New Zealand has had some form of general anti-avoidance rule (GAAR) since 1878. The current GAAR, found in section BG 1 Income Tax Act 2007, provides that a tax avoidance arrangement is void for income tax purposes.
The GAAR ostensibly applies to an arrangement that has a tax avoidance purpose or effect, or has tax avoidance as one of its purposes or effects that is more than merely incidental.
In recent years the pendulum has swung firmly in IRD's favour in relation to the interpretation of the GAAR. The watershed occurred in the Supreme Court's first foray into the tax world in Ben Nevis Forestry Ventures and others v Commissioner of Inland Revenue (2009) 24 NZTC 23,188.
The taxpayers in Ben Nevis argued that the arrangements in question fell squarely into the relevant specific taxing provisions and that they were entitled to the deductions claimed. IRD argued however that the arrangements were caught by the GAAR.
The Supreme Court adopted a test which involves ascertaining Parliament's intention when it enacted the provision. It put the issue in this way: "The ultimate question is whether the impugned arrangement, viewed in a commercially and economically realistic way, makes use of the specific provision in a manner that is consistent with Parliament’s purpose." This new approach (generally referred to as the "Parliamentary contemplation" test) brings factors such as artificiality, contrivance and commercial reality to the fore.
This new approach has favoured IRD.
Ben Nevis also resolved the long-standing tension between the specific taxing provisions and the terms of the GAAR. The Court made plain that neither the specific provision nor the GAAR is given precedence, stating that "they are meant to work in tandem".
The test in Ben Nevis has subsequently been expressly approved and applied by the Supreme Court and is being applied in current disputes and now forms the foundation of IRD's interpretation statement on the GAAR. The most recent judicial comment on the GAAR is the Court of Appeal in Alesco New Zealand Limited v Commissioner of Inland Revenue (2013) NZCA 40, a dispute concerning the tax treatment of deductions for notional interest payments which did not give rise to assessable income for the recipient.
Like Ben Nevis, the taxpayer argued that the arrangements fell squarely into the relevant specific taxing provisions and that they were entitled to the deductions claimed. IRD however argued that the taxpayer had used the relevant provisions in a way which was not within Parliament’s contemplation and the arrangements were therefore void. The Court of Appeal agreed and the matter is now proceeding to the Supreme Court.
The mismatch between tax benefit and economic cost clearly troubled the Court. Indeed, it asked itself whether the taxpayer suffered an economic cost commensurate with the deductions claimed. This is not an element of the GAAR test, but an element that the Court nonetheless took into account in considering Parliament's contemplation. Also troubling is the emphasis of the Court on the "wider fiscal consequences" of the case. This is also not contained in the language of the GAAR.
Attitudes of IRD
In 1974 the Court of Appeal called on Parliament to "state in precise language not only what classes of transactions are to be struck down, but what are to be the results of that action" (Gerard v Commissioner of Inland Revenue (1974) 1 NZTC 61,151). Notwithstanding this, an often-heard criticism of IRD is its continual reluctance to provide any clear and unequivocal guidance, preferably with worked examples, as to the types of transactions that will and will not be caught by the GAAR.
In 1990 IRD issued its first policy statement on the (then) GAAR. The statement extended to four pages, plus a further twelve pages of examples illustrating the effect of IRD's policy. The statement focused on evaluating arrangements in terms of whether they frustrate the underlying scheme and purpose of the relevant specific taxing provisions and asserted that in trying to discern such scheme and purpose, primary regard must be had to the words of the statute.
A new interpretation statement was circulated for comment in 2004. Judicial developments in the intervening period (notably Ben Nevis) led to a further redraft and external consultation. The new statement was publically released on 1 July 2013. The redrafted statement is 133 pages long and provides a detailed summary of case law in relation to the current GAAR and its predecessors, but fails to provide the certainty that taxpayers require. Certainty was expressly addressed by an unsympathetic Supreme Court in Ben Nevis: "The courts should not strive to create greater certainty than Parliament has chosen to provide." IRD has seized upon this and suggested that it is not clear that certainty is either possible or desirable in this area. Certainty however promotes integrity of the tax system which is vital if investment is to be made into New Zealand promoting economic growth.
IRD's approach in practice mirrors that espoused in the statement – a broad application of the GAAR. The test formulated in Ben Nevis has been treated as a 'silver bullet' by IRD. IRD does not reflect upon the unique facts of the Ben Nevis case and instead seeks to apply the 'sniff test' described therein as a blanket rule. The approach adopted by IRD, notwithstanding the recognition in Ben Nevis that "taxpayers have freedom to structure transactions to their best advantage" restricts the taxpayer's freedom to enjoy tax consequences that are incidental to a commercial purpose.
