carrying some tax risk. I accept the BNZ did not think there was any significant risk indemnities would be called on. All was normal enough RPS business.
[12] The Judge had earlier noted that CML was developing the MCN transaction template and that the proposed structures would not utilise tax losses or exempt income in the orthodox way. Instead, although not known to BNZ, the transactions would involve conversion of interest received abroad into dividends of an exempt character by movement through tax haven jurisdictions. The process, complicated enough already by the accruals rules brought in in 1987, was about to become further complicated by intended legislation implementing international tax reforms which had been announced in March 1988 to take effect from 1 April 1988 but which had not yet actually been enacted. The structure eventually finalised obviously involved very considerable expertise and effort.
[13] Importantly, the Judge found that Fay Richwhite had good commercial reasons for keeping this structure secret as far as and for as long as possible. It would not have wished to see that effort picked up and used by competitors, including BNZ.
[14] And referring to the first RPS investment offered by CML, the Judge expressly accepted that CML did not disclose any aspect downstream of the issue vehicle CMIL and continued (para [15]):
I accept BNZ had no reason to think the proposal was anything other than commonplace RPS financing utilising tax losses, whether on the part of CMIL or an associated entity. Tax loss companies abounded following the October 1987 crash. BNZI, subject to one exception, did not ask CMIL what CML planned to do with the money. CML was a known securities trader, and BNZ assumed funds raised would be used for that purpose. As noted, CML was a competitor, and secretive. BNZ had a high regard for FR expertise. BNZ was adequately covered by indemnities and security of a high quality. I accept that in principle, and certainly in the context of smaller businesses or suspect security, a bank does generally inquire as to funds utilisation intentions. However this transaction was of the special character noted, and I see nothing suspicious in absence of inquiry by the BNZ.
[16] As I have said, there was one exception. Interestingly, a relatively junior bank executive responsible for negotiations did ask Mr Tompkins of CML what CML would do with the funds raised. I consider this inquiry arose from personal curiosity, and was not an official inquiry on behalf of the bank. Mr Tompkins said something close to the effect it was none of the bank's business. Matters were left at that.
[15] Documentation and settlement followed the agreement in principle and, to return to McGechan J:
[18] ... BNZ, from banking instructions received and actioned, became aware that BNZI payments to CMIL were transferred by CMIL to a European Pacific New Zealand account with the BNZ, then onward by EuroPacific to a Royal Bank of Canada ANZ account. BNZ became aware, to that extent, that the RPS funds were paid to a bank based in the Cook Islands tax haven. The bank could not know one way or the other whether there were intermediate transactions involved, with funds simply held on trust meantime in the EPBC BNZ account. Given the apparent immediate onward payment to the Royal Bank of Canada there would be no particular reason to speculate along those lines. Fortuitously, BNZ did come to learn that along with the transfer by EPBC to the Royal Bank of Canada the Fay Richwhite Group had taken up Royal Bank of Canada notes, as an announcement to that effect was picked up from the Reuters trading screens the next day. ...
[19] BNZI knew nothing of the circuitous character of the route used to fund dividends due from CMIL. It simply received dividends as and when due.
[16] What became the second MCN transaction followed. Next, CML worked up the Alasdair/Fenstanton scheme, deploying s195 debentures. McGechan J found that CML had never informed the BNZ of the character of its downstream structures, and unsurprisingly saw no reason to disclose this change. He continued (para [28]):
In the course of negotiating the dividend rate, CML found it necessary to disclose the fixed security rate it would receive from the Sanwa bank. The BNZ thus knew the destination of the RPS funds (apart from the intended onward placement by Sanwa with HCNZ) and knew CML's gross return. BNZ had no other details of downstream transactions. There were changes to indemnities and indeed a (new) loan agreement document reflecting alteration to fixed rate securities. Kensington Swan shelf companies were used again. The bank again knew that funds received went to an EPBC BNZ account, and then onward to Sanwa at a local Sanwa Westpac account. BNZI knew nothing of the route along which dividends were funded.
The one arrangement issue: the rival arguments in the High Court
[17] The question was whether as affecting BNZI the upstream (issuer and upwards) transactions and the downstream (below issuer) transactions were to be regarded for the purposes of s99 as one arrangement.
[18] The argument for BNZI was that an arrangement must have an element of mutuality, that being drawn from the definition of arrangement in s99(1), from the application of the operative provisions of subs (2) to an "arrangement made or entered into", from the reference in subs (3) to "party" and from dicta in various cases.
[19] The argument for the Commissioner was that the court had at least four policy options:
22.1 First, the Court could consider it sufficient that the RPS deals are interdependent tax-driven transactions built around simple cashflows, and including shared tax advantages. There is no requirement for notice of any risk of avoidance on the part of the investor.
22.2 Secondly, the Court could require knowledge that there would be a plan or structure, and consider that ignorance of its content is no excuse for not including a person within that plan or structure if the content of the plan was left to another party.
22.3 Thirdly, it could require, or rely on as present in any event, notice by the investor of the risk of avoidance.
22.4 Fourthly it could require actual notice of the content which makes the transaction void, before including in the arrangement the steps to which the Objector was a formal participant.
[20] The Commissioner supported 1, 2 and 3 and rejected 4. In discussing the submissions the Judge noted that the Commissioner fairly conceded that there was considerable appeal in an interpretation of s99 which would not apply the section to “innocent” taxpayers, who are in fact affected by avoidance behaviour, but not under notice that they might be deriving advantage from such behaviour, and that there may be some need for notice of risk of avoidance. Next, as to option 2, the Commissioner's submission was that, given that the RPS market was built primarily on exploitation of tax losses, a reasonable person would be put on inquiry as to how dividends would be funded. In the absence of such inquiry such a taxpayer was to be regarded as indifferent to an avoidance mechanism or as relying on the promoter. Then, as to option 3, the Commissioner submitted that, while BNZ may not have known the details of downstream transactions, it knew there was a risk of tax avoidance.
McGechan J's conclusions
[21] Focussing on s99(1), McGechan J concluded that all four elements, contract, agreement, plan or understanding, had one essential common factor inherent in the term "arrangement" itself, namely a conscious involvement by the taxpayer. The concept of conscious involvement and multiple parties inherent in the terms used is reinforced by reference in s99(2) to "arrangement" and to "party thereto". "Arrangements", it seems, have "parties". The reference to "parties" also points to specifically identifiable persons rather than to vague or inchoate groupings. The overall concept is one of conscious involvement by other parties to an end. The Judge preferred to avoid the BNZI term "mutuality" as carrying certain contractual baggage but the concept, he said, was similar.
[22] The Judge saw the authorities cited for BNZI as providing only slender support but they could be viewed as consistent with the conscious involvement test. Turning to policy considerations, McGechan J rejected the proposition advanced by the Commissioner that, s99 being intended to suppress tax avoidance, it should be interpreted in whatever way it does so. Parliament's objective approach envisaged limits, the Judge said, the first being the requirement for an arrangement. That deliberately limited focus is to be respected and advanced, not subverted by expansionist approaches passing beyond the normal meaning of terms used which predicate conscious involvement.
[23] There were, too, in the Judge's view, some real difficulties in a concept which drags a taxpayer within a multi-step arrangement on a simple basis of taxpayer knowledge. The Judge saw the terminology of s99(1) as stemming from the observations of Lord Denning in Newton v Federal Commissioner of Taxation [1958] AC 450, 465:
... the word 'arrangement' is apt to describe something less than a binding contract or agreement, something in the nature of an understanding between two or more persons — a plan arranged between them which may not be enforceable at law. But it must in this section comprehend, not only the initial plan, but also all the transactions by which it is carried into effect — all the transactions, that is, which have the effect of avoiding taxation, be they conveyances, transfers or anything else.
[24] Consistently with Newton, Parliament in enacting the definition of arrangement confined itself to consensual activity towards an end and that intention should be respected. And, on the threshold question of arrangement, he did not find the fiscal nullity approach in the Ramsay line of cases (W T Ramsay Ltd v Inland Revenue Commissioner [1981] UKHL 1; [1982] AC 300) helpful. The Ramsay doctrine was not intended to determine the scope of an arrangement within an exhaustive definition as in s99. Also, if invoked, it would not add much of present assistance. Unlike the BNZI case, those cases pointed towards taxpayers who were fully informed, whether in person or through imputed advisor knowledge, in relation to the full chain of transactions, and who actively promoted that entirety.
[25] The Judge concluded that the Commissioner's "composite interdependent preordained transaction" encompassing both upstream and downstream transactions was seriously flawed because of agreed inapplicability to "innocent" transactions. The BNZI theory, based on a requirement for conscious involvement ("mutuality"), provided a narrower and stronger definition which did not require an illogical exception, and had greater attraction accordingly.
[26] McGechan J turned to consider the Commissioner's second and third options (knowledge a structure would exist but ignorance of content; and notice of risk of avoidance). To the extent that those options might rest solely on such knowledge or notice, they were rejected. Arrangement, he said, required conscious involvement. There was a conceptual divide between grounds for suspicion an activity may occur and arranging such activity. And, he said (para [64]):
While to suspect, or to have grounds for suspicion, and even to know, do not in themselves predicate involvement in a “contract, agreement, plan or understanding” , it does not take very much more to move a situation onward to a point where tacit involvement may be found. ... If, for example, there are factual matters which point to an interconnected downstream scheme at risk of avoidance under s 99, and the downstream counterparty is correspondingly justified in assuming the taxpayer is aware of those matters and is comfortable with any such risk, there may be room in some cases for a factual finding the transaction proceeded on the basis of a tacit “understanding” those downstream matters would occur. The situation in that way could move past mere suspicion, or even knowledge, to one of “mutuality” , albeit tacit. The same will follow, of course, in Nelsonian cases of wilful blindness. A taxpayer who deliberately refuses to see the obvious, but proceeds with a transaction in which the obvious occurs downstream, readily enough could be held to be part of at least an “understanding” to that effect. A taxpayer who actually knows all the details, and proceeds nevertheless, is of course at equal or greater risk.
...
In such latter factual situations, there would then be one composite transaction, comprising both upstream and downstream elements. The question will always be highly fact specific.
[27] Turning to the facts the Judge found that BNZI started with two factual features strongly in its favour: (i) the upstream transactions were routine RPS investments, of a type widely considered to fall outside s 99 avoidance; (ii) there were good grounds to believe CML would utilise tax losses in conventional fashion for RPS investments. BNZI started from the position of strength that its own upstream transactions were not avoidance, and that the probable course of whatever downstream transactions CML intended would not involve avoidance. From that perspective, there would not be notice of possible downstream avoidance, and there would be little room for a finding of tacit mutuality.
[28] He then considered whether there were any weaknesses in that initial position. He saw the concern over the risk of avoidance in relation to deduction of interest as between BNZ and BNZI as slight and as related to upstream rather than downstream matters. Second, and in answer to the point suggested that Fay Richwhite was an innovative bank quite capable of putting together downstream avoidance arrangements, his finding on the evidence was that the almost overwhelming likelihood, and indeed the BNZ assumption, was that tax losses would be the shelter utilised. Third, responding to the view expressed by a banker called by the Commissioner that in general banks should make inquiries as to the transaction to be undertaken by the recipient with the money provided by the bank and be able to fully evaluate risk accordingly, he did not regard the absence of inquiry as suspicious, and concluded that inquiries were neither needed, and nor would they have been productive. This was not a case of neglect, or a turning of a blind eye. BNZ could accept it did not need to know downstream proposals beyond the standard assumptions which it made. Fourth, he observed in relation to the evidence that RPS funds had to BNZI's knowledge gone to EPBC, a company operating in the Cook Islands, that BNZI's actual knowledge went no further than immediate payment by EPBC into an apparent ultimate investment in a prime overseas bank. It had no knowledge or reason to suspect the existence of complicated intermediate downstream transactions. Transactions of that character through an offshore bank part owned by Fay Richwhite could have been for reasons other than utilisation of tax haven status and did not by any means necessarily displace the apparent likelihood of primary reliance on tax losses in the normal and approved way.
[29] Finally, the taking of tax indemnities had developed to become an invariable market practice in all RPS transactions and the Judge's finding on the evidence was that the requirement for indemnities in these transactions could not be taken as betraying any particular banking knowledge or concerns in relation to s 99.
On the facts, BNZI was entitled to view the RPS investments as normal in character, very probably turning on tax losses recognised as outside s 99. The features noted such as lack of exact knowledge, an inability for commercial reasons to enquire as to accuracy of understandings, the passage of RPS proceeds through the Cook Islands tax haven company, and tax and general indemnities negotiated, were not such in my view as would or should have created a suspicion of downstream tax avoidance, let alone to a degree and in circumstances capable of amounting to an understanding such would occur. The pointers toward suspicion or knowledge simply do not go far enough to overcome the clear evidence BNZ regarded this as a standard transaction which would fall outside s 99.
Discussion: factual findings
[30] In the light of the factual findings, Mr Fogarty for the Commissioner did not pursue on appeal the third argument advanced in the High Court, namely that BNZI had notice of the risk of avoidance. The Commissioner submitted that, as interdependent transactions including sharing of tax advantages, the RPS deals were part of the arrangement within s99. Alternatively, if knowledge of how the tax advantage was to be obtained was required as part of the plan or understanding, BNZI had left that part of their arrangement to CML and must be taken to have authorised what was done. (See paras [19] and [20] above.)
[31] Before turning to analyse the elements of an arrangement under s99 it is as well to summarise the Judge's material findings of fact relative to any ultimate arguments in respect of the first and second propositions as to BNZI's involvement or complicity in, knowledge of, or suspicion about downstream transactions, and to provide the factual setting for the legal analysis in this case.
[32] The Judge accepted that BNZ had no reason to think CML's proposal which led to the first MCN transaction was anything other than commonplace RPS financing utilising tax losses whether on the part of CMIL or an associated entity. There was nothing suspicious in the absence of inquiry by BNZ into CML's intended utilisation of funds to be invested by BNZI in the RPS. BNZ became aware from banking instructions that the BNZI payments to CMIL were paid to a bank based in the Cook Islands and then onward to a Royal Bank of Canada account, but there was no reason to speculate as to whether there were intermediate transactions involved and BNZI knew nothing of the circuitous character of the route used to fund dividends due from CMIL.
