Tax Avoidance Image

In the New Zealand case of Honk Land Trustees Ltd v Commissioner of Inland Revenue [2017] NZCA 54; BC201760307, the Court of Appeal considered a tax avoidance scheme relating to a shift of profits from a profitable entity to a loss-making one. The appellant (HLT) is the trustee of the Honk Land Trust (Trust), which owned Honk Land Group Limited. Honk Land Group Limited in turn owned various other companies, including Honk Land Limited (HLL).

In the 2005 income year, the Trust received income from commercial rentals, dividends and interest. It also sold two commercial properties. In that same year, the financial statements for the Trust recorded management fees totalling $1,152,824 as an expense of the Trust. This sum comprised $1,116,000 charged by HLL and $36,824 charged by another management company. As a result of the payment of $1,116,000 to HLL, the Trust had no tax to pay. On HLL’s end, it offset the $1,116,000 management fee against existing losses such that HLL paid no tax on the sum.

The issues considered by the Court of Appeal included:

  • Were management services provided by HLL to HLT (as trustee of the Trust)?
  • Was there sufficient nexus shown between the management fees and the earning of the Trust’s assessable income and/or in the course of carrying on its business?
  • If the management fee was deductible, was it part of a tax avoidance scheme?

 

Were management services provided by HLL to HLT?

The Court of Appeal found that while it was not in dispute that the assets and business of the Trust required some management, HLT could not identify what management services were provided to the Trust or show that they were performed by HLL. It also could not be shown how the sum charged was calculated. On the contrary, it was conceded that the payment made by HLT was for management services that HLL had provided to all the entities in the Honk Group. The Court of Appeal hence agreed with the lower courts that the proper inference to draw is that the management fees for 2005 were fixed by reference to the Trust’s taxable income and for the purpose of eliminating its liability to tax.

Was there sufficient nexus shown between the management fees and the earning of the Trust’s assessable income and/or in the course of carrying on its business?

In seeking to deduct an expense for income tax purposes, the expense must have been incurred by the taxpayer in order to gain its assessable income or in order to carry on a business for that purpose. In this instance, the management services were provided to individual entities in the Honk Group. There was thus insufficient proof of the required nexus between the fees and the earning of the Trust’s income. Although the court accepted the appellant counsel’s submission that complete precision might not always be possible with regard to the division of management services between members of a group of companies, there was simply no division of management services at all in this instance.

If the management fee was deductible, was it part of a tax avoidance scheme?

The Court of Appeal referred to earlier Supreme Court cases (including Ben Nevis Forestry Ventures Ltd v. CIR [2009] 2 NZLR 289) which confirmed the principles applicable to general anti-avoidance provisions. Where a taxpayer has relied on a specific provision to achieve a tax result, the court must consider the taxpayer’s use of the specific provision in light of the arrangement as a whole. The court is not limited to legal considerations but may view the arrangement in a commercially and economically realistic way.

If it is apparent that the taxpayer had used the specific provision and altered the incidence of income tax in a way which cannot have been within the contemplation or purpose of Parliament when it enacted the specific provision, then the transaction will be a tax avoidance arrangement. A classic indicator that the specific provision has been used outside Parliament’s contemplation is the gaining of the benefit of the specific provision in an artificial or contrived way.

In this instance, even if HLT was found to have been entitled to deduct the management fees under the specific deduction provisions, the court held that it would have found that there was a tax avoidance arrangement as the circumstances in which the management fees were fixed and charged were contrived and artificial.

Editorial Note

The Singapore Court of Appeal case of Comptroller of Income Tax v AQQ [2014] SGCA 15 had earlier similarly cited the New Zealand Supreme Court case of Ben Nevis and adopted the scheme and purpose approach used therein.



Image credit: Sidney Hoff (10/28/1950), The Complete Cartoons of the New Yorker