Professional advisers and taxpayers alike would prefer to return to a more orthodox analysis, reinstating the emphasis on the language of the legislation in question in determining Parliament's intention, which can only be divined from the words of the legislation and its context. However, as a consequence of Ben Nevis Parliamentary contemplation is the primary test to be applied to determine whether an arrangement constitutes tax avoidance. This effectively substitutes the test in Ben Nevis for the words of the GAAR. This approach cannot be right. The Supreme Court itself confirmed that ascertaining whether an arrangement is a tax avoidance arrangement should be firmly grounded in the statutory language of the provisions themselves.
Most recent criticism of the GAAR has focused on its interpretation and application rather than its form. Taxpayers and advisers would agree that the GAAR performs a necessary function, acting as a mechanism for combating artificial and contrived structures.
New Zealand is heavily reliant on offshore investment which depends on a stable and predictable legal system. The reforms proposed by the report by the Taxation Committee of the New Zealand Law Society, the Corporate Taxpayers Group and the Taxation Committee of the New Zealand Institute of Chartered Accountants were drafted with this in mind. Referring to a comment of the then Minister of Revenue that we should strive for a world class tax-system, the report suggests that "If New Zealand is serious about having a "world class tax system" the impact arising from the uncertainty arising from the GAAR cannot be ignored".
This reflects the attitude of advisers struggling to advise clients in this unsettled environment. Transactions which hitherto did not attract IRD's attention are now at risk of scrutiny. Worse, the shift in approach affects transactions which IRD had previously chosen not to challenge. Notwithstanding that there is firm case law which supports the view that transactions with commercial purpose should not be caught by the GAAR, 'commerciality' is no longer an antidote.
The report's primary suggestion is for the dissemination of detailed guidance as to when the GAAR will and will not apply. The commercial imperative of certainty is cited as the reason for need for clear guidance. The report notes that the requirement for official guidance is especially important given that IRD, its lawyers and even divisions within IRD can disagree on the scope of the GAAR.
This lack of clear guidance can be contrasted with the new United Kingdom GAAR. 35 pages of guidance together with 136 pages of examples of how the GAAR applies to tax arrangements was released when the GAAR was enacted. A separate 24 page document explaining the procedural elements of the application of the GAAR was also made available to taxpayers. This open collaborative approach is to be applauded. In contrast, IRD's statement does not contain any meaningful examples as to how the GAAR applies to real life situations. Much can be learned by IRD from other jurisdictions.
The report also recommends establishment of an independent advisory panel to consider cases where avoidance is alleged by IRD; the idea being that private sector input will assist IRD distinguish between the artificial and commercial norms. The panel would be made up of specialist tax lawyers and accountants together with appropriate IRD representatives. The panel would make non-binding recommendations as to the application of the GAAR to a particular structure. The perceived benefit is to promote transparent decision making and allow scrutiny where required.
The panel proposal is not novel. A similar panel was established in Australia in 2000. The United Kingdom has also established a panel to advise the tax authority whether there are reasonable grounds for invoking the GAAR in respect of particular arrangements. Such a panel also provides an internal safeguard by reviewing individual tax officer's decisions.
Bringing back certainty?
The last decade has seen a significant shift in our tax avoidance jurisprudence. IRD and subsequently the courts have taken a substantially broader application of the GAAR than seen previously. The global financial crisis and the subsequent pressure on tax authorities to collect higher tax receipts cannot be ignored in considering the causes of the change.
Consequently, it is a very difficult time for advisers. Unfortunately, IRD's approach has exacerbated the difficulties and the resulting uncertainty is damaging foreign investment, so crucial to our small economy. Taxpayers are reluctant to enter into any arrangement which may have an uncertain outcome. With recent court decisions all favouring IRD, there is scant guidance as to when the GAAR will not apply.
It does not help that the courts appear to be 'papering over the cracks' in defective legislation, rather than leaving it to the consultative Parliamentary process to remedy any deficiencies. This cannot be right. There must be a more reasoned basis for resorting to application of the GAAR. This approach unfairly favours IRD and the resulting imbalance needs to be addressed.
There needs to be a return to a more pure form of statutory interpretation. It is long established that the intention of Parliament should be discerned from the language of the statute itself, together with its scheme and purpose and arguably not from a concept as illusory as Parliamentary contemplation.
Fundamentally however, there needs to be a shift in the mindset of IRD. Care should be taken such that its actions do not stifle investment and normal transactions. Taxpayers should be free to make arrangements to secure reasonable benefits based on the choices afforded by the legislation. After all, the courts have consistently acknowledged taxpayers' freedom to choose between two commercially valid ways of structuring a transaction.