HC Services Limited v Commissioner of Inland Revenue [2014] NZHC 1169 (29 May 2014)

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[1] The appellant appeals against the decision of the Taxation Review Authority (the Authority) (Judge P F Barber), delivered on 6 November 2013 and the earlier threshold ruling delivered on 11 September 2012.¹

[2] By these decisions, the appellant (called a disputant before the Authority) has been found to have entered into a tax avoidance arrangement.²As a result, the disputant company has been found to have had an abusive tax position, being in an unacceptable tax position which, “viewed objectively”, the taxpayer takes in respect of or as a consequence of an arrangement which was entered into with a dominant purpose of avoiding tax.³

[3] As a consequence of these findings, the partners of the accounting firm, of which the disputant is the limited liability corporate body, are now vulnerable to being identified as promoters of tax avoidance and subject to personal penalties.

[4] In this appeal the appellant argues that it was not party to a tax avoidance arrangement because the first requirement of any tax avoidance arrangement is that there must be an arrangement which directly or indirectly alters the incidence of any income tax.⁴Mr Chemaly argues:

(a) That there were in law and fact no obligations or arrangements entered into in the history of this matter so that there was no foundation in fact for the applications and the provisions of the taxing statutes. Rather, his client was a victim of fraud.

(b) That the fraudsters never put arrangements into place. Rather, they persuaded the appellant to part with money on the understanding that

⁴Ben Nevis Forestry Ventures Ltd v CIR [2008] NZSC 115; [2009] 2 NZLR 289 at [105].

there was going to be a welfare fund for the benefit of employees of the appellant and that the appellant was contributing $100,000 per annum to fund that fund.

(1) An employer is allowed a deduction for an amount that they pay to, or set aside as, a fund to provide individual personal benefits to their employees if -

(b) the employees’ rights to receive benefits from the fund are fully secured.

[6] As a supporting argument to fraud, Mr Chemaly argues that because there was no arrangement, there was nothing to reconstruct. Section BG1 of the Income Tax Act 2004 provides:

(1) A tax avoidance arrangement is void as against the commissioner for income tax purposes.

(2) Under Part G (Avoidance and non-market transactions), the Commissioner may counteract a tax advantage that a person has obtained from or under a tax avoidance arrangement.

[7] The Commissioner submits that there was such an arrangement verified by numerous documents discovered in a joint investigation by the Commissioner in New Zealand and the Australian Tax Office into a number of companies being administered by Avowal Administrative Attorneys Limited, operated by Mr Petroulias. The Commissioner concedes that not all the documents have been

recovered but there is sufficient material to meet any burden of proof that there was an arrangement, that it had the predominant purpose of tax avoidance, and that the appellant was a party to it. Furthermore, whether or not a direct party, the Commissioner submits that the appellant obtained advantage from it. In broad terms, the Commissioner said that, in return for taking out a loan from an off-shore bank in the sum of $100,000 which was treated as being applied as the annual contribution to the fund, the appellant obtained a substantial tax advantage in each year.

[8] As to penalties, the second step in the appellant’s argument before this Court was that if it was not a party to nor obtained advantage from a tax avoidance arrangement, it had not taken a tax abusive position for the purposes of s

141D(7)(b)(i) of the Tax Administration Act 1994. At worst, the appellant can only fall under subpara (ii) of the same section.

[9] In such an event, while the appellant will be subject to penalties as fixed by the Commissioner and confirmed by the Authority, the chartered accountants behind the appellant will not be exposed to the risk of being found promoters of an arrangement with the dominant purpose of avoiding tax. So by either or both of these two arguments, the appellant seeks a reversal of the judgment of the Authority.

[10] Overarching both arguments as to liability and penalty, Mr Chemaly contended that the true characterisation of events is that HC Services Limited, and particularly its director Mr Harding, were the victims of a fraud. In that regard, the Authority had found so. Mr Chemaly relied on the following passages in the Authority’s second substantive judgment:

[38] I agree with Mrs Courtney that, based on the following facts, I should find that the disputant had in mind something other than providing individual personal benefits when engaging in the transactions that are in issue, namely:

[a] Mr H accepted that there were other ways of providing benefits to employees that would have been more effective in keeping them, e.g. paying them more;

[c] The difference between the usual scenario in business of paying out an amount, as a result of which the disputant suffers an economic loss, and claiming a deduction for that;

[e] The nature of the transactions undertaken; the lack of documentation; and the vagueness about the scope of what was covered;

[f] As a professional person (an accountant, shareholder and director), a high standard of behaviour is expected of Mr H, and there were sufficient indicators that the scheme was not genuine, including the use of multiple jurisdictions, entitles using different names, and spelling errors in documents that should have raised warning signals.