[33] Next, as to the Alasdair/Fenstanton scheme worked up by CML deploying s195 debentures, McGechan J found that CML had never previously informed BNZ of the character of its downstream structures and unsurprisingly saw no reason to disclose that change. He went on to find that BNZ knew that the funds were to be paid to the Sanwa Bank and the fixed security rate it would pay but BNZI knew nothing of the route along which dividends were funded.
[34] After he had discussed the elements of arrangement under s99 and the submissions of counsel in that regard, the Judge returned to factual matters. Importantly, he found that BNZI started with two factual features strongly in its favour. The first was that the upstream transactions were routine RPS investments of a type widely considered to fall outside s99 avoidance. The second was that there were good grounds for BNZI to believe CML would utilise tax losses in conventional fashion for RPS investments. Its own upstream transactions were not avoidance and the probable course of whatever downstream transactions CML intended would not involve avoidance. From that perspective, there was no notice of possible downstream avoidance and there would be little room for a finding of tacit mutuality.
[35] In his further findings of fact, responding to suggested contra-indications, the Judge concluded that the almost overwhelming likelihood, and indeed the BNZ assumption, was that tax losses would be the shelter utilised; that the absence of inquiry of CML as to the intended utilisation of the funds was not suspicious, and was not a case of neglect or turning a blind eye; that the requirement for indemnities could not be taken as betraying any particular banking knowledge or concern; that the features noted were not such as would have or should have created a suspicion of downstream tax avoidance; and that on the facts BNZI was entitled to view the RPS investments as normal in character and very probably turning on tax losses.
[36] The evidence in the High Court was extensive and detailed. BNZI called their two bank executives particularly concerned with the transactions, a solicitor who was involved in the preparation of the documentation, three expert witnesses who testified as to RPS transactions, including two who had extensive experience in constructing such transactions and, as well, the CML executive who was particularly involved in negotiation with BNZ and BNZI. For the Commissioner, the senior international audit officer of the department and an experienced banker were called as witnesses.
[37] On the argument of the appeal Mr Fogarty for the Commissioner sought to challenge certain of those factual findings and we were taken through parts of the briefs and oral evidence-in-chief and cross-examination of particular witnesses. McGechan J had the advantage as trial Judge of assessing the witnesses and their evidence. Having carefully considered the evidence and counsel's submissions, we are satisfied that there was ample evidence to support the Judge's material findings of fact and we cannot possibly say that he was wrong in the factual conclusions he reached on that evidence.
Arrangement: analysis of s99
[38] In terms of s99(1), "'Arrangement' means any contract, agreement, plan, or understanding (whether enforceable or unenforceable) including all steps and transactions by which it is carried into effect". By s99(2) "Every arrangement made or entered into ... shall be absolutely void ... " if it has a more than a merely incidental tax avoidance purpose or effect "whether or not any person affected by that arrangement is a party thereto". And the adjustment provisions of s99(3) apply to the assessable income of "any person affected by that arrangement".
[39] For the reasons discussed in the cases (e.g. Challenge Corporation Limited v Commissioner of Inland Revenue [1986] 2 NZLR 513, 545), s99 as the expanded successor of the old s108 of the Land and Income Tax Act 1954 is perceived legislatively as an essential pillar of the tax system designed to protect the tax base and the general body of taxpayers from what are considered to be unacceptable tax avoidance devices. By contrast with specific anti-avoidance provisions which are directed to particular defined situations, the legislature through s99 has raised a general anti-avoidance yardstick by which the line between legitimate tax planning and improper tax avoidance is to be drawn.
[40] Line drawing and the setting of limits recognise the reality that commerce is legitimately carried out through a range of entities and in a variety of ways; that tax is an important and proper factor in business decision making and family property planning; that something more than the existence of a tax benefit in one hypothetical situation compared with another is required to justify attributing a greater tax liability; that what should reasonably be struck at are artifices and other arrangements which have tax induced features outside the range of acceptable practice - as Lord Templeman put it in Challenge at p562, most tax avoidance involves a pretence; and that certainty and predictability are important but not absolute values.
[41] The function of s99 is to protect the liability for income tax established under other provisions of the legislation. The fundamental difficulty lies in the balancing of different and conflicting objectives. Clearly the legislature could not have intended that s99 should over-ride all other provisions of the Act so as to deprive the taxpaying community of structural choices, economic incentives, exemptions and allowances provided by the Act itself. Equally the general anti-avoidance provision cannot be subordinated to all the specific provisions of the tax legislation. It, too, is specific in the sense of being specifically directed against tax avoidance; and it is inherent in the section that, but for its provisions, the impugned arrangements would meet all the specific requirements of the income tax legislation. The general anti-avoidance section thus represents an uneasy compromise in the income tax legislation.
[42] Line drawing represents the legislature's balancing of the relevant public interest considerations. In terms of s99, that line drawing is directed to three elements, each of which contains its own limits. There must be an arrangement coming within the section. The arrangement must have a more than merely incidental purpose or effect of tax avoidance. And where those two ingredients are present, the assessable income of any person affected by the arrangement is adjusted so as to counteract any tax advantage obtained by that person from or under that arrangement.
[43] The definition of arrangement closely follows the meaning given to the composite expression "contract, agreement or arrangement" in Newton and other decisions under the former s108 and its Australian counterpart, s260 of the Income Tax Assessment Act 1936. In Davis v Federal Commissioner of Taxation (1989) 86 ALR 195, 227 Hill J saw the bilaterality requirement as founded in the very nature of the words of s260, contract, agreement or arrangement. And an arrangement cannot exist in a vacuum. As did the former s108, s99 bites on an "arrangement made or entered into". It presupposes there are two or more participants who enter into a contract or agreement or plan or understanding. They arrive at an understanding. They reach a consensus.
[44] The crucial issue in this case is the extent of the understanding: how much knowledge is required and how and where the line is to be drawn when it is contended that A has left downstream matters to the decision of B. The inquiry is also relevant under s99(3) which provides that, if the arrangement is void against the Commissioner, then any person affected by that arrangement can have his or her income adjusted accordingly.
[45] The words contract, agreement, plan and understanding appear to be in descending order of formality. A contract is more formal than an agreement, and in ordinary usage is usually written while an agreement is generally more formal than a plan, and a plan more formal or more structured than an understanding. And it is accepted in the definition of arrangement that the contract, agreement, plan or understanding need not be enforceable. Section 99 thus contemplates arrangements which are binding only in honour.
[46] In Jacques v Federal Commissioner of Taxation (1924) 34 CLR 348, 359 Isaacs J said that arrangement in s260 meant an arrangement which was in the nature of a bargain but which might not legally or formally amount to a contract or an agreement. And in Bell v Federal Commissioner of Taxation [1952] HCA 34; (1953) 87 CLR 548, 573, the High Court of Australia described arrangement as extending beyond contracts and agreements "so as to embrace all kinds of concerted action by which persons may arrange their affairs for a particular purpose or so as to produce a particular effect". Newton v Federal Commissioner of Taxation (para [23] above) is to similar effect. Their Lordships considered arrangement apt to describe something less than a binding contract or agreement, something in the nature of an understanding between two or more persons - a plan arranged between them which may not be enforceable at law. Lord Denning went on in the same paragraph to say that the whole set of words in the section denoted concerted action to an end; (at 455) that the "the whole complicated series of transactions must have been the result of a concerted plan"; (at 467) that looking at the whole of the arrangement, "the whole of the transactions show that there was concerted action to an end"; (and at 468) that the exposition of the law given by the High Court of Australia in Bell was a valuable guide to the true understanding of the section. Similarly, in Rowdell Pty Ltd v Federal Commissioner of Taxation [1963] HCA 61; [1963] 9 AITR 177, 194, Kitto J said: "The operation of s260 extends, of course, beyond the arrangement (in the limited sense of the consensus between the parties) to everything done as part of the concerted means adopted for the avoidance of a liability to tax."
[47] The more difficult question under s99 is how and where the line is to be drawn in those cases where it is argued that the understanding extended to giving one party a free hand as to how it would produce revenue of a particular character and whether by legitimate or illegitimate means.
[48] In that regard we do not read the additional words in the definition of arrangement, "including all steps and transactions by which it is carried into effect", on which Mr Fogarty relied, as assisting his argument. Clearly they are concerned with the implementation of the established contract, agreement, plan or understanding. The word "it" in "by which it is carried into effect" refers back to the applicable "arrangement" and does not extend it.
[49] The meaning given to an expression such as "arrangement" or "understanding" in other statutory contexts is no sure guide to its meaning in s99. But it is, we think, helpful to note the approach taken under the Commerce Act 1986. Section 27 of the 1986 Act is directed to contracts, arrangements or understandings substantially lessening competition; and "arrive at" in relation to an understanding is in turn defined as including "reach, and enter into" (s2(1)). The governing words are "enter into a contract or arrangement or arrive at an understanding". In New Zealand Apple and Pear Marketing Board v Apple Fields Ltd [1991] 1 NZLR 257, 261 Lord Bridge said: " 'Arrangement' is a perfectly ordinary English word and in the context of s27 involves no more than a meeting of minds between two or more persons, not amounting to a formal contract, but leading to an agreed course of action". Again, in Commerce Commission v Caltex NZ Ltd (1999) 9 TCLR 305, 314 Salmon J, after citing from Lord Bridge and an earlier dictum of Tipping J in NZ Magic Millions Ltd v Wrightson Bloodstock Ltd [1990] 1 NZLR 731 as to the need for a meeting of minds between the parties to the alleged contract, arrangement or understanding, held that mutuality or meeting of the minds is an essential ingredient of an arrangement or understanding under s27. He also endorsed the observation of Jeffries J in Commerce Commission v Wellington Branch NZ Institute of Driving Instructors (1994) TCLR 19, 24 that "Arrangements and understandings result from an apprehension shared by two and more persons that there will be accord among them as to future acts in a specified area". To similar effect, the Laws of Australia 30.2.52 state: "The essential element of an arrangement and an understanding is a meeting of minds between one or more persons. ... There must be a consensus as to what is to be done."
[50] In our view that reasoning is also applicable under s99. In short, an arrangement involves a consensus, a meeting of minds between parties involving an expectation on the part of each that the other will act in a particular way. The descending order of the terms "contract, agreement, plan or understanding" suggests that there are descending degrees of enforceability, so that a contract is ordinarily but not necessarily legally enforceable, as is perhaps an agreement, while a plan or understanding may often not be legally enforceable. The essential thread is mutuality as to content. The meeting of minds embodies an expectation as to future conduct. There is consensus as to what is to be done.
[51] The justification for construing the concept of arrangement in that way is that it would be inequitable for a taxpayer who enters into an apparently unobjectionable transaction to be deprived of its rights thereunder merely because, unknown to the taxpayer, the other party intended to meet its obligations under that transaction, or in fact did so, in a legally objectionable way. In that regard the effect at common law of illegality in the performance of a contract by one party, where the other party is not implicated, is of some assistance as an indirect analogy. As stated in Chitty on Contracts, 28th ed 17-011:
But when the contract does not necessarily involve the commission of a legally objectionable act and the legally objectionable intention or purpose of one party is unknown to the other, the latter is not precluded from enforcing the contract. ... The justification for this result is that it would be inequitable for a person who enters into an apparently unobjectionable contract to be deprived of his rights thereunder merely because the other party had an unlawful object in mind in entering into the contract.
[52] In order to avail the Commissioner, the consensus - the meeting of minds - necessary to constitute an arrangement under s99 must encompass explicitly or implicitly the dimension which actually amounts to tax avoidance; albeit the taxpayer does not have to know that such dimension amounts to tax avoidance. Whether there has been a meeting of minds as to what is subsequently done in a particular respect by one party to an arrangement, and whether in answering that question the concept of wilful blindness (discussed by McGechan J - see para [26] above) may provide guidance, will depend on the particular facts.
[53] In assessing the extent to which the relevant minds have met the following considerations may be helpful. One is the assumption which each party may be entitled to make, other things being equal, that the other will act consistently with the justified expectations of the first, in relation to the way their common purpose is to be achieved. An unexpected departure from those expectations should not, without more, be regarded as part of the meeting of minds and hence as part of the arrangement.
[54] On the other hand, a commercially realistic approach should be adopted when assessing the extent of the meeting of minds, particularly in cases where a significant feature of the arrangement is the obtaining, and sometimes the sharing, of tax benefits. Where that feature is present, a court is unlikely to find persuasive the stance of a taxpayer who professes to have had no knowledge or expectation of the mechanism by which the benefit was to be delivered. In such a situation the taxpayer may well appropriately be regarded as having authorised or accepted whatever mechanism was actually used. In such circumstances a consensus could properly be found in respect of the use of that mechanism.
[55] By contrast, if the taxpayer believes on reasonable grounds that the particular and legitimate tax saving mechanism is to be used by the other party, whereas in fact the other party uses a mechanism amounting to tax avoidance, it would be difficult to conclude that the taxpayer had entered into an arrangement extending that far. In such circumstances there would ordinarily be no consensus in respect of the dimension which constituted the tax avoidance. But as we have emphasised the extent of the arrangement entered into by the taxpayer will always depend on the facts of the particular case. That inquiry, of course, precedes consideration of its purpose or effect under s99(2).
Arrangement: conclusions
[56] On the present facts as found by McGechan J, there was no meeting of minds as to what steps or activities CMIL would undertake downstream. CML did not become BNZI's agent entrusted to act on its behalf. CML acted throughout in the course and furtherance of its own business. BNZI did not know CMIL's plans. CMIL would not disclose its intended template. The course actually undertaken by CMIL could not be legally challenged by BNZI. Certainly there was no expectation on BNZI's part or any other basis for knowing that CMIL would or might act illegally or in breach of tax avoidance provisions. There was a natural divide between the upstream and downstream transactions. The upstream arrangement was a standard commercial RPS investment which in terms of the Income Tax Act entitled BNZ to a deduction for interest on the sums borrowed for investment in the RPS and provided that the dividends on the RPS would be exempt income as inter-company dividends. The RPS investments are a far cry from the self cancelling and circular schemes that have come before the New Zealand and Australian courts under the general anti-avoidance provisions. On the facts as found by McGechan J, BNZI's arrangement to invest in the RPS and the downstream transactions organised by CML were separate and different arrangements for the purposes of s99.