[123] ... At this stage, I have no reason to disbelieve Mr H’s evidence and description of the fraud which I have outlined above; but it does not alter any outcome as I explained in my decision of 11 September

[125] Frankly, it is sad to see a top accountancy firm, and apparently a number of other accounting firms duped and misled into losing funds when intending to provide for their staff. However the law must be meticulously observed by taxpayers seeking deductions and in this case, the law was not so observed.

[11] The findings at [38] of the judgment, as set out above, apply to the disputant, not to the promoters of the arrangement. The tax avoidance arrangement was purporting to take advantage of s DF2 of the Income Tax Act 1994 and s DC5 of the Income Tax Act 2004. These allowed employers’ deductions for payments into employee welfare funds, but provided that those funds fully secure the rights of the employees to receive benefits. Judge Barber had earlier reasoned:

[12] The brief of evidence of Mr H states that the EEF was intended to be for the benefit of all employees. The evidence shows that, whatever the disputant intended, no fund has been set aside for the benefit of the disputant’s employees. Even if it had been, the risks that were identified as

[13] The Indemnity Fund (HIF), as structured, could never have complied with the ingredients required for the disputant to be entitled to the deductions claimed for contributions under s DF2 Income Act 1994 (ITA 1994)/s DC5

Income Tax Act 2004 (ITA 2004), because contributions to the HIF were not set aside or paid to provide individual personal benefits to employees of the

disputant; and the HIF was not established in a way that fully secures the rights of employees to receive the benefits.

[14] For a deduction to be allowed under s DC5, the following requirements must be satisfied:

[a] There must be an amount that an employer has paid to, or set aside, as a fund;

[c] The amount paid to, or set aside, must be to provide individual personal benefits to employees;

[15] Even if it were to be accepted that the first two requirements were satisfied in this dispute, the third and fourth requirements were not. That is because the funds were not set aside or paid to provide individual personal benefits to employees of the disputant; and the fund was not established in a way that fully secures the rights of employees to receive the benefits.

[16] Funds were not paid or set aside to provide “individual personal benefits” to employees.

[12] I agree with Judge Barber’s reasoning. It was not challenged in oral argument. No fund deed was ever found. The promotional documents have many indications that it would function principally as an insurance policy in the event the employer was not able to meet employment related costs, e.g. “litigation settlements in relation to employee rights”. All ABN Union Bank loans (to the taxpayer) to fund the fund had to be repaid before the fund would pay out to employees. Given that all the funding here was by the disputant entering into loans with ABN Union Bank, this was a significant deterent to making a claim on the fund. Most pertinently, however, there is no evidence that there was any intention, let alone provision, to “fully

secure” employees’ rights to receive benefits from the fund.⁵Not surprisingly, therefore, Mr Chemaly did not pursue orally any argument to the contrary.

[13] The second passage, part of [123], which is relied upon as a finding of fraud by Mr Chemaly, does apply to the promoters. It is the concluding paragraph of a section headed “Section DB33 – Fraud Allegations”. Section DB33 of the Income Tax Act 2004 provides:

(b) an employee of the business, or a person who provides services to the business, misappropriates property; and

(c) no other provision of this Act allows the person who carries on the business a deduction for the loss resulting from the misappropriation.

(a) the person who misappropriates the property is a relative of the person who carries on the business; or

(i) the company and the person who misappropriates the property are associated persons; or

(ii) the company and a relative of the person who misappropriates the property are associated persons; or

(c) the person who carries on the business is a trustee of a trust, and the person who misappropriates the property either created the trust, settled property on the trust, or is a beneficiary of the trust.

(3) The person is allowed a deduction for the loss that they incur in the course of the business as a result of the misappropriation of the property.

(4) The deduction is allocated to the income year in which the loss is ascertained, or in 1 or more earlier years if, in the circumstances, the Commissioner considers it would be fair.

(5) This section supplements the general permission and overrides the capital limitation. The other general limitations still apply.

Defined in this Act: associated person, business, capital limitation, Commissioner, company, deduction, employee, general limitation, general permission, income year, relative, supplement, trustee

[119] The disputant claims that this arrangement was a fraud on it by the promoters. However, any allegations of fraud on the disputant by a third party are irrelevant to whether or not the deductions were allowable under the black letter law provisions or whether s.BG1 applies (as confirmed by me in the said threshold decision herein).

[120] In any event, the reasons for the disputant stating this was a fraud also support a finding of tax avoidance; e.g. the HIF involved an artificial, circular and contrived arrangement designed to enable the generation of tax deductions, not to generate an employee benefit fund. The disputant got what it paid for as the fees were paid for the “turn-key” package to enable large deductions of tax.

[121] The disputant has suggested the arrangement was a fraud on it in the amount of $24,000 in fees over three years. Yet Mr H gave evidence that the promoters never removed the $90,000 in cash sitting in the HIF Ltd bank account in respect of the 2006 year, and he later stated that amount has now been used to pay for a unit on Magnetic Island, Australia, which he personally has stayed in on a couple of occasions.

[122] With regard to the application of s DB33, the disputant has asserted that the Commissioner denied the deductions because “it does not know if there was a fraud”. As indicated above, the Commissioner denies this allegation and states that proof of fraud by the promoters on the disputant is not required (or sufficient) to meet the elements of s DB33 of the ITA 2004. I agree. The Commissioner denied these deductions because, in her then view, the disputant was unable on the balance of probabilities to meet the ingredients required to prove the fraud, namely:

[a] Identify the party alleged to have misappropriated property from the disputant;

[c] Prove that the loss was from a misappropriation of property by a person rendering services to the disputant for the purposes of the disputant’s business.

[123] In my said threshold ruling of 11 September 2012, I concluded that, even if a fraud had occurred, that does not preclude the application of the anti-avoidance provision. As the Commissioner contends, I am required to determine whether the assessments were correct. At this stage, I have no reason to disbelieve Mr H’s evidence and description of the fraud which I have outlined above; but it does not alter any outcome as I explained in my said decision of 11 September 2012 and above

[14] I am satisfied that Judge Barber did accept, on the balance of probabilities, the description of the fraud on the part of the promoters, in as much as the promoters did not deliver an employee benefit fund as promised. There was a variety of evidence and related findings of fact confirming the same: that the welfare fund or

[15] But this finding is not that no transactions took place. Nor that the fraud on the part of the promoters was present from the outset.

[16] It is apparent from Judge Barber’s reasoning that he saw the tax avoidance arrangement involving artificial circular and contrived but, nonetheless, real transactions; consistent, however, with fraud in the course of the performance of that arrangement by the promoters failing to set up a compliant fund. I will return to this proposition.

[17] This paragraph came at the end of the Authority’s judgment and is not readily referable to particular findings of fact. In argument before this Court, Mr Chemaly disputed the existence of the bank, ABN Union Bank of Latvia (ABN), and the insurance company, Standard Charter Insurance Limited (SCI).

[18] Clearly both names are misleading. ABN invites an inference that the bank concerned was part of the famous and part of the well known and substantial Dutch bank, ABN Ambros. Standard Charter Insurance invites an inference that this is

_{connected with the international bank based in the UK, Standard Charter.
This was}

not the case. These were obscure entities with impressive names operating out of virtual offices. But they were corporate entities.

[19] A senior New Zealand IRD officer went to Latvia when investigating ABN Union Bank of Latvia, and traced the registered office to a hotel in Riga, where a receptionist in the business centre told the investigator that the business centre offered mailboxes to clients and would forward mail on as requested. This presents to the court as akin to the provision of virtual offices, a phenomenon now available internationally. It enables off-the-shelf corporate entities to present to the world as being established with receptionist facilities, a real address, etc. This ABN Union Bank, with at least two entities, presented itself in its own literature as being a boutique international bank offering you “the very best and structured financial solutions with the privacy of a boutique international bank”. This is but one instance. All the entities operated using virtual offices.