[57] In the result it is unnecessary to consider other issues raised on the appeal and cross-appeal, all dependent on a conclusion, which we have rejected, that there was a single arrangement encompassing upstream and downstream transactions.
Result
[58] In accordance with the views of the majority, the appeal is dismissed. Costs in the sum of $20,000 to BNZI together with all reasonable disbursements as fixed, if necessary, by the Registrar.
THOMAS J
|
Table of Contents |
|
|
|
Para No
|
|
Introduction
|
59
|
|
The English approach
|
63
|
Section 99 –
objective
|
64
70
73 80 |
Form over
substance
(i) Lord
Tomlin’s dicta reinterpreted
(ii) And now “business substance”
3) Substance over form |
81
84 85 89 91 97
100 101
103 105 109 113 |
|
Section 99 – interpretation
1) A purposive approach 2) An analysis of s 99 3) It is the “effect” that counts 4) Some specific points refuted |
117
117 119 126 129 |
|
Section 99 – application
|
138
|
|
1) The accepted facts – common ground
2) BNZI’s knowledge 3) BNZI makes no inquiries 4) The upstream/downstream analysis 5) The real scope of the arrangement 6) The expected use of tax losses 7) The ignorance of a taxpayer in perspective 8) Tax avoidance facilitated 9) No inhibition of commercial activity in this case 10) Those who fly blind ... |
138
143 145 146 150 153 155
157 160
162 |
|
Conclusion
|
166
|
Introduction
[59] The Commissioner of Inland Revenue’s appeal puts the scope of this country’s statutory general anti-avoidance provision directly in issue. On the facts of this case as found by McGechan J at first instance, this appeal would seem to me to give rise to two key questions:
[60] An affirmative answer to the first question would make any requirement of “conscious involvement” or “mutuality” in the specific transactions avoiding the tax irrelevant for the purpose of determining the scope of the arrangement for the purposes of s 99. The consensus or meeting of minds of the participants would not need to embrace the steps or transactions used to carry the arrangement into effect or an awareness that any such steps or transactions would constitute tax avoidance. The scope of the arrangement, as well as its effect, would be determined objectively. A positive answer to the second question would mean that a transaction incorporating a tax advantage for a taxpayer based on the use of a tax shelter would fall within the scope of the arrangement if the taxpayer failed to ascertain the nature of that tax shelter. No such concept as “negative knowledge” would pertain. In failing to make the necessary inquiries, the taxpayer would be said to have accepted the risk that the tax shelter which it left the other party to determine and implement will involve tax avoidance contrary to s 99.
[61] These questions are essentially questions of statutory interpretation. The sole objective must be to give effect to Parliament’s intent. For this purpose, the Court is required to examine the text of the section in the light of its purpose, the scheme of the statute and, as far as it can be gleaned, the legislative policy. The resulting answers can be said to represent Parliament’s intent.
[62] In pressing these issues, I will respectfully differ from the majority. I do not intend to address the submission pressed by BNZI’s counsel that the steps or transactions which were undertaken by CML do not constitute tax avoidance. As this is a dissenting judgment, it would be futile to do so. I do not, however, feel uncomfortable about proceeding on the assumption that tax avoidance took place, and restricting my opinion to the question of the scope of the arrangement.
The English approach
[63] But the straight-forward approach for which I contend would seem to be precluded by the glosses, concepts, distinctions and doctrines which have been judicially developed in relation to tax statutes. There is, in respect of almost any issue relating to tax, a baggage of judicial rules that impedes an orderly and logical decision-making process. In no other branch of the law is formalism more prevalent. Legalistic requirements and suppositions overlay the plain task of statutory interpretation.
1) The role of the Privy Council
[64] Because it is the highest Court in this country’s judicial hierarchy, the Privy Council bears ultimate responsibility for this approach. The Board’s decisions handed down from London over the years have set the tone and direction of judicial debate in the area of tax law. The Privy Council (or the House of Lords, the permanent members of which also sit on the Board) has dictated the judicial methodology.
[65] This different approach has been acknowledged. In Commissioner of Inland Revenue v Wattie [1999] 1 NZLR 529, the Privy Council upheld a decision of the majority of this Court to the effect that a lump sum incentive payment paid by a lessor to an intending lessee to take up a lease at an inflated rental represented a “negative premium” and was therefore exempt from income tax. The Board quoted at length (at 531-534) the commercial background to the payment as described by Fisher J at first instance, in the course of which the learned Judge identified the premium payment as a payment in lieu of rent. It accepted (at 538) that the premium was commercially, financially and mathematically linked to the rental payments due from the lessee under the lease. Consequently, while the legal form of the payment was a premium, the payment was in substance a rental subsidy. As no consideration moved from the lessee, the notion of a “negative premium” has subsequently been widely perceived as a contradiction in terms and essentially untenable.
[66] Prior to the Privy Council’s decision, the Supreme Court of Canada had unanimously arrived at the opposite conclusion in Ikea Ltd v Canada [1998] 1 SCR 196. In reaching this conclusion the Supreme Court upheld a decision of the Federal Court of Appeal of Canada [1996] 3 CTC 307; 96 DTC 6526. That Court had in turn dismissed an appeal from a judgment of Bowman J [1994] 1 CTC 2140; 94 DTC 1112, holding that a lessee had to include a tenant inducement payment in its income in the year of receipt.
[67] The Supreme Court of Canada is a prominent and respected Court in the common law world. This Court has benefited from its jurisprudence in many areas of the law. How, then, did the Privy Council deal with the Canadian decision? It did so with astonishing abruptness. The Board simply stated (at 539):
Their Lordships would wish to make no comment upon the decision of the Supreme Court of Canada in the Ikea case save to observe that the Canadian Courts appear to have adopted a different approach from that of the Courts of New Zealand and the United Kingdom, and of Their Lordships’ Board. (Emphasis added).
[68] Subsequent to their Lordships’ advice in Wattie, the Privy Council’s decision was expressly rejected by a majority of the High Court of Australia in FCT v Montgomery [1999] HCA 34; (1999) 198 CLR 639. The majority were unable to accept the reasoning of the Privy Council and fully explained why that was so (at 670-671).
[69] In Auckland Harbour Board v Commissioner of Inland Revenue (1999) 19 NZTC 15,433, at para [95], I expressed a clear preference for the approach of the Supreme Court of Canada and the High Court of Australia. I could see no reason to adopt any different or particular approach simply because the subject matter is tax. Other instances which are consistent with this reaction may be mentioned. In Peters v Davison (No. 3) (1998) 18 NZTC 14,027, at 14,063, I referred to what has happened in practice with the over-zealous application of the doctrine of form over substance by various corporate taxpayers and their tax advisers. The doctrine has spawned a culture in certain sections of the community and the specialist tax advice industry dedicated to extreme legalism in the application of the doctrine. In Wattie v Commissioner of Inland Revenue (1997) 18 NZTC 13,297, at 13,311, I was critical of the way the so-called doctrine of economic equivalence is applied, and in Colonial Mutual Life Assurance Society Ltd v Commissioner of Inland Revenue (2000) 19 NZTC 15,614, at 15,641 para [125], I confirmed that the doctrine is an extremely flexible and portable concept all too often invoked to exclude recognition of the substance of a transaction or even to avoid a rigorous analysis of the legal arrangement actually entered into. In Wattie, supra, at 13,310-13,311, I also suggested that the “sham or genuine, no halfway house” rule could not withstand scrutiny.
2) The cost to New Zealand of the English approach
[70] I do not doubt that the Privy Council’s approach to tax cases has cost this country inestimable millions of dollars in tax revenue. See Auckland Harbour Board v Commissioner of Inland Revenue, supra, para [95]. The formalism of that approach has provided a fecund breeding ground for dubious schemes to avoid tax. The glosses, concepts, distinctions and doctrines are exploited and have created a commercial environment in New Zealand in which tax avoidance has been a significant feature. The evidence before the Commission of Inquiry into Certain Matters Relating to Taxation, Report of the Wine Box Inquiry, August 1997 (The Wine-Box Inquiry) provided ample evidence of the extent of tax-driven schemes in this country. Inevitably, the tax avoidance industry has thrived on such concepts as form over substance, economic equivalence, the sham or nothing classification, “legal substance” (as distinct from the actual substance), the choice principle, “tax mitigation”, and the like. In the result, the tax base of this country has been hugely eroded and the equitable incidence of tax on its taxpaying citizens correspondingly distorted.
[71] It would appear that no empirical study of the economic cost of tax avoidance in New Zealand has been carried out. (See Robert McLeod, “Tax Avoidance Revisited”, (2000) 6(2), NZJTLP 103, at 104). Related measures, however, confirm that the cost, including the dead-weight loss, would run into billions of dollars. See Report to the Treasurer and Minister of Revenue by a Committee of Experts on Tax Compliance, December 1998 (Tax Compliance Report 1998), at 151-152, 217, and 224-225. One particular avoidance scheme alone had the cumulative effect on the tax revenue of New Zealand costing the state tens of millions of dollars. But as it is incontrovertible that the cost of tax avoidance, as distinct from evasion, has amounted to billions of dollars and represents a sizeable percentage of this country’s gross national product, the calculation of a precise figure is neither here nor there.
[72] I am not, of course, suggesting that the entire cost to the revenue of tax avoidance in this country is attributable to the particular approach of the Privy Council. Some degree of tax avoidance is inevitable, whatever the system or approach adopted. Nor am I unaware that there have been favourable landmarks in the House of Lords’ and Privy Council’s succession of tax cases. WT Ramsay Ltd v Inland Revenue Commissioners [1981] UKHL 1; [1982] AC 300 and Inland Revenue Commissioners v McGuckian [1997] 1 WLR 991 are notable departures from the legalistic approach which has otherwise been preferred. Overall progress has certainly been made towards a more substantive approach devoid of undue literalism, technicalities or complex concepts. But there is a way to go yet, and the promise of better to come does not alleviate the past and present cost of the English approach to the revenue base of this country.
3) A world apart – a different perception
[73] I should in fairness add that I fully appreciate the difficulties which their Lordships on the Privy Council face in dealing with tax cases from this jurisdiction. New Zealand is a small country with a fraction of the population of the United Kingdom. The economic and commercial structure and activity of the two countries is vastly different. The spread of wealth is dissimilar and the incidence of tax in this country is at variance with the regime in the United Kingdom. For example, in New Zealand the top income rate is 39 per cent (or 33 per cent for corporations). It is much higher in the United Kingdom. At a time when it was 98 per cent, a commentator observed that, where the tax rate is so high, tax avoidance has an essential role as a “safety valve”. Without it, social stability would be endangered! See JA Kay, “The Economics of Tax Avoidance”, [1979] British Tax Review 354, at 355. That is certainly not the case in New Zealand.
[74] Critical tax legislation is also different. There is, for example, no general statutory anti-avoidance provision in the United Kingdom. Tax avoidance provisions in that country deal with a specific abuse or, more generally, an abuse of a specific part of the tax code. The Courts in the United Kingdom have judicially created a general anti-avoidance concept, the fiscal nullity doctrine, but that doctrine does not equate with the language of s 99. Fiscal nullity is a concept within but not co-extensive with the scope of s 99. The section must prevail in New Zealand unencumbered by the influence of any such judicial doctrines.
[75] An example of the different perspective of United Kingdom Judges from New Zealand Judges is to be found in the Privy Council’s description of a provision such as s 99 as a “long stop” for the revenue. In Commissioner of Inland Revenue v Auckland Harbour Board (24 January 2001, No. 30 of 2000), in a judgment delivered by Lord Hoffman, the Privy Council stated (at 11) that some of the work such provisions used to do has nowadays been taken over by the more realistic approach to the construction of taxing acts exemplified by WT Ramsay Ltd v Inland Revenue Commissioners, supra. He added: “...although their Lordships should not be taken as casting any doubt upon the usefulness of such tax avoidance provisions as a long stop for the Revenue”. Blanchard J has pointed out (para [182]) that this dictum appears to be in conflict with the views expressed by the High Court of Australia in John v Federal Commissioner of Taxation [1989] HCA 5; (1989) 166 CLR 417 and the Supreme Court of Canada in Stubart Investments Ltd v The Queen (1984) 10 DLR (4th) 1. The tax statutes in both Australia and Canada contain general anti-avoidance provisions.
[76] The immediate point, however, is that the Privy Council’s view is contrary to more indigenous perceptions of the function of s 99. In New Zealand, the general anti-avoidance provision is regarded as a core provision. (See e.g., Tax Compliance Report 1998, supra, at paras 2.53 - 2.58 and 2.120 – 2.122. See also the Consultative Committee on Taxation of Income from Capital The Core Provisions of the Income Tax Act 1976, Discussion Paper, September 1990, para 1.3.) In this Court in Challenge Corporation Ltd v Commissioner of Inland Revenue [1986] 2 NZLR 513, Woodhouse P described s 99 (at 532) as being “obviously a central pillar of the income tax legislation”. Richardson P has adopted that description in this case (para [39]) confirming that s 99 is perceived legislatively as “an essential pillar of the tax system” designed to protect the taxpayer and the general body of taxpayers from what are considered to be unacceptable tax avoidance devices.
[77] I agree with this perception of the function of s 99. The section is not to be relegated to a “long stop”; it is the core bulwark against tax avoidance and the central means of protecting the integrity of the tax system in this country. (The status of the general anti-avoidance provision as a “core provision” in New Zealand’s tax system has been confirmed with the enactment of the Taxation (Core Provisions) Act 1996. The Long Title records that the Act seeks to “clarify the core principles on which the income tax law is based”. Sections BG1 and GB1 relating to tax avoidance arrangements are included in the Act).
[78] All told, it is perhaps inevitable that an approach which is thought appropriate in the United Kingdom should be transported to New Zealand. But as this country knows to its cost, not everything introduced into New Zealand has proved beneficial. In this case the cost has been immense damage to the tax base of this country and the inequitable distribution of the tax burden to the disadvantage of those taxpayers who choose to comply with their tax obligations.
[79] Before leaving this topic, however, I should clarify that I am not to be taken as implying that the abandonment of the present right of appeal to the Privy Council would rectify this situation. Because of the principle of stare decisis, the Privy Council’s approach has become embedded in the law and judicial methodology of this country and would, I fear, survive the Privy Council’s demise. Indeed, nothing short of further legislation will be needed to reverse the English approach and create a climate in which tax avoidance in this country is significantly reduced.
Section 99 – objective
[80] Section 99 nullifies against the Commissioner for Inland Revenue any arrangement to the extent that it has the purpose or effect of tax avoidance, unless that purpose or effect is merely incidental. The wording of the section will be examined later. Its purpose is to preserve the tax base and protect the general body of taxpayers from avoidance devices. (See Rt Hon Sir Ivor Richardson, “Reducing Tax Avoidance by Changing Structures, Processes and Drafting” Chapter 10, Tax Avoidance and the Rule of Law, (1997 - Ed, Graeme S Cooper) 327, at 328)).
1) A public interest enactment
[81] The provision and its predecessor, s 108, were enacted to promote Parliament’s perception of what is required in the public interest. It is an acknowledgement that market forces cannot provide adequate protection for that public interest (See Rt Hon Sir Ivor Richardson, supra, at 328), and that legislative intervention is required. It is also an acknowledgement that in New Zealand a general anti-avoidance provision is thought to be necessary in the public interest, apart from or additional to any specific anti-avoidance provisions which may be enacted to fill particular loopholes which emerge.
[82] A commentator has succinctly summarised the respects in which tax avoidance is harmful to the public interest. (McLeod, supra, at 103-4). First, as the government seeks to collect taxes to achieve its national welfare objectives, tax avoidance undermines that purpose. Secondly, tax avoidance is characterised by an excessive degree of tax influence in decision-making, which magnifies the dead-weight loss of the tax system. Thirdly, equity considerations tell against tax avoidance. It results in an unfair redistribution of the tax burden. Excessive tax avoidance also undermines public confidence in the tax system, and affects some people’s willingness to comply with tax laws and procedures. Voluntary compliance with tax laws is a critical element in New Zealand’s taxation regime. It substantially reduces transaction costs. But voluntary compliance is affected by perceptions of fairness and the destruction of confidence in the tax system as a result of tax avoidance necessarily impairs this compliance. (See Robert A McLeod “An Economic Approach to Taxation Avoidance” (1996) 2 NZJTLP, 171, at 173).
[83] Being a public interest enactment, therefore, s 99 should ideally act as a deterrent to tax avoidance arrangements which, while they might otherwise appear to comply with the Act, do so in a way that is likely to undermine the integrity of the tax system. (See Tax Compliance Report 1988, para 6.31, at 125, and para 13.44 at 223).
2) The Courts traditional reaction
[84] But from the outset the Courts have bridled against accepting a broad or unrestricted interpretation of s 99, and its predecessor. See, for example, the observations of Lord Donovan in Mangin v Commissioner of Inland Revenue [1971] NZLR 591, at 597; Richardson J in Challenge Corporation Ltd v Commissioner of Inland Revenue [1986] 2 NZLR 513, at 548; McCarthy P in Commissioner of Inland Revenue v Gerard [1974] 2 NZLR 279, at 280; and, in Australia, Deputy FCT v Purcell [1921] HCA 59; (1920) 29 CLR 464, at 466. It has been thought that a strictly literal application of the section would vest it with too wide a scope and lead to unacceptable results. Commercial decisions are regularly made with an eye to reducing a taxpayer’s tax liability. As stated by Richardson J in the Challenge Corporation case, supra, at 548, the legislature could not have intended s 99 to override all other provisions of the Act so as to deprive the tax planning community of structural choices, economic incentives, exemptions and allowances provided for by the Act itself. Economic incentives, for example, can have a useful economic function, furthering economic efficiency or the government’s social policy. On the other hand, as the learned Judge points out (at 549), s 99 would be a dead letter if it were subordinate to all the specific provisions of the legislation. It is inherent in the section that but for its provisions the impugned arrangements would meet all the specific requirements of the income tax legislation.
3) Back to Parliament’s intent
[85] But Parliament, I am satisfied, never intended the section to be overwhelmed by the morass of glosses, concepts, distinctions and doctrines which have been devised and imposed by the Courts. The approach contemplated by Parliament was indicated in the speech of Dr A M Finlay, then Minister of Justice, and a senior barrister of the highest repute. He noted in the debate on the Land and Income Tax Amendment Bill (No. 2) (NZPD Vol 393, 1974, at 4191), that the section was one of the most enlightened and beneficial pieces of legislation in the statute book. Later, he pointed out (at 4192) that, if everyone in this country paid the tax that Parliament intended, there would be two important and widely welcomed results. One would be that the tax burden would be more equitably shared resulting in a significant lightening of the burden for what he called the ordinary taxpayer. A bigger contribution would be made by some of those whom, Dr Finlay suggested, avoid tax rather than evade it. The second consequence would be that this country’s tax legislation would be enormously simplified. Noting that the ingenuity of the tax avoider is boundless, greater simplicity in the tax legislation would mean that this proclivity to avoid tax would be minimised. Dr Finlay referred with approval to the judgment of Woodhouse J in Elmiger v Commissioner of Inland Revenue [1966] NZLR 683. (See also the Hon Michael Connolly, Minister of Police, at 4228, and Mr O’Flynn QC, at 4239, referring to Elmiger).
[86] Woodhouse J’s judgment in Elmiger was a tour de force and undoubtedly influenced the Government’s thinking. The distinguished Judge was conscious of the reality of tax avoidance. He observed (at 686-687) that ingenious legal devices which contrived to enable individual taxpayers to minimise or avoid their tax liabilities were often, not merely sterile or unproductive in themselves, but had social consequences which were contrary to the general public interest. He also noted that the legislature is usually lagging several steps behind the ever developing arrangements worked out by experts in this field on behalf of their taxpayer clients. Woodhouse J did not think it surprising that the legislature, in enacting a general anti-avoidance provision, should attempt to anticipate the manoeuvres of some taxpayers to obtain tax advantages denied generally to the same class of taxpayer. Nor did he consider (at 687) it could be thought to be “unfair to those affected” if the method adopted by the legislature should be “... the method of general proscription”. If, he suggested, there seemed to be difficulties in this last area they should be related, not to anticipated injustices to the body of taxpayers, but to the problem of discovering the intended limits of any general embargo (ibid).
[87] Woodhouse J concluded (at 694) that the section is a general provision aimed at otherwise legal methods of tax avoidance. He considered it was designed to forestall the use by individual taxpayers of ordinary legal processes for the deliberate purpose of obtaining relief from the natural burden of taxation denied generally to the same class of taxpayer. In his opinion, family or business dealings would be caught by the anti-avoidance provisions, despite their characterisation, if there was associated with them the additional purpose or effect of tax relief in the sense contemplated by the section pursued as a goal in itself and not arising as a natural incident of some other purpose. The learned Judge realistically observed that, if this were not so, “appropriate legal window-dressing” could still be devised to defeat the general object of the section.
[88] Woodhouse J’s decision related to s 108. But it is clear from the speeches in Hansard that what he said represented the policy of a general anti-avoidance provision, and that s 99 was designed to make that provision more effective. (Woodhouse J’s judgment was affirmed on appeal; see Elmiger v Commissioner of Inland Revenue [1967] NZLR 161).
4) Parliament is disappointed
[89] Parliament’s aspiration that the anti-avoidance provision would be more effective was to be disappointed. No great detail is necessary to record the reason for this disappointment. The Committee of Experts responsible for the Tax Compliance Report 1998 recorded that it was not so much deficiencies in the anti-avoidance provisions, as the Commissioner’s past understanding and application of those provisions that was the problem (para 13.47). This view, the Committee noted, is echoed in the Report of the Davison Commission where it was observed that the Department of Inland Revenue had adopted a “conservative interpretation” of the general anti-avoidance provisions on the tax issue and that the “weakness exposed by the wine-box deals is not the legislation itself ... but the use of it by the Commissioner” (at 3:1:50). The Committee believed that, in order to preserve the integrity of the tax system, a far greater degree of “robustness” in the administration of the anti-avoidance provisions is required. (Chap 13, “Applying the Law”, at 213). It stated that, as the incentive to create schemes intended to test the boundaries of the legislation is high, so also is the temptation to devise schemes, often deliberately complex, in an attempt to confuse the Department and so to fail to meet equal obligations. “The tax system,” it said, “needs to be robust if it is to cope” (para 13.5).
[90] While the Department has undoubtedly been conservative in its application of the general anti-avoidance provision, the impact of the English approach in the Courts cannot be disregarded. What point is there in the Department seeking to be more robust in enforcing the provision if the Courts do not vest it with the objectives and scope that Parliament intended? Put another way, why should the Department be more proactive in invoking s 99 if the prevalent judicial approach will render that proactivity futile? The environment created by the English approach in the Courts has encouraged taxpayers who are prone to adopt tax avoidance schemes, and their tax advisers, to raise numerous issues designed to stall and delay the Commissioner’s inquiry. Eventually, if still pursued by the Department, such taxpayers will seek a favourable settlement, the ultimate payment to the Department being made up in large part, if not wholly, from the interest which has accrued from the use of the money in the meantime. Such tactics are inevitable having regard to the fact that, if the Commissioner’s ruling proceeds to Court, the question whether the impugned arrangement avoids tax will be beset by the glosses, concepts, distinctions and doctrines to which I have referred. A more robust approach by the Department needs to be backed by a purposive approach to s 99 by the Courts.
5) The unrealistic perception of certainty
[91] In part, the problem with both the interpretation and application of s 99 is an unrealistic expectation of the certainty which it is possible to achieve with a general anti-avoidance provision. Of course, as much certainty as possible is desirable, but general anti-avoidance provisions are necessarily uncertain if they are to cover the multiplicity of schemes designed to avoid tax.
[92] As one commentator has stated, referring to the argument that the wording of taxing legislation should be made certain, all statutory language is inherently uncertain in practice because general words are being applied to specific fact situations. The basic concepts of income tax law are imprecise. They must be flexible concepts. Thus, the author continues, taxation statutes apply what is essentially legal language to statistical material prepared by accountants according to different concepts. “The belief”, he concludes, “that taxation law can and should be certain is therefore a chimera”. (Geoffrey Lehmann “Judicial and Statutory Restrictions on Tax Avoidance” in Australian Taxation: principles and practice (1987, Eds, Richard E Krever and Gretchen Kewley) Chap 10, 295, at 296). Over a decade later these words are even more self-evidently true.
[93] Experience confirms that this uncertainty cannot be eliminated. Judicially created anti-avoidance doctrines, such as the fiscal nullity doctrine in the United Kingdom, in jurisdictions not having a statutory general anti-avoidance provision are also uncertain, possibly even more so than statutory provisions. In the result, no provision (or judicial doctrine) can ever enable taxpayers to predict with absolute certainty that a proposed arrangement will or will not constitute tax avoidance. Most commercial arrangements are undoubtedly legitimate, the tax saving being incidental, but at the margin no bright line can be drawn between a valid commercial scheme and tax avoidance, and it has become unproductive to hanker after a level of precision and certainty which can never be realised. The Tax Compliance Report 1998 confirms (at para 6.47) that, to be effective, a general anti-avoidance provision cannot be precise. The Committee adds that flexible wording of the general anti-avoidance rule allows the Courts to address new and different types of tax avoidance arrangements and so help to preserve the robustness of the tax system.
[94] Yet, from the outset, the Courts criticised the general anti-avoidance provision for its generality and pressed for greater precision. The dicta of McCarthy P in Commissioner of Inland Revenue v Gerard, supra, at 280-281, provides an example. Having adverted to the criticisms of s 108 by the Privy Council, the learned Judge went on to say that one could only hope that the legislature would listen to what had been said and state in precise language not only what classes of transactions are to be struck out, but what are to be the results of that action.
[95] Parliament rejected all this trenchant judicial criticism. The impetus for replacing s 108 was not any concern on Parliament’s part about the uncertain scope of the former provision, but rather two perceived problems. The first was the observations of Lord Wilberforce in Mangin v Commissioner of Inland Revenue, supra, at 603, to the effect that the former s 108 focused on “altering the incidence” of income tax rather than the “avoidance” of income tax. Hence, the section would not apply to certain arrangements which were clearly tax avoidance. Parliament confirmed that Lord Wilberforce’s perception was not its intent with the enactment of s 99. The second problem was that s 108 did not give the Inland Revenue Department a positive power to levy tax on an avoidance arrangement. This defect was remedied by subs (3) of s 99.
[96] In asserting that uncertainty increases transaction costs, economists and other commentators tend to focus on the uncertainty of a general anti-avoidance provision. What is overlooked is the fact that, with the attempt to provide greater precision, the uncertain boundary between legitimate tax planning and tax avoidance simply moves. It moves from, say, an assessment whether the transaction in substance provides for the taxpayer a saving from the natural burden of taxation which is generally denied to the same class of taxpayer, to an assessment whether the transaction falls within the scope of one of the glosses, concepts, distinctions and doctrines which the Privy Council have ordained. Moreover, because of its complexity and pervasive influence in commercial decision-making, transaction costs are almost certainly increased. Greater simplicity in the tax law, as contemplated by Parliament, would or should have the effect of reducing such costs.
(6) An exaggerated fear of deterring commercial activity
[97] Nor does a realistic appraisal mean, as is at times suggested, that in the absence of greater precision, the uncertainty will operate to deter legitimate commercial transactions. It is a claim which, as Lord Templeman stated in the Challenge Corporation case [1986] 2 NZLR 513, at 560; “...requires serious but sceptical consideration”. In the first place, as just pointed out, the boundary between legitimate tax planning and tax avoidance shifts from one more simple form of assessment to another form of assessment involving the glosses, concepts, distinctions and doctrines of which I have spoken. Commercial decision-making is still affected, but at a different point. But the latter process results in the collection of less revenue as the boundary is pushed further out in the would-be tax avoider’s direction.
[98] Secondly, there is something awkward about the argument that “legitimate” commercial transactions will be deterred when the question under inquiry is what transactions are legitimate. The argument seems to presuppose that there is, or should be, a range of transactions which, although tax avoidance transactions in terms of s 99, are or should be legitimate. A value judgment at odds with the legislature’s intent underlies this argument.