[20] I have not been persuaded that the Authority erred in his findings in [123] and [125], of fraud on the part of the promoters of this scheme. Judge Barber, as trial judge, was in the best position to decide whether or not Mr Harding was duped, and otherwise a victim of fraud. And he did so.

[21] That brings us to the critical argument advanced by Mr Chemaly in this Court, that this fraud on the part of the promoters precludes application of the avoidance provisions.

[22] In the Authority’s threshold decision of 11 September 2012, the Authority held that fraud on the taxpayer did not preclude the tax avoidance provisions of the Income Tax Act and previous legislation to applying to a fraudulent arrangement.

[23] As discussed above, there was no real challenge that on black letter law basis the EEF arrangement did not comply with the statutory provisions of s DC5 of the Income Tax Act, that benefits be secured to employees before they become deductible. Therefore the arrangement was not tax effective, and so it was an

avoidance arrangement, as it sought to justify deductions from income tax which were not in law deductable.

[24] The principal argument was that because of the findings of fraud, there were no valid transactions and therefore there can be no tax avoidance arrangement.

Means an agreement, contract, plan or understanding (whether enforceable or unenforceable), including all steps or transactions by which carried into effect.

He relied on both the recent decision of the Court of Appeal in Russell v CIR⁷and the dissenting judgment of Thomas J in CIR v BNZ Investments⁸(BNZI) to the effect that it is not necessary for the taxpayer to be part of any consensus or meeting of minds. In the BNZI case, the bank had argued successfully that because it thought

that the structure would be effective, probably because the promoters could use available tax losses, and because the bank did not know how this was done, the bank was not party to the arrangement. The argument in this case is not dissimilar.

The test is objective and there are a number of features of the arrangement and aspects of the evidence, from which I may infer the arrangement has a clear purpose or effect of tax avoidance.

[133] Any fraud on the disputant by a third party is not relevant to the application of s.BG 1 by the Commissioner to void a tax avoidance arrangement. The Commissioner must satisfy himself that there is a tax avoidance arrangement and once so satisfied, that arrangement is void as against the Commissioner. The Commissioner will then adjust the income of those persons affected by that agreement.

[134] The fact that the disputant may have been defrauded and claimed tax deductions as a consequence of a tax avoidance arrangement, does not alter the fact that the arrangement existed, that the purpose of that arrangement

was to avoid tax, and that the disputant obtained tax advantages under that arrangement.

[135] Actions of a third party on the disputant cannot work to prevent the Commissioner from carrying out his duties and responsibilities under the Inland Revenue Acts, in particular to protect the tax base. If the disputant has been defrauded by a third party, the disputant has legal remedies available to it to pursue those third parties. That does not affect the Commissioner’s ability to adjust the income of taxpayers who are affected by a tax avoidance arrangement.

[136] The disputant’s contention that, unless a transaction is genuine, no taxing provision is “triggered”, so no tax advantage could ever have arisen, is incorrect. The disputant claimed deductions. Its position is starkly illustrated in respect of its claimed deduction for contributions in the 2006 income year. The “contributions” money was placed on deposit in a bank account which the disputant set up and it has remained there ever since. Yet, the disputant claimed a deduction, and has thereby obtained a tax advantage for six years.

[28] Mr Chemaly stated the position of the appellant on appeal “in its simplest form”, as follows:

● Under New Zealand tax law, tax consequences generally follow the form of the legal arrangements (legal transactions) entered into by a taxpayer, (i.e. an arrangement that has legally enforceable terms);

● As fraudulent arrangements have no tax consequences, the appellant could never have obtained a deduction as no expense was incurred, and as a consequence no tax advantage can arise, and therefore there can be no tax avoidance arrangement.

● In any event, even if there was a tax avoidance arrangement, as there was no

● Consequently the deductions under s DC 5 could never be justified and so if a shortfall penalty is required to be assessed, (which is not conceded), an unacceptable interpretation shortfall penalty should follow, as there was never any chance that such deductions could ever be successfully allowed;

● However as a consequence of the fraud, the appellant paid out money as a result of the fraud, (‘entrance and audit insurance fees’ and ‘interest’), and is entitled to deductions for these losses under s DJ 8 of the Income Tax Act

[29] I agree with the reasoning of Judge Barber set out above. But that reasoning does not address an argument put before this Court, that the effect of fraud in an arrangement has the same vitiating effect as a sham.