[99] Thirdly, I do not accept that the absence of the judicially created and imposed glosses, concepts, distinctions and doctrines which attach to the section would create a climate detrimental to commercial activity and growth. This was the view of Parliament when it enacted s 99, and before that s 108, and it still holds good today. The notion that a simplified interpretation and a more straight-forward application of s 99 would suppress commercial activity owes more to the judicial formulation of the problem than to commercial reality. Of course, business people will wish to reduce the incidence of tax, but few are incapable of knowing whether a proposed transaction has a commercial objective or function or is simply being pursued to obtain a tax advantage. It is advice that the latter is “permissible” if it can be presented in a form which conveys a commercial purpose that creates the difficulties.
Form over substance
[100] The crucial and depressing problem from the point of view of reducing tax avoidance is that the Privy Council has inhibited the Courts in examining the substance of a transaction. In the result, it is open to commercial taxpayers and their tax advisers to explore whether a transaction which is in substance tax avoidance can be presented in a form which conceals its true substance. I do not accept for one moment that Parliament intended this exercise to have any place in the interpretation and application of a general anti-avoidance provision. United States courts have tended to adopt a bold substantive approach in attacking tax avoidance. See Lehmann, supra, at 295. If the judicial will is there, it can be done.
1) ...and a general tax avoidance provision
[101] Whatever its function might be thought to be in interpreting a specific tax section, therefore, the form over substance doctrine is misplaced in the interpretation and application of a general avoidance provision. How can the Courts know whether the “effect” of a transaction is to avoid tax if they do not know what the substance of the transaction is? Phrases such as “legal substance” or “business substance” simply obscure the critical question: does the impugned arrangement avoid tax contrary to s 99?
[102] It is beyond argument that a general anti-avoidance provision is to be interpreted in a way which is consistent with the intent and policy of the taxing statute as a whole. What I said in Peters v Davison (No. 3), supra, at 14,063, bears repeating. The objective of the Income Tax Act is to collect tax on income. Income is derived from the substance of a transaction, not its form. It is therefore necessary to have regard to the substance of a transaction and not just the form in which it is fabricated to determine the true income and the tax which is payable on that income. For either the tax authorities or the Courts to do otherwise is to thwart the objective of the Act. In no other provision of the Act is this requirement more pronounced than the general anti-avoidance section.
2) Macniven
[103] I am brought at this point to the House of Lords’ most recent discussion on tax avoidance in Macniven v Westmoreland Investments Ltd (Unreported, [2001] UKHL 6; (2001) UK HL6), delivered earlier this year. The straight-forward reasoning emphasised in the previous paragraph cannot be reconciled with the approach of the House of Lords in Macniven. I acknowledge, of course, that there are occasional dicta in the decisions of the Privy Council which might suggest that substance is to prevail. See, for example, Commissioner of Inland Revenue v Europa Oil (NZ) Ltd [1971] NZLR 641, per Lord Wilberforce at 648. But Macniven provides the latest word.
[104] Four of their Lordships delivered judgments in Macniven. Lord Nicholls provided a succinct and penetrating analysis of what the House of Lords decided in WT Ramsay Ltd v Inland Revenue Commissioners, supra, in which he stressed the importance of identifying the “legal nature of the transaction”. (See e.g. paras 2 and 5). Lords Hope and Hutton focused on the need to eliminate any steps in a transaction which are “artificial”. (See e.g. Lord Hope, para 77, and Lord Hutton, paras 92, 93 and 94). Steps are considered artificial if they have no commercial purpose other than the purpose of seeking to obtain a tax advantage. It is, however, the comprehensive judgment of Lord Hoffman, with which Lord Hobhouse agreed, that I wish to examine as it deals more fully with the issue of form over substance.
(i) Lord Tomlin’s dicta reinterpreted
[105] Lord Hoffman first quotes (at para 39) Lord Tomlin’s famous dictum in Inland Revenue Commissioners v Duke of Westminster [1936] AC 1, at 19. His Lordship states that to look at the transaction as a whole would not be to commit the heresy condemned by Lord Tomlin as the “doctrine that the Court may ignore the legal position and regard what is called ‘the substance of the matter’”. He added Lord Wilberforce’s qualification in Ramsay (at 323) that, while Lord Tomlin’s statement was a “cardinal principle”, it did not require a court to “look at a document or a transaction in blinkers”.
[106] Lord Hoffman then asserted that Ramsay established a new principle of construction which recognises that the statutory language is intended to refer to “commercial concepts”. Thus, it is the statute itself which applies the tests of “ordinary business”. The significant feature of applying a test of ordinary business is that it may require an aggregation of transactions which transcends their juristic individuality. But Lord Hoffman appreciated (para 38) that, if it is accepted that the various juristically discrete transactions making up the scheme are genuine, their Lordships in Ramsay could not collapse them into a composite self-cancelling transaction without it appearing that they had been guilty of ignoring the legal position and looking at the substance of the matter.
[107] In an endeavour to reconcile Ramsay with the Duke of Westminster’s case, therefore, Lord Hoffman is able to perceive an ambiguity in Lord Tomlin’s statement that the courts cannot ignore the “legal position” and have regard to “the substance of the matter”. If, his Lordship states (para 39), the “legal position” is that a tax is imposed by reference to a legally defined concept, such as stamp duty payable on a document which constitutes a conveyance on sale, the court cannot tax a transaction which uses no such document on the ground that it achieves the same economic effect. On the other hand, if the legal position is that tax is imposed by reference to a “commercial concept”, then to have regard to the “business ‘substance’” of the matter is not to ignore the legal position but to give effect to it.
[108] With respect to Lord Hoffman, and while admiring his intellectual acuity, I consider his attempt to reconcile Lord Tomlin’s dictum with what their Lordships decided in Ramsay teeters on the brink of casuistry. When the House of Lords in Ramsay held that any steps inserted in a related series of transactions for the purpose of avoiding tax can be disregarded by the Commissioner and the related transaction then be viewed as a whole, the House necessarily had to have regard to the substance of the transaction. This is simply the reality of what must be done to reach the conclusion that certain legal steps or transactions can be disregarded. Lord Wilberforce’s three key features indicating avoidance schemes; their self-cancelling structure, their non-commerciality, and the expectation that all the consecutive steps in the exercise would be performed even though there was no contractual stipulation that this would be so, require a full understanding of the substance of the scheme.
(ii) And now “business substance”
[109] Nor am I particularly comfortable with the latter part of Lord Hoffman’s dictum drawing a distinction between the legal position of tax imposed by reference to a legally defined concept and the legal position of tax imposed by reference to a commercial concept, and his conclusion that to have regard to the “business substance” is not to ignore that legal position but to give effect to it. Of course, the example of tax liability arising on a document is clear enough, but I suspect that the distinction will lead to endless argument as to whether the tax in issue is imposed by reference to a legal concept or by reference to a commercial concept. Tax on “income”, the most fundamental concept in tax legislation, for example, could be said to be imposed by reference to a legal concept (that is, the sum of one’s earnings) or by reference to a commercial concept (the economic or commercial perception of income). I suspect that the distinction will have little value in the effective operation of general anti-avoidance provisions where the essential issue is whether the impugned transaction actually has the purpose or effect of avoiding tax.
[110] (Since completing the draft of this judgment, including the above paragraph, I have read the decision of the Court of Appeal in the United Kingdom in DTE Financial Services Ltd v Wilson (Inspector of Taxes) [2001] EWCA Civ 455. It would seem to bear out my fears. In that case counsel for the Inland Revenue argued that the concept of “payment” in the context of the PAYE system was par excellence a practical, commercial concept as opposed to a juristic concept of the kind referred to by Lord Hoffman. Opposing counsel, however, submitted that the concept of “payment” in a PAYE context is not a commercial concept but rather a legalistic concept. (See paras [37] and [39]). The Court found in favour of the Revenue, holding that, for the purpose of the PAYE system, “payment” ordinarily means actual payment, that is, a transfer of cash or its equivalent. But the Court could readily have reached this conclusion without reference to the dispute as to whether it was a commercial or legalistic concept. (See para [42])).
[111] I also question the introduction of the notion of a “business substance” (there is already a “legal substance”). Does this “business substance” differ from the true substance of a transaction? If, as Lord Hoffman posits, the legal position is that the tax is imposed by reference to a commercial concept and to have regard to the “‘business substance’” of the matter is not to ignore that legal position but to give effect to it, the implication is that there may be a business substance to a transaction which may not reflect the tax avoidance effect of that transaction.
[112] This outcome would seem to be confirmed by Lord Hoffman’s short reference to the Wattie case, which I have already referred to, (although that case was not a case under s 99). Citing Wattie as an example, Lord Hoffman states (para 61) that a transaction which, for the avoidance of tax, has been structured to produce say, capital, and does produce capital in the ordinary commercial sense of that concept, cannot be “recharacterised” as producing income. There is no doubt that the legal form or legal nature of the transaction in Wattie was the payment of the premium by the lessor to the incoming lessee. It cannot be correct to say, however, that the individual payment was structured to produce capital and did produce capital in the ordinary commercial sense of that concept. The parties no doubt hoped that the receipt of the premium in the hands of the lessee would be regarded as capital by the Commissioner and by the Courts. But that is not to say that the premium produced capital in the ordinary commercial sense of that concept. If Lord Hoffman’s analysis represents the “business substance” of the transaction, then, it is not the actual substance of the transaction. The substance was that the “premium” was paid by the lessor to the lessee to offset an inflated rent agreed to by the lessee to suit the lessor’s collateral objective of promoting tenancies elsewhere in the building at a higher rental. (See above, para [65]).
3) Substance over form
[113] I therefore hold firm to the view that, whatever approach is adopted in respect of specific tax sections, a general anti-avoidance provision requires the Courts to examine the substance of a transaction. Semantics aside, this question can only be answered by reference to the true nature of the transaction. As I have already indicated, such an examination is necessary to determine whether certain steps or transactions in an arrangement are fiscally ineffective and to be disregarded in terms of the Ramsay principle or approach. Other perceptions or tests fare no better without regard to the substance of the arrangement. How else can the courts determine whether a transaction has a “business purpose”, apart from the purpose of gaining of a tax advantage? Or how can the courts know whether a transaction or step in a transaction is “genuine” or “artificial”, to coin two of the words in regular currency, without regard to its substance? Assume a transaction which is in substance unquestionably tax avoidance. Is it to be regarded as permissible tax avoidance simply because it is not artificial, or does not contain an artificial step or transaction, or because it does not appear on an analysis of the legal form to be artificial? In all these cases the courts are playing word games unless they have recourse to the substance of the transaction.
[114] Nor would I countenance the notion that Parliament intended a general anti-avoidance provision to be applied having regard to the “legal nature of the transaction” only. The legal nature of a transaction may be determined from its legal form. But that legal form may or may not accord with the substance of the transaction, and the possibility that it may not do so cannot be known without regard to the substance. The legal nature of the transaction, I accept, will incorporate rights and duties and give rise to liabilities intended to be undertaken and discharged by the parties, but may still not represent the substance of the transaction from the point of view of the incidence of tax. I prefer the thinking of Deane J in Commissioner of Taxation v Watson and Gulland, Pincus v Commissioner of Taxation (1985) [1985] HCA 83; 160 CLR 55, at 94. Deane J admitted to having difficulty with the emphasis upon legal form and the disregard of substance which earlier Australian cases had required in the application of s 260, the equivalent of s 99. “Uninstructed by authority,” he said, “I should have thought that the legislative intent to be discerned in s 260 was ... that, if it can be objectively predicated that either form or substance must be explained as – to use the vernacular – a “tax dodge”, it should be disregarded.”
[115] Determining the “purpose or effect” of a transaction, which is what s 99 requires, must prove equally elusive without regard to the substance of the transaction. Parliament cannot have intended this question to be subjugated to the judicial glosses, distinctions, concepts and doctrines which have become the regular tools of tax avoidance. The legislature’s objective of receiving tax on all income not specifically exempt must be thwarted to the extent that transactions which are in substance tax avoidance escape the imposition of the tax by taking advantage of one or other of these judicial adhesions.
[116] I turn now to approach the interpretation of s 99 untrammelled by the judicial glosses, distinctions, concepts and doctrines of which I have spoken, and to then apply my interpretation of the section to the arrangement in issue having regard to its substance.
Section 99 – interpretation
1) A purposive
approach
[117] I earlier described the House of Lords’ decision in McGuckian as a landmark departure from the English approach. Fairly construed, it brought about a radical new approach to the interpretation of tax statutes. The purposive approach is to prevail. This means that, in interpreting s 99, full regard must be had to the fact the section was enacted to promote the public interest imperative in protecting the tax base of this country and avoiding an inequitable distribution of the tax burden as between taxpayers. Section 99 is designed to preserve the integrity of the tax system and, by ensuring that tax is collected on income, that public confidence in the tax system is maintained. The text of the section is to be approached with these public interest objectives in mind.
[118] Adopting this purposive approach, I believe that the text of s 99 clearly confirms the following features relevant to the questions in issue:
- The word “arrangement” is to be given a wide meaning;
- The scope and effect of an arrangement is to be determined objectively; and
- The “innocence” or ignorance of a participant in the arrangement does not exclude liability.
2) An analysis of s 99
[119] First, reference may be made to the heading; “Agreements purporting to alter the incidence of tax to be void”. “Agreement” is, of course, only one of the specific words used to define “arrangement”. The key words in the heading are “purporting to alter the incidence of tax”. The objective of avoiding any alteration in the incidence of tax or relieving any person from liability or avoiding, reducing or postponing any liability to income tax is substantively incorporated in paras (a),(b) and (c) of the definition of “tax avoidance”. That purported alteration in the incidence of tax occurs when, to adopt the phraseology of Woodhouse J in Elmiger, supra, at 694, the taxpayer uses the ordinary legal processes for the deliberate purpose of obtaining relief from the natural burden of taxation which is denied generally to the same class of taxpayer. It reflects Parliament’s aim to render void arrangements which are tax driven and achieve a tax saving for the particular taxpayer at the expense of taxpayers generally.
[120] Secondly, the definition of “arrangement” could not be expressed more widely. The words “plan” or “understanding”, especially in the context of a statute imposing liability for tax, are indubitably broad. The arrangement does not have to be enforceable, and it includes all steps and transactions by which that arrangement is carried into effect. In its terms, the definition does not import any requirement of conscious involvement or awareness of the tax avoidance. Moreover, from the structure of the section it is clear that, on the one hand, there may be a plan or understanding and, on the other, steps and transactions by which the plan or understanding is carried into effect, without any suggestion that one party must be privy to both the plan or understanding and the steps and transactions by which it is carried into effect.