Fraud, it is submitted, can be treated for tax purposes as being like a sham, but with one guilty party and one innocent party, not two guilty parties. In each case the legal arrangements entered into (if any) are not reflected in what are suggested to be the legal contractual arrangements.

[31] In support of this argument, Mr Chemaly relied upon the Supreme Court decision in Ben Nevis Forestry Ventures Ltd v CIR¹⁰and, in particular, on this following passage:

[33] There is no need for us to engage in any extended discussion of what constitutes a sham for present purposes. In essence, a sham is a pretence. It is possible to derive the following propositions from the leading authorities. A document will be a sham when it does not evidence the true common intention of the parties. They either intend to create different rights and obligations from those evidenced by the document or they do not intend to create any rights or obligations, whether of the kind evidenced by the document or at all. A document which originally records the true common intention of the parties may become a sham if the parties later agree to change their arrangement but leave the original document standing and continue to represent it as an accurate reflection of their arrangement. A sham in the taxation context is designed to lead the taxation authorities to view the documentation as representing what the parties have agreed when it does not record their true agreement. The purpose is to obtain a more favourable taxation outcome than that which would have eventuated if documents reflecting the true nature of the parties’ transaction had been submitted to the Revenue authorities.

Clearly the Court was simply restating the position that fraudulent contracts do not create tax consequences, as in essence any deduction based on a fraudulent expense would be a fictitious deduction. The Court at paragraph

[35] rejected the sham argument because the arrangements were intended to create “legal rights and obligations of the kind purportedly created”.

[33] This last submission misunderstands [33] of Ben Nevis and the law of fraud. For a document to be a sham it is a necessary precondition that that be the true common intention of the parties. This proposition is long settled common law, and was being followed in Snook v London and West Riding Investments Ltd.¹¹. The Court of Appeal in Snook relied upon Yorkshire Railway Wagon Company v Maclure.¹²This was a case where the argument that a sale of railway stock was not real, was void. In that case, a railway company in serious difficulties did not have the power to borrow. So it entered into the sale of some of its rolling stock to the Wagon Company with the ability to buy back the stock for a pound. Effectively, that transaction operated as a loan. Jessel MR said:¹³

But even if the Wagon Company knew it was a loan you must show that the railway company understood it was a loan, in order to set aside the deed, that is to treat it as a nullity, you must show that the Railways Company were parties to the understanding. You cannot leave a bargain on one side, and if the Railway Company only sealed this document because it carried out their intention, you cannot say it is not a real contract between the parties.

[34] To explain, the Judge had found that the Railway Company’s advisers had convinced themselves this was a valid sale of stock, not a loan. Ironically the Wagon Company understood it as a loan. But the essential point is the need for a common intention that the contract is a sham, otherwise it is real. That is how the judgment

[35] It is an ancient maxim of the common law, reinvigorated by Lord Denning in Moir v Wallersteiner¹⁵that fraud unravels all. The very proposition contains within it the prior proposition that a fraud can nonetheless transfer property rights or create obligations or benefits. The presence of fraud by a party to a transaction enables the innocent counterparty to apply to have the transaction declared void.¹⁶But until that

_{happens, the transaction is valid. To recover remedies for fraud, the
victim has to}

¹¹_{Snook v London and West Riding Investments Ltd
[1967] 1 All ER 518; [1967] 2 QB 786.}

commence a cause of action based on fraud. A car might be sold by the vendor fraudulently, but the innocent buyer obtains title.¹⁷

[36] There is good reason for this basic organisation of the legal system. It is vital in a private market economy that property can be traded free of the need to inquire first whether the counterparty is engaged in fraud. When the fraud emerges, it is up to the innocent party to take advantage of any cause of action that might assist. In that way, goods can be bought and sold and the transaction not tainted by an intervening fraud in the chain of transactions.

[37] So the fact that one of the principals behind this tax arrangement may have intended at some point, either from the outset or during the transactions, to defraud the taxpayer, does not mean that there were no rights and obligations created by the transactions, that they were not real.