[121] Thirdly, the term “arrangement” may apply to more than one contract, agreement, plan or understanding. It is to be noted that the definition is exhaustive. “Arrangement” means “contract, agreement, plan or understanding” and does not merely “include” those matters. The word “arrangement” does not have a discrete life. (Lord Denning’s famous dictum as to the meaning of arrangement in Newton v Federal Commissioner of Taxation [1958] AC 450, at 465, must be read subject to this statutory formulation). In the result, the Court is not looking for an arrangement, as such, but an agreement or agreements, or plan or plans, or understanding or understandings (as under s 33 of the Interpretation Act 1999, the singular includes the plural) or any combination of them. Any such agreement, plan or understanding will then constitute an arrangement if it falls within the terms of s 99. Thus, the section does not contemplate that the Courts will examine a series of transactions and conclude that some form part of one arrangement and the remainder part of another arrangement before turning to subs (2). Once there is an agreement, plan or understanding, subs (2) applies and the question then arises whether the arrangement amounts to a tax avoidance arrangement pursuant to that subsection. The definition exists for the purpose of that subsection. It does not invite a two stage process.
[122] Fourthly, by virtue of subs (2), every arrangement is then absolutely void as against the Commissioner, not at the discretion of the Commissioner, but by virtue of the statutory direction that every arrangement which is made or entered into is void if and to the extent that, “directly or indirectly”, its purpose or effect is tax avoidance. The plain wording means that the purpose and effect may be indirect. The word “indirectly” is also used in the definition of “tax avoidance”. Thus, if the effect of the arrangement is to indirectly avoid tax, it matters not that the tax avoidance may not have been the direct aim of the arrangement. The repeated use of the word “indirectly” is not decisive, but it must count against an interpretation which would restrict an arrangement to those persons who are consciously involved in it or which would stipulate a requirement that there must be a consensus or meeting of the minds in relation to the tax avoidance. Indirect consequences will not necessarily have been intended or foreseen, at least not by every party to the arrangement.
[123] Fifthly, where, by virtue of subs (2)(b), the arrangement has two or more purposes or effects, and one of those purposes or effects constitutes tax avoidance, the arrangement will be void as against the Commissioner unless the tax avoidance purpose or effect is “incidental”. If the tax avoidance effect of the arrangement is other than incidental that aspect of the arrangement is to overwhelm any other purpose or effect referable to ordinary business or family dealings. The distinction between what a party to the arrangement may intend and the effect of the arrangement is again clear.
[124] Sixthly, the qualification in subs (2)(b) is to apply “whether or not any person affected by that arrangement is a party thereto”. This phrase was not included in the earlier unamended s 108. It clearly indicates that the scope of an arrangement that is void as against the Commissioner is intended to be wider than the persons who may be parties to the arrangement. The arrangement is void as against persons who are merely affected by it. This extension is clearly inconsistent with any requirement of conscious involvement or mutuality.
[125] The same wording is used in subs (3), that is, “... of any person affected by that arrangement”, in relation to the Commissioner’s power to adjust assessable income to counteract any tax advantage obtained by that person from or under the arrangement. I accept that, before the section applies, there must be an arrangement and that begs the question in issue; whether BNZI is a party to the arrangement to avoid tax in terms of s 99(2). But the language nevertheless points to the intended scope of the section. If a person affected by the arrangement is subject to the Commissioner’s powers, and therefore not necessarily involved or aware of its tax avoidance implications, it is difficult to see why a party would need to be consciously involved or agree to the tax avoidance. It would be anomalous if a person was excluded from an arrangement because he or she was not aware of the tax avoidance, but another person who is also not aware of the arrangement but is affected by it could be subject to reassessment under subs (3).
3) It is the “effect” that counts
[126] Finally, all the above phrases confirm, as has been firmly held, that s 99 is to be construed objectively. Viscount Dilhorn said in Ashton v Commissioner of Inland Revenue [1975] 2 NZLR 717, at 722, that the section is not concerned with the motives of individuals. It is not concerned with the parties’ desire to avoid tax, but only with the means which they employ to do it. See also Newton v Commissioner of Taxation, supra, at 465. The word “effect” directs the focus to the result or consequence of the arrangement as opposed to a bare description of tax avoidance. It focuses on the physical characteristics of the arrangement. (See The Valabh Committee, Key Reforms to the Scheme of Tax Legislation, Discussion Paper, October 1991, para 3.5, and para 3.6). The courts have also held that the purpose of an arrangement is to be determined by its effect. It is sufficient to refer to the succinct statement of Woodhouse P in the Challenge Corporation case (at 533): “I am satisfied as well that the issue... is something to be decided, not subjectively in terms of motive, but objectively by reference to the arrangement itself.”
[127] It is because s 99(2) is directed at the effect of an arrangement that it does not matter that the taxpayer is “innocent”. He or she may be innocent because they genuinely believe the arrangement does not avoid tax, or they might be acting on the advice of an expert whom they have no reason to distrust. The expert him or herself may honestly believe that the proposed arrangement does not involve tax avoidance. Or the taxpayer may be innocent in that he or she is subject to the section only as a person affected by the arrangement in terms of that phrase in subs (2) and (3). None of this “innocence” matters. It is the effect of the arrangement that is pertinent. To include “innocent” persons in the arrangement is therefore consistent with the thrust of the section.
[128] I therefore believe that it is plain that tax avoidance for the purposes of s 99 does not turn on what the taxpayer knew or intended. It is subjectively benign. No element of mens rea is required. The section does not require moral impropriety. The notion that moral judgment is required has been consistently repudiated. (See O’Neil and Others v Commissioner of Inland Revenue (Unreported, No 40 of 2000, 10 April 2001, per Lord Hoffman at para 9.) The fact that tax avoidance does not turn on what the taxpayer knew or intended must tend to support an interpretation of s 99, and of the key word “arrangement”, which does not itself turn on the mental element or specific knowledge of the taxpayer. Both or all parties may have intended a legal transaction, but if its effect when viewed objectively is to avoid tax, then knowledge or even suspicion of tax avoidance will be of no avail. Parliament did not intend that such persons would inadvertently become entitled to a tax saving by tax avoidance.
5) Some specific points refuted
[129] The above reasons preclude the majority’s approach and interpretation of s 99. In essence, the majority’s interpretation restricts the scope of subs (2) by restricting the scope of the word “arrangement” in subs (1) so as to make the definition of that term narrower than what is then obviously contemplated by the terms of subs (2). Some specific points, however, may be proffered in refutation of that interpretation.
[130] I do not agree, as held by the majority (paras [43] to [50]), that the words used to define arrangement; that is, “contract, agreement, plan or understanding”, or the fact that subs (2) refers to an arrangement “made or entered into” points to the need for a consensus or meeting of the minds between the participants which must embrace the specific tax avoidance function or steps. A tax-driven agreement, plan or understanding may exist and involve a consensus or meeting of minds as between the participants without that consensus or meeting of minds extending to the particular tax avoidance steps or transactions. An agreement, plan or understanding is still “made or entered into” even though one party may not know the mechanism by which the agreement, plan or understanding is to be carried into effect. The question, then, is whether the agreement, plan or understanding either directly or indirectly has the purpose or effect of tax avoidance. Indeed, it would be possible for parties to make or enter into an agreement, plan or understanding with none of them being aware that the indirect “effect” of that agreement, plan or understanding was tax avoidance. Furthermore, the taxpayer whose income is adjusted as a “person affected by that arrangement” is not a party to the agreement, plan or understanding and is unlikely to be part of any consensus or meeting of minds relating to the tax avoidance. I would therefore decline to find anything in the definition of arrangement or the words “arrangement made or entered into” in subs (2) which point to the need for the taxpayer to be consciously involved in the tax avoidance transaction or steps.
[131] With respect, I would reiterate the point. The emphasis placed by the majority on the words “made or entered into” as an indication that Parliament intended there to be a consensus or meeting of minds embracing the tax avoidance steps or transactions is conspicuously strained. What other words could the draftsperson have used? A “plan”, for example, may be “made” by a single person. The “agreement” or “understanding” of two persons may clearly not extend to the steps or transactions by which the understanding is carried into effect. Finally, the claim that the words “made or entered into” point to the need for a consensus or meeting of minds as to the tax avoidance or mechanism used to avoid that tax avoidance is to disregard the fact that it is the effect of the arrangement which is critical. The critical character of the effect is reinforced by the use of the words in subs (2) to describe a tax avoidance arrangement; “whether or not any person affected by that arrangement is a party thereto”.
[132] Similarly, the suggestion (at para [48]) that the words, “including all steps and transactions by which it [the arrangement] is carried into effect”, mean that there must be a consensus or meeting of minds as to those steps and transactions deprives the section of any significant force. Those taxpayers predisposed to tax avoidance could drive a coach and horses through a section importing that requirement. The words point to the scope of the arrangement, not the state of mind of the participants.
[133] Nor do I consider that it is particularly helpful to have regard to the approach taken under the Commerce Act 1986 in interpreting the meaning of an expression such as “arrangement” or “understanding”. (See majority judgment, paras [49] to [50]). The objective of that Act, or of s 27 of that Act, is quite different from the objective of s 99. The factors making up the public interest underlying both statutory provisions are different. From a broad perspective, the Commerce Act can be said to focus on collusive action simply because it is generally such action that will have the effect of lessening competition. Any emphasis on agreement arises because co-operation increases the risk of anti-competitive action, expands market power, creates an anti-competitive restraint not otherwise possible, and surrenders important decision-making autonomy on a matter of competitive significance. See Areeda, 6 Antitrust Law (1986), para 1402(b). Consequently, an arrangement or understanding where the purpose is to lessen competition in the marketplace may reasonably obtain a meeting of minds. But an arrangement does not require a meeting of minds if tax avoidance is the effect of that arrangement.
[134] In any event, determining that a meeting of minds is required to complete an arrangement or understanding does not resolve the question whether all taxpayers participating in that arrangement must be aware of the specific steps or transactions which will amount to tax avoidance. Thus, in this case, there was undoubtedly a consensus or meeting of minds between BNZI and CML as to the basic or overall arrangement or understanding. As I have explained above, the majority’s finding that this consensus or meeting of minds must embrace the tax avoidance is an unwarranted gloss on the section, is inconsistent with the terms of subs (2), is contrary to the public interest factors relating to that section, and runs counter to the legislature’s policy in persistently enacting a general anti-avoidance provision.
[135] Further, however, it is to be noted that the Commerce Act does not require that all parties be privy to the illicit purpose in issue. Section 2(5)(a) of the Act provides that a provision of a contract, arrangement or understanding shall be deemed to have a particular purpose if the provision is included in the arrangement or understanding for that purpose and is a substantial purpose. This provision was discussed in Tui Foods Ltd v New Zealand Milk Corporation (1993) 5 TCLR 406. Cooke P said (at 410) that it is sufficient in the light of the definition that one of the purposes of the inclusion of the provision should be an exclusionary one, provided that it is a substantial purpose. It seemed inevitably to follow, he continued, that if the party responsible for the presence of the provision has had such a purpose, then “the purpose of the other party is not material; for the purpose of the first-mentioned party is likely to be a substantial purpose and thus to satisfy the definition”.
[136] Although Tui Foods Ltd v New Zealand Milk Corporation related to s 29 of the Commerce Act which places restrictions on the use of exclusionary provisions, the same reasoning applies to s 27. In Port Nelson Ltd v Commerce Commission [1996] 3 NZLR 554, at 563, this Court rejected the argument that the common purpose which contravened the Act had to be shared by both parties to the contract, arrangement or understanding in issue. If this were so, the Court held, the effectiveness of s 27 would be considerably limited. But as a matter of construction, it was held, the argument is flawed; first, because it is the “provision” that must be shown to have the purpose and, secondly, the inquiry as to the purpose of the provision must be undertaken having regard to s 2(5)(a). In the result, not all parties need share in the illicit purpose.
[137] It would seem to me, therefore, that the Commerce Act provides little or no comfort for an interpretation of s 99 which would require a consensus or meeting of minds between the parties extending to the tax avoidance aspect of their arrangement. Just as under the Commerce Act it is the “provision” which must be shown to have the illicit purpose, so in this case it is the “effect” of the arrangement which must be shown to constitute tax avoidance. But I would prefer to resort to my primary argument that because of their different objectives, nothing is to be gained in seeking to interpret s 99 by referring to the phrases “arrangement” and “understanding” in the Commerce Act.
Section 99 - application
1) The accepted facts
– common ground
[138] I accept McGechan J’s finding of fact that BNZI (a subsidiary of the Bank of New Zealand (BNZ)) was not consciously involved in the specific tax avoidance transactions alleged by the Commissioner in this case. In my view, however, the transaction between the Bank and CML was part of the arrangement made or entered into for the purposes of s 99. Whether the transaction is called an agreement, plan or understanding does not matter.
[139] The transaction is the most recent fallout from the Wine Box Inquiry. It involved nine separate transactions set up by CML in which redeemable preference shares (RPS) were subscribed by BNZI. The nine transactions comprised four different structures of two broad types. Each structure, however, had the same twin aims. These aims were, first, to allow BNZI to raise funds in such a way that the interest it paid on those funds was deductible and, secondly, to convert the assessable income stream generated by the investment of those funds into exempt income. It is that part of the arrangement designed to give effect to the latter objective which the Commissioner claims amounts to tax avoidance.
[140] RPS entitle their owners to special privileges such as preferential rights to dividends and return of capital on the specified date or at the company’s option. These two features make RPS transactions, although equity based, similar to debt transactions such as loans. With a loan, of course, the investor or creditor lends a sum which the debtor must repay together with interest. With an RPS transaction, the investor subscribes monies for the shares, which monies the investor may redeem together with a preferred dividend, often at a fixed rate. The main commercial difference is that a dividend is only payable out of profits.
[141] The tax legislation in force at the time, however, created two further significant differences. Interest payable on a loan was assessable in the lender’s hands and deductible by the borrower. Dividend payments, on the other hand, constituted exempt income pursuant to s 63 of the Income Tax Act 1976, known as the “inter-company dividend exemption” (now replaced by the imputation credit system), and were a non-deductible expense for the borrower. Consequently, it was advantageous for an investor to enter into an RPS transaction instead of a loan. But, if the borrower obtained funds by an RPS transaction instead of a loan, the cost of the borrowing (the dividend) was non-deductible by the investor. In the result, RPS transactions were only economically viable where the borrower took advantage of a tax shelter and could discount the dividend rate, and so reflect the tax saving to the investor in the dividend yield.
[142] Each of the nine transactions were preceded by a separate agreement between BNZI and CML termed an option agreement in which BNZI gained a put option on the shares and CML promised to pay the favourable dividend yield. The yield was calculated so as to divide the anticipated tax saving equally between BNZI and CML. The agreements also contained complex indemnities protecting BNZI should the arrangement attract income tax.
2) BNZI’s knowledge
[143] McGechan J found that Fay Richwhite (CML’s parent company) was a tax aggressive and innovative merchant bank. It was quite capable, he held, of putting together “downstream” avoidance arrangements and BNZI would or should have been aware that CML would not necessarily be committed to standard arrangements. On the evidence, he considered, the overwhelming likelihood, and, indeed, BNZ’s assumption, was that tax losses would be the shelter which would be utilised. McGechan J further held that BNZI knew the destination of the RPS funds. But the Bank knew nothing of the circuitous character of the route used to fund the dividends due to CML, although the Judge also pointed out that the dividends were received by the Bank from the same prime overseas Bank that received the deposit.
[144] As between BNZ and/or BNZI, on the one hand, and CML, on the other, therefore, it was agreed or understood that the Bank would advance monies by way of an RPS subscription to CML; CML would utilise a tax shelter; the resulting tax saving would be divided between the Bank and CML equally; the monies advanced by way of RPS would be invested via a CML structure in a foreign bank; the interest earned on the investment would be used to fund the RPS dividend; CML would supply securities of matching term and tenor to the underlying deposit; CML would warrant that the monies were not pledged back as security; and CML would provide BNZI with comprehensive tax indemnities (although BNZI could end up carrying some tax risk). Overall, the objective of the structure was to provide an avenue whereby income earned from securities would be channelled “tax-effectively” to BNZI who had subscribed for the RPS. In essence, it involved the conversion of interest income into capital so as to fund the RPS dividend.
3) BNZI makes no inquiries
[145] McGechan J found that BNZI (subject to one exception which he explained) did not ask CML what it planned to do with the monies. CML was a known securities trader and BNZ assumed funds raised would be used for that purpose. Thus, the learned Judge held, “BNZ made no official inquiries as to the downstream activities intended.” He noted that RPS funds received by the issuer company to BNZI’s knowledge went to a known Cook Islands tax haven operator. From BNZI’s perspective, he said, that may have seemed unnecessary if indeed CML’s “downstream” shelter involved solely the utilisation of tax losses. But, the Judge concluded, the point should not be over-emphasised as there was no obvious need to know the “downstream” transactions.
4) The upstream/downstream analysis
[146] I first wish to make the point that the upstream/downstream analysis which has been adopted in this case is an artificial reconstruction of the arrangement. It suggests, as no doubt desired by BNZI’s counsel, that the Bank’s arrangement to subscribe for RPS, on the one hand, and the transaction providing a tax shelter, on the other, were discrete transactions. But this is to ignore the overall basic agreement or understanding whereby BNZI subscribed for RPS with CML, provided a put option, had the right to redeem at a fixed dividend rate, such rate being calculated at a discount from the prevailing interest rate of half the amount of tax saved. Following the use of the tax shelter by CML the funds are returned to BNZI as dividends and therefore exempt income.
[147] In pressing this upstream/downstream analysis, counsel for CML produced a diagram to the Court which drew a bright line between the RPS transaction between BNZI and CML, and CML’s subsequent handling of the monies. A more objective diagram is shown in Fig 1. It is much less easy, if at all possible, to draw a bright line on this diagram to accord with any upstream/downstream analysis.
[148] There is not, therefore, as the majority have asserted (para [56]) a “natural divide between the upstream and downstream transactions”. As can be seen, it is artificial to seek to divide the overall arrangement in this manner. The same reasoning could be applied in any situation where the mechanism for obtaining the tax advantage is separate from the wider agreement, plan or understanding that a tax shelter be used. The “divide” is between the knowledge of the parties as to what is transpiring, but that cannot restrict the scope of the arrangement.
[149] I accept that BNZI could not legally require CML to utilise a tax shelter or use the monies in any particular way. But the fact that parts of the transaction are “unenforceable” is explicitly provided for in the definition of “arrangement”. Moreover, as Lord Nicholls said in his summary of Ramsay in Macniven, supra, at para 2; “Courts are entitled to look at a pre-arranged tax avoidance scheme as a whole. It matters not whether the parties’ intention to proceed with a scheme through all its stages takes the form of a contractual obligation or is expressed only as an expectation without contractual force.”
5) The real scope of the arrangement
[150] The homogeneous nature of the arrangement can be demonstrated by postulating the situation where BNZI actually knew of the tax shelter to be used and, indeed, knew that tax avoidance would be involved. There would then be no doubt that the RPS transaction was part of an arrangement for the purposes of s 99, and that BNZI had made or entered into that arrangement. Yet, the overall arrangement would be exactly the same. So, too, the same could be said if BNZI had, in terms of the majority’s reasoning, shut its eyes to the projected tax avoidance. What would change the scope of the arrangement by virtue of BNZI’s ignorance? To my mind, therefore, the majority’s decision to exclude the RPS transaction because there was no consensus or meeting of minds as to the transactions carried out by CML, or as to the use of a tax shelter amounting to tax avoidance, is clearly an arbitrary restriction on the scope of the arrangement for the purposes of s 99.
[151] I fully acknowledge that RPS are a conventional means of funding companies. Again, however, the fact it was agreed or understood that the dividend yield would reflect a tax saving obtained as a result of the use of a tax shelter from which BNZI would obtain a direct benefit cannot be ignored. BNZI’s tax exemption arising from the use of RPS is not in issue. This case is not a case where the arrangement in question falls within a category of transaction which it is open to the taxpayer to pursue under the Act. It does not displace the application of other provisions of the Act. BNZI is fully entitled to subscribe to RPS and obtain the deduction available on them. The element of the arrangement which is in issue relates to the tax saving obtained by directing the funds through a tax shelter. This element was an integral part of the understanding between BNZI and CML and the fact that BNZI could claim a legitimate exemption on RPS does not make that understanding legitimate.
[152] The transaction was not driven by a need for CML to borrow but by BNZ to lend by way of RPS. Thus, it was BNZ which sought a party to invest in RPS. The reason it did so was its desire for a tax advantage and it entered into an agreement which would realise that tax advantage. Thus, from the outset, it was a tax-driven structure based on a rate of return made possible by sharing the tax saving with CML. Without this tax advantage the transaction would not have been commercially viable. BNZ would have had no part of it, and the monies subscribed for the RPS would have been utilised for conventional lending transactions or for other purposes.
6) The expected use of tax losses
[153] It follows from the interpretation of s 99 which I have adopted that it is not material BNZI assumed that tax losses would be utilised as the tax shelter. The effect of the arrangement is the same irrespective of any such assumption on BNZI’s part. Nor are tax losses automatically a secure tax shelter. Reflecting the view that the tax benefit of a company’s losses should be available only to the proprietors of the business which incurs the loss, the statutory exemption required that a certain minimum shareholding in the loss-making company remain constant throughout the period of loss until it is eventually offset. The exemption was intended to give effect to the reality of group profits and losses. Only those shareholders of the company which incurred the net losses were entitled to benefit from those net losses in future income years. Challenge Corporation, supra, is an example of a case where the attempted use of tax losses as a tax shelter constituted tax avoidance.
[154] Consequently, it would be an over-simplification to conclude that BNZI’s assumption tax losses would be utilised was a safe assumption that no tax avoidance would be involved. But the more telling point is that BNZI’s assumption could not vary the effect of the arrangement. Nor could it restrict the scope of the basic arrangement whereby BNZI and CML made or entered into an agreement or understanding which would ultimately permit them to share a tax saving resulting from the use of a tax shelter which was to be provided by CML.
7) The ignorance of a taxpayer in perspective
[155] I have previously stressed that s 99 is designed to promote the public interest. The main aspects of the public interest were identified. (See paras [81] to [83] above). In the absence of specific language which would indicate that to constitute an arrangement for the purposes of that section there must be a consensus or meeting of minds as to the mechanism to be used to avoid the tax, s 99 is to be interpreted in such a way as to promote the public interest, in particular, the protection of the tax base and the avoidance of an inequitable distribution of the tax burden. In this context, it should be asked why a party in BNZI’s position who is unaware of the tax shelter to be used should obtain that tax advantage when it results from an illegitimate mechanism? Not only is ignorance bliss, it would seem, but it may also be rewarded with a tax saving.
[156] A taxpayer who is aware of the steps taken to obtain a tax advantage cannot meet a charge that the arrangement falls within s 99 by claiming that he or she did not know that tax avoidance contrary to that section would be or was involved. Indeed, it is not even a defence to have a positive belief that tax avoidance is not involved. This settled law reflects the public interest aspects underlying s 99. Why, then, should a person who is unaware of the details of the tax avoidance mechanism which is used be in a better position? At the very least, he or she should not be heard to say that they are not part of that arrangement simply because they were not aware of the mechanism or details of the mechanism. Such taxpayers have in effect agreed to accept the tax advantage resulting from whatever mechanism is utilised, and ignorance of it, or its details, should not permit them to retain that advantage. In short, if an honest belief that steps known to the taxpayer do not amount to tax avoidance is no defence, why should an honest belief based on ignorance be a defence?
8) Tax avoidance facilitated
[157] Further, I believe there is force in the Commissioner’s claim that the contrary interpretation would enable promoters of tax avoidance structures to insulate their customers from the “arrangement” by ensuring that they remain ignorant of the mechanism to be used to obtain the tax advantage. With many tax shelters it would be relatively easy for the taxpayer to be “kept in the dark” as to how the tax shelter works - as was the situation with BNZI in this case. There would be very few tax avoidance schemes in which the actual transaction avoiding the tax could not be separated out from the basic agreement or understanding. (The infamous Magnum transaction provides an example). Secrecy is a common feature of tax avoidance and information imparted on a “need to know” basis is a not uncommon commercial stance. To allow taxpayers who benefit from a tax shelter to escape the reach of s 99 where they do not know all the steps or transactions being taken to achieve that benefit must necessarily impede the Commissioner’s ability to combat tax avoidance.
[158] In his separate judgment, Blanchard J suggests that this concern is exaggerated ([para [176]). He states that taxpayers are not often likely to be found to have been willing to part with large sums of money and incur the risk of an assessment and substantial penalties on the basis of a prospective tax advantage without their advisers first having gained a sufficient understanding of what is to occur so as to feel comfortable with it. I believe that the learned Judge seriously under-estimates the ingenuity of the tax avoidance industry. As the Wine Box Inquiry demonstrated, massive profits are to be made by the adoption of tax schemes and structures designed to avoid tax. Indeed, in some cases the substantial profit of a company consists in total or in large part of the net tax savings resulting from tax avoidance schemes.
[159] With the incentive profits provide, it would be naïve to conclude that schemes will not be adopted in which a party may be kept unaware of the tax avoidance mechanism to be used. Moreover, any risk facing that party in lending a large sum of money in ignorance of the details as to how the promised tax advantage is to be achieved can be eliminated or minimised by taking adequate securities or obtaining indemnities from the promoter. Finally, I also think it is ingenuous not to recognise that in the tax field parties do not always act in good faith. Bluntly stated, the paper trail which is laid may not conform to the reality of the arrangement.
9) No inhibition of commercial activity in this case
[160] Nor do I accept that to hold a party to an arrangement which is tax driven where that party is unaware of the mechanism to be used to obtain the tax saving, as in this case, would inhibit legitimate commercial activity. (See also paras [97] to [99] above). In such circumstances what kind of activity, if any, is being inhibited? The answer can only be arrangements where the taxpayer, for whatever reason, chooses not to know or does not know the full details of a tax-driven arrangement and cannot, as I have indicated, protect him or herself by taking adequate securities or obtaining indemnities from the party who is responsible for what is involved. A tax-driven arrangement entered into by a party in ignorance of the tax shelter or mechanism to be used to avoid the tax which would otherwise be payable might be thought to be the very kind of activity that s 99 is aimed at. Whatever appeal the general proposition may have that s 99 should not be interpreted in such a way as to stifle or undermine legitimate business activity, it has little or no application to cases of the present kind. Lord Templeman’s healthy scepticism may in this instance be replaced with disbelief.
[161] Further, I believe that there is merit in the Commissioner’s description of the respects in which the present arrangement differs from ordinary commercial transactions. As the Commissioner’s counsel submitted, ordinary commercial lending transactions are usually instigated as a result of a borrower’s needs and not a lender’s needs and are not motivated by the lender’s desire to obtain a tax advantage based on an understanding that the loan money will be further invested in a way which involves “tax sheltering” for its efficacy. In other words, ordinary commercial transactions seldom rely on non-incidental tax avoidance as the means of delivering the return to the lender.
10) Those who fly blind...
[162] There is yet another way in which the arrangement in this case can be analysed for the purposes of s 99. BNZI was fully aware and prepared to take advantage of the proposed tax saving, but it did not know how that saving was to be produced. It left that task to CML. In order to achieve the saving for BNZI, therefore, CML was in effect the Bank’s agent in selecting the tax shelter or mechanism which would be used.
[163] If the tax shelter or mechanism actually used amounts to tax avoidance, the taxpayer obtaining the benefit of the resulting tax saving cannot then disown the avoidance on the basis that it left the task of selecting the tax shelter or mechanism to the other party. I do not think that in such circumstances it is necessary to find that an agency relationship in contract law need exist. For the purpose of s 99 it is enough that the other party is, by an agreement or understanding, entrusted with the task of selecting and providing the tax shelter or mechanism and the first party has agreed to accept the benefit of it. In other words, taxpayers who set out to obtain a tax advantage by means of a transaction, the exact details of which they deliberately leave to the other party, are to be regarded as having entered into an arrangement to accept whatever tax shelter or mechanism is in fact utilised. Metaphorically speaking, they have agreed to fly blind and must be taken to have agreed to accept the consequences of whatever mechanism may ensue. BNZI is in this position.