[38] The overarching submission of the appellant is that this is not an arrangement because it did not amount to any real transaction which directly or indirectly altered the incidence of tax.¹⁸In part, this is alleged to be so because of fraud. I have discussed that point. A subsidiary argument was that the transactions were not real because the parties to the transaction were paper companies - one masquerading as a bank, another as an insurance company - having virtual offices or false addresses and there appeared to be no money moving in the arrangement, and only impressive looking insurance policies etc.

[39] Helpfully the parties have reached an agreed statement of facts which, for this exercise, I summarise.

[40] The disputant appellant’s business activity was accounting services. In 2004 it had 11 employees and by 2006 it had 17 employees. In three income years, 2004 to 2006, it participated in plans or funds which it variously described as: an

_{Employee Entitlement Fund; an Entitlement Safeguard Indemnity Assurance
Plan;}

an Employee Indemnity Plan/Fund; a Pension, Loyalty, Rewards and Welfare Plan; and an Employee Safeguard Plan. The funds purported to constitute an employee indemnity fund for the benefit of the disputant’s employees, as provided for in s DC5 of the ITA 04. For convenience, this arrangement is called the EEF arrangement in this judgment, as it was called in the TRA decision.

[41] After initial development overseas, the EEF arrangement was licensed to an Australian company (MCI) and redrafted to suit New Zealand employment conditions, on the instructions of a Wyoming corporation. The developer overseas, a Mr MP, was convicted of corruption in 2008 for offences committed in Australia. The beneficial owners of MCI were unknown. But representatives of MCI contacted accountants and tax agents and conducted seminars throughout New Zealand to market their products and a number of accountants and tax agents signed up as associate members and also to have access to these products, including this EEF arrangement.

[42] For example, on 20 September 2004, Standard Insurance wrote to Auspac Corporate Management Limited, the attorney of Mr Harding for the disputant, enclosing three documents:

The life policy has the seal of Standard Capital Insurance Limited affixed and signed by its duly authorised agent and attorney. The schedule has the policy number and name, Maurice Harding, as the insured and records the premium of $100,000 NZD, and promises a “minimum guaranteed income” of 3.5 per cent. The “target period is described as a “minimum of 10 years”. The bond statement has two entries. The first, on 1 April 2004, describes unit value as $100,000 and zero interest. The second, on 30 June 2004, has unit value of $100,000, interest of $872, and balance of

$100,872. Such documents record entitlements. A policyholder gets the entitlements entered, whether or not the insurance company is profitable or not.

[43] Attached to this judgment are two annexures. The first is headed “Steps in the Arrangement”. The second is a schematic presentation of the arrangement. Both were prepared for the Commissioner, relying on the discovered documents to explain the scheme. There\\ reader will find it helpful to read these annexures at this point.

[44] In its most basic form, the subject transaction was intended to take advantage of the deductability of payments made by employers to benefit funds for their employees. The set of transactions was sold as a package deal whereby an employer could borrow funds to make such payments into a properly constructed benefit fund which complied with the relevant statutory provisions. In its most basic form, the EEF structure contained the following steps:

(a) Step 1: a loan was obtained by Mr Harding or De Roit from an entity called ABN Union Bank of Latvia (ABN);

(c) Step 3: the appellant then transferred the accounts purportedly obtained to setle the promissory notes previously issued as the appellant’s contribution to the benefit fund manager, named Auspac Corporate Management Pty Limited;

(d) Step 4: the fund invested the contributions into a large fund which in turn invested in a capital guaranteed investment bond with Standard Capital Insurance Limited (SCI) generating a 3.5 per cent interest rate that was to be capitalised to the benefit fund. The interest was stated not to be payable to the taxpayer until the senior expiry date of the bond.

[45] To implement the structure, the taxpayer completed an application form and a power of attorney. The attorney was appointed to make such financial undertakings and incur such liabilities to effect the plan. A fee was paid to the promoter. Once the power of attorney had been granted, a promissory note was issued in favour of the

fund-management company for the amount of contribution and in consideration of it setting up the fund. At this point a liability was considered to have occurred and, on this basis, a tax deduction in respect of the contribution was claimed.

[46] For the first two years the promissory note requirement was satisfied by raising a loan with ABN. An application was made using the power of attorney to that entity for a loan of the amount of the contribution to satisfy the promissory note. Then by a series of book entries, not seen by the taxpayer, the loan funds were advanced by the borrower to the employer company, being a participant in the EEF arrangement, onto the fund manager and then to SCI, for the purchase of a capital guaranteed 10-year investment linking life policy or fund or bond.

[47] In addition to the amount of contribution, further tax deductions were claimed for the administration/establishment or professional fee for any loan repayment/auditor insurance, plus interest on the ABN loan. The fund was under the name of the S Foundation (S). S had the sole responsibility for the management and administration of the fund and its assets. S appointed an Australian company, AC Management Pty Limited, which managed an exclusive fund for all New Zealand employer participants. The same company applied for a product ruling from the Commissioner of Inland Revenue in November 2004, and again in July 2005, largely identical to this arrangement.

[48] Participants in this arrangement paid a fee for entering into this arrangement and an ongoing management fee.

[49] The appellant disputant made a $100,000 contribution in 2004 and 2005, each one by way of loan obtained from ABN. In 2006 the appellant disputant opened a bank account in the name of HIFNZ Limited and deposited either $90,000 or

$100,000 into it. These funds were never released to AC Management Pty Limited, as it never made a call on the funds.

[50] During this period the appellant disputant paid professional and administration fees and interest and audit insurance and deducted the same so that

the total deductions claimed for each year were as follows: $109,000, $117,025 and

[51] The picture that emerges is that contemporaneously during the years of the operations of MCI, numerous book entries were prepared, many of which would not be seen by purchasers of the product. The fact that such documents were created is consistent with producers of a product being, to a significant degree, convinced of the efficacy of the arrangement, that it was a set of genuine transactions, and of the need to carefully document the transactions in order to withstand scrutiny of the transactions by a government tax agency. The fact that the entities had impressive names, suggesting they were main street banks, insurance companies, or managers, does not mean that the entities were not legal persons with the capacity to be parties to transactions. But the names operated to dupe taxpayers to have confidence in the efficacy of the arrangement.

[52] It is quite possible that the arrangement was sold and put into some degree of effect without the promoters and vendors of the arrangement having figured out how to bring it to an end. It is a characteristic of most taxation arrangements that money is not put at risk in any commercial sense. Any funds involved usually go around in circles. Another way of putting it is that parties enter transactions and incur liabilities, which are offset or cancelled by later transactions. The technical challenge can be to close the circle with cancelling transactions with ABN, as banker to both the taxpayer and to SCI, offsets by commercial paper can readily be arranged.

[53] It is quite normal for taxpayers buying into such schemes not to be told how they work in any detail, on the basis that this knowledge is of proprietary value. For example, Mr Chemaly said that Mr Harding, the director, did not know when the appellant disputant would have to repay the loans from ABN. It would appear the loan was indefinite, the catch being it had to be repaid before any claim on the scheme could be made.In any normal borrowing, the borrower always knows the repayment obligations in detail. But in a tax avoidance scheme, it is quite possible they do not.

[54] ABN advised Global Administration, agent for Mr Harding, that the request for loan, proceeds, satisfaction of promissory note liability, and payment into the larger fund – were all “completed ... by creating internal accounts recording the fund movement”.¹⁹

[55] The Authority found as a fatal characteristic of this scheme: that there were no rules drawn up for the benefit of the employees, so that the scheme did not meet the requirements of s DC5, as it did not “secure any benefits” to specific employees. That may have been deliberate. For example, it is possible that there was an erroneous judgment by the promoters that it was sufficient for all employees of the disputant to be discretionary beneficiaries.

[56] One has considerable doubt as to whether in any real sense any money existed here at all. The contribution by the disputant taxpayer of $100,000 a year was by way of taking a loan from an essentially unknown “bank”. The “Bank” did not need to have any assets to lend, if the “loan” was to be offset directly by matching transactions. This was likely given the advice recorded above.²⁰

[57] Those proceeds were meant to create a fund, the employer welfare fund, the contents of which the taxpayer never saw and was likely never intended to see. The evidence shows, said counsel for the Commissioner, that whatever the appellant intended, no fund was set aside.

[58] As discussed, the fund did not, in any event, have any promised benefits to any particular beneficiaries. Just who of the employees of the disputant’s firm were going to get benefits from that fund would be decided in the future.