[164] Support for this approach is to be found in the Canadian case of David v The Queen [1975] CTC 197, which was referred to and adopted by Baragwanath J in Withey v Commissioner of Inland Revenue (1998) 18 NZTC 13,606, at 13,609. I endorse what Walsh J said (at 208):
A taxpayer cannot, by professing ignorance and shutting his eyes to what has been done on his behalf, avoid fiscal responsibility for the consequences of what has been arranged for his advantage by an accountant or by his lawyers or by other professional advisers. Neither does it matter whether the scheme is one which has been devised by or on behalf of the taxpayer, by his advisers, or is one which has been submitted to him by the advisers of a third party with whom he is dealing at arm’s length. If he accepts the scheme and adopts it as his own, whether personally and without full knowledge or comprehension of all the details thereof, or through his advisers and agents who are better informed than he is, the scheme becomes his own when he accepts it and he is bound by the consequences thereof.
Baragwanath J accepted this statement subject to amending the first sentence to read; “A taxpayer cannot, by reason of ignorance, or failure for other reasons to understand the significance of what has been arranged on his behalf...”.
[165] I fully agree with this approach. BNZI accepted the arrangement promoted by CML without full knowledge or comprehension of the details and, in doing so, cannot now, having accepted the tax advantage flowing from it, disown the arrangement. There is no reason why the position with a promoter should be any different than it is with an adviser. It is a matter of accepting fiscal responsibility for what has been arranged for one’s tax advantage.
Conclusion
[166] I therefore commend the view that the agreement or understanding between BNZI and CML was within the scope of the arrangement for the purposes of s 99. Its effect was tax avoidance contrary to that section interpreted purposively having regard to the text, the purpose or objective of the provision, the public interest factors it was enacted to achieve and the policy of the legislature. Neither BNZI’s innocence or ignorance of the actual steps or transactions by which the tax avoidance was achieved served to place its agreement or understanding with CML outside the scope of the arrangement.
[167] To my mind, it does not matter in this case whether this finding is based on an interpretation of s 99 which excludes any notion of conscious involvement or mutuality in respect of the nature or details of the tax avoidance transactions, or on an interpretation which would require a taxpayer to ascertain the nature and details of the tax shelter to be used or accept the risk that it may involve tax avoidance. In the former case, BNZI would be within the scope of the arrangement notwithstanding the finding of the Judge at first instance. In the latter case, it is a finding of fact that BNZI did not inquire into, or know, the nature or details of the tax shelter. In neither case, therefore, is the Bank entitled to resist the Commissioner’s readjustment of its assessable income in respect of the discounted dividend resulting from the tax saving which it enjoyed. This result would not be inappropriate for an arrangement which, in substance, had no rationale other than obtaining a tax benefit.
BLANCHARD J
[168] The Commissioner’s case must fail if the Judge was correct when he found that what he called the upstream and downstream transactions were not, in their combination, a single transaction, or, as the Judge put it, that BNZ/BNZI (whom I will refer to as “the Bank”) were not party to an “arrangement” within s99 of the Income Tax Act 1976 involving the downstream transactions.
[169] The Commissioner advanced two arguments against this view. First, he said, as the Bank was admittedly seeking a tax advantage in taking up the redeemable preference shares, it took the risk that the issuer company’s ability to fund the covenanted dividends on those shares might be dependant on the downstream transactions and that those transactions might involve tax avoidance mechanisms. (For present purposes I treat those transactions as in themselves constituting a tax avoidance scheme). The Commissioner’s argument was that a taxpayer who enters into interdependent transactions which may involve tax avoidance is caught by s99 if it transpires that avoidance is in fact being practised, whether or not the taxpayer understood that this might occur. On this argument of the Commissioner, the taxpayer would be liable even if it was the taxpayer’s understanding that there would be no tax avoidance and even if that view were reasonably held by the taxpayer.
[170] The Commissioner’s alternative argument was that where a taxpayer does not know how a tax advantage will be produced but expressly chooses, or must be taken to have chosen, to authorise someone acting on behalf of the taxpayer to procure such an advantage, being indifferent to whether or not what is to occur will involve tax avoidance, that other person is the taxpayer’s agent and the agency will encompass the avoidance mechanisms. The taxpayer is thus a party to the avoidance arrangements and is caught by s99.
[171] I consider that the first of these arguments fails as a matter of law. I accept the Commissioner’s alternative formulation in principle but his appeal must fail on the particular facts of this case as they have been properly found by McGechan J.
[172] It is a fundamental pre-requisite to the use of s99 against a taxpayer that there be a contract, agreement, plan or understanding (the words the legislature chose to use in s99(1) in defining “arrangement”) in which the taxpayer is a participant. This state of affairs cannot exist for the taxpayer unless there has been formally or informally – even if unenforceably – a consensus between the taxpayer and another or others as to what, in general terms, will occur pursuant to the arrangement. The taxpayer does not have to know all the detail or be able to discern exactly how the arrangement will avoid tax by producing the illegitimate tax advantage, by which I mean an advantage which the legislature cannot have contemplated as flowing from the legislation. But the taxpayer must at least have a broad appreciation of the character of what is occurring.
[173] Hence the taxpayers in Hancock v Federal Commissioner of Taxation [1961] HCA 90; (1961) 108 CLR 258 were liable because they were found to have agreed to a plan which they knew had an effect which could otherwise have been produced only by their retaining their shares, receiving the dividends free of tax and applying most of the money in purchasing the shares of their partners after the dividends had been paid. As Kitto J said (at p291), the arrangement was, therefore, a means for avoiding the income tax which the taxpayers would have been liable to pay if they had achieved the same results without an arrangement.
[174] And in Federal Commissioner of Taxation v Gregrhon Investments Pty Ltd (1987) 87 ATC 4,988, a case much relied upon by counsel for the Commissioner, though the taxpayers themselves may have professed ignorance of the scheme, the Court plainly considered that their accountant and bank manager were aware that the structuring of the deal was done for tax reasons. As in Hancock, there was no way, other than a tax avoidance arrangement, whereby the advantage sought could be achieved. The remarks of Fisher J (at p4996), highlighted by counsel for the Commissioner, concerning the significance, viewed objectively, of the purpose and effect of an arrangement and the undesirability of allowing a taxpayer to point to and rely upon naivety, ignorance and calculated abstention from knowledge, do not in my view take the matter any further. Indeed Fisher J immediately referred to circumstances which should have alerted the taxpayers and their accountant, a tax specialist, to a scheme of tax avoidance.
[175] As the principal judgment records at para [42], there are three successive inquiries. The first is as to the extent of the arrangement; the second is as to whether it has the purpose or effect of tax avoidance and the third, which arises only where the second is answered affirmatively, is as to the adjustment to be made to counteract the tax advantage. The adjustment can be made against both a party to the arrangement and a person affected, who is not necessarily a party. But it can be made only where a tax advantage has been obtained “under that arrangement”. The Commissioner therefore cannot make an adjustment as against someone who is not a party merely because that person has received a payment subsequent to the operation of an arrangement but outside the arrangement. BNZI received payments funded by means of the tax advantage obtained by the Cook Island entities under the downstream avoidance arrangement, but the dividends paid to it were not obtained under that arrangement.
[176] It is said for the Commissioner that unless his first argument is accepted the promoters of tax structures will be able to insulate their customers from allegations of participation in tax avoidance by ensuring that they remain in ignorance of the mechanism whereby a tax advantage is delivered. That concern, if it were realistic, is not I think a reason for departing from the language of s99, which defines an arrangement in terms of a meeting of minds. But in any event I consider that the concern is exaggerated. Taxpayers are not often likely to be found to have been willing to part with large sums of money and to incur the risk of an assessment and substantial penalties on the basis of a prospective tax advantage without their advisers first having gained a sufficient understanding of what is to occur so as to feel comfortable with it. Professions of ignorance about the existence of tax avoidance are likely to be treated with the same scepticism as in the Australian cases just mentioned, especially where what occurs has no business, professional or family purpose of the taxpayer or the final position could not have been achieved by any legitimate means. The taxpayer carries the burden of proof. It will be for the taxpayer to prove that it genuinely and reasonably had an understanding that the person or persons with whom it was dealing did not intend to practice tax avoidance from which the taxpayer would directly or indirectly benefit.
[177] Furthermore, there is an additional protection for the Revenue. The party which undertakes the formation of the scheme may itself attract a liability for taxation, as it appears that certain of the Cook Island entities did in the present case, where the Commissioner missed his opportunity of assessing them.
[178] The Judge has found that the Bank satisfied him on the evidence that it had no knowledge of what was occurring in the downstream transactions. My survey of the relevant evidence does not persuade me that he was wrong. It was open to him to conclude that the Bank believed that Capital Markets Ltd would fund its special purpose company to the extent necessary to pay the dividends on the redeemable preference shares by reducing its own taxation (on a group basis) by legitimate utilisation of tax losses. Because of the provision of prime securities and the Bank’s general confidence in the integrity of the Fay Richwhite group, which is to be judged in the light of the Bank’s knowledge at the time and not on the basis of information which has subsequently become known, the Bank was content to proceed on the basis of limited information. It made no stipulation concerning what use was to be made of its share subscriptions because it held a put option from Capital Markets Ltd, which was the economic equivalent of a guarantee, and in the event of default it had an entirely satisfactory means of resort to the securities. It came to know, after the first transaction, where the money was finally placed, but the Judge was well entitled to hold that such knowledge and an awareness of some form of involvement of an associated bank in the Cook Islands (European Pacific) was not sufficient to alert the Bank to the presence of an illegitimate tax scheme when it was considering subsequent transactions.
[179] The tax advantage which the Bank sought from the redeemable preference shares appeared to be achievable legitimately. Redeemable preference share transactions, structured as this one was in the upstream transaction, were relatively common-place. So far as the Bank was concerned, the structure consisted of and went no further than the subscription for the preference shares, the put option and the securities. (The securities were part of the upstream transaction, being provided at the same time as the share subscription moneys were paid.) It is not suggested for the Commissioner that such an arrangement, of which there were many in the market place at the relevant time, in itself could constitute a tax avoidance arrangement within s99. The transaction merely sought to take legitimate advantage of the provision by virtue of which tax was not assessable in the hands of a company on dividends received from another company. There was nothing unusual in the use of a special purpose company and the provision of a put option. The former was necessary to insulate the supplier of funding from the business risks of Capital Markets Ltd; the latter was required to avoid falling foul of s62 of the Companies Act 1955. The giving of a tax indemnity for each transaction was a sensible and normal precaution in view of the uncertainty for the time being created by the Commissioner’s stated view, which he later changed, that redeemable preference share dividends were liable for tax in the hands of a recipient company. The Bank was aware that Capital Markets would take the position that what it might choose to do with the money was not to be dictated by the Bank and was a commercial secret. When Mr Turley made his informal inquiry of Mr Tompkins he got exactly that kind of response. Reasonably enough, I consider, secrecy in this context was not taken as indicative of the existence of an illegitimate scheme. The Bank has discharged the burden of showing that it did not believe that there would be any tax avoidance and that it had good reason to so believe.
[180] By the same token, there is no proper basis for the suggestion by the Commissioner, in his alternative argument, that the Bank engaged the Fay Richwhite group as its agent to construct a scheme consisting of the whole of the upstream and downstream transactions, with the Bank being indifferent to whether tax avoidance was involved and being prepared to accept the advantages if it was. The Bank gave no authority to Capital Markets Ltd to formulate any downstream transactions on its behalf. Certainly it made no inquiry about what steps might come between its own subscription for shares in each special purpose company and the placement of the money at its final destination but, as I have mentioned, it had an acceptable reason for taking that attitude.
[181] In the recent decision of the Privy Council in Commissioner of Inland Revenue v Auckland Harbour Board (24 January 2001, No 30 of 2000), delivered by Lord Hoffman, the Board remarked that some of the work of a provision like s99 has now been taken over by “the more realistic approach to the construction of taxing acts exemplified by WT Ramsay Ltd v Inland Revenue Commissioner [1981] UKHL 1; [1982] AC 300 although their Lordships should not be taken as casting any doubt upon the usefulness of such tax avoidance provisions as a long stop for the revenue”. [Emphasis added].
[182] In view of this dictum, which, it should be noted, appears to be in conflict with views expressed by the High Court of Australia (John v Federal Commissioner of Taxation [1989] HCA 5; (1989) 166 CLR 417) and the Supreme Court of Canada (Stubart Investments Ltd v The Queen (1984) 10 DLR (4th) 1), I have considered the possible application to the present case of the fiscal nullity doctrine, although the Commissioner has very understandably not sought to rely upon it. As the Board says, it is a method of construction. It is quickly apparent, however, that the approach taken in the fiscal nullity cases would not have been of assistance to the Commissioner on the present facts. The doctrine has been applied in the United Kingdom where a series of transactions is preordained or composite so that they constitute a single and indivisible whole or a “unitary arrangement” as it is called in O’Neil v Commissioner of Inland Revenue (Privy Council, 10 April 2001, No 40 of 2000). It proceeds on the basis that the legislature intended tax to be imposed by reference to the business substance of the composite of the transactions. Accordingly, artificial steps inserted for a tax purpose and having no commercial purpose are disregarded in applying particular taxing provisions (Macniven (Inspector of Taxes) v Westmoreland Investments Ltd [2001] 2 WLR 377). But, as Lord Keith of Kinkel said in Inland Revenue Commissioners v Fitzwilliam [1993] 1 WLR 1189,1204, it must from a construction point of view be possible realistically and intellectually to treat a series of transactions as one composite whole. That cannot be done in the present case, for the reasons I have given in relation to s99. Even if it could, there might be a difficulty in applying the doctrine so as to enable the dividend income received by the Bank to be taxed in its hands.
[183] I agree that the appeal should be dismissed.
Solicitors
Crown Law Office, Wellington, for
appellant
Rudd Watts & Stone, Wellington, for respondent
NZLII:
Copyright Policy
|
Disclaimers
|
Privacy Policy
|
Feedback
URL: http://www.nzlii.org/nz/cases/NZCA/2001/184.html