[59] The UK, Australian and New Zealand tax avoidance provisions have a common provenance. The courts have accumulated a vast experience of such tax avoidance schemes, and appreciate their typical characteristics, in a way which may

_{not be familiar to individual taxpayers participating in one for the
first time. Part of}

this understanding is that there is no need for cash to be used if documents of obligation are created.

[60] I am satisfied from the presentation by Mrs Courtney, for the Commissioner, replicated in the findings of Judge Barber, that the transactions were intended to be real, at least by the disputant taxpayer, and probably the promoters. There was no collective agreement that they be shams. On the contrary, the promoters of the schemes probably believed they were both real and effective. I have not been persuaded that Judge Barber was wrong.

[61] The documents obtained by the tax authorities reflect a state of mind typical of these arrangements. As explained by Donaldson LJ in Elbeck v Rawling:²¹

There is no suggestion that transactions with which we have been concerned were shams. Of course, it is common ground that collectively they constituted a tax avoidance scheme. Indeed, they may reasonably be described a choreographed, stylised or contrived. They may have lacked all point, if the judgment under appeal is right. But they were real transactions, which had real results in terms of altering rights and obligations. ... And it is nothing to the point that the only outward and visible signs of the transactions were some pieces of paper and associated book entries. This is the normal machinery of banking and finance (Emphasis added).

[62] An argument that elements of fraud - either in the construction, promotion or operation of the tax avoidance arrangement - vitiated the arrangement so that the tax avoidance provisions could not apply – would render tax avoidance provisions of the Act significantly ineffectual. On such a construction, the best way to sell a tax avoidance package would be to sell an ineffective one! That has to be nonsense.

[63] For these reasons, I dimiss the appeal against the Authority finding the disputant party to tax avoidance.

[64] The Authority dismissed an appeal against the Commissioner’s finding that

(1) The purpose of this section is to penalise those taxpayers who, having taken an unacceptable tax position, have entered into or acted in respect of arrangements or interpreted or applied tax laws with a dominant purpose of taking, or of supporting the taking of, tax positions that reduce or remove tax liabilities or give tax benefits.

(2) A taxpayer is liable to pay a shortfall penalty if the taxpayer takes an abusive tax position (referred to as an abusive tax position).

(7) For the purposes of this Part and section 177C, an abusive tax position means a tax position that,—

(a) is an unacceptable tax position at the time at which the tax position is taken; and

(i) In respect, or as a consequence, of an arrangement that is entered into with a dominant purpose of avoiding tax, whether directly or indirectly; or

(ii) Where the tax position does not relate to an arrangement described in subparagraph (i), with a dominant purpose of avoiding tax, whether directly or indirectly.

[65] The Commissioner applied subs 7(b)(i). As mentioned in the introduction, this appeal was pursued with the goal of moving the classification of abusive tax position to subs 7(b)(ii).

[66] Accordingly, having dismissed the appeal arguments, leaving the taxpayer being found to be a party to a tax avoidance arrangement, subs (7)(b)(i) must apply. This Court has no power to apply subs (7)(b)(ii).

[68] The Commissioner is entitled to costs. If costs cannot be settled, I will receive five pages of submissions from each party, having previously been exchanged in draft.

1. Shareholder signs an application form and

appoints a Power of Attorney

(administrative company). The Power of

Attorney (“POA”) is to:

a. Make the application

b. Nominate the risk categories

c. Enter into a promissory note with the fund manager

2. A fee is paid to the promoter and the tax

agent

3. The POA entity satisfies the promissory

note by either:

a. a payment of cash from the shareholders

b. a part payment of cash and the

remainder by loan from the bank

c. Loan from the bank – default method

4. POA completes a loan application to the

bank

5. POA entity facilitates the loan from the

shareholders passing on to the fund manager

6. The fund manager invests the contribution

7. The POA entity signs a Deed of Covenant

and Authority

8. Interest and loan repayment insurance is

paid on the loan by the shareholders.

BETWEEN	HC SERVICES LIMITED Appellant
AND	COMMISSIONER OF INLAND REVENUE _Respondent

Hearing:	7 May 2014
Counsel:	T M Chemaly for Appellant P H Courtney and A W Fraser for Respondent
_Judgment:	_{29 May 2014}

High Court of New Zealand Decisions

HC Services Limited v Commissioner of Inland Revenue [2014] NZHC 1169 (29 May 2014)