| Tax Avoidance and IRD’s Interpretation Statement and SMEs
By Phil Barlow – 10 October 2013

Inland Revenue released a draft interpretation statement in June 2013 updating the Commissioner’s view of the laws on tax avoidance in New Zealand. This draft statement is intended to replace Inland Revenue’s previous statement on the general anti-avoidance rule (“GAAR”), released in 1990.

Published at a time when there continues to be significant uncertainty for SMEs around what constitutes legitimate tax planning and what will be interpreted as tax avoidance the statement provides no definitive guidelines as to the circumstances in which a particular arrangement will or will not be subject to the general anti avoidance provision.

Amendments

There are three main areas where the finalised statement differs from the December 2011 draft:

  • Three worked examples are included;
  • The reconstruction section has been amended to confirm that Inland Revenue is required to reconstruct an arrangement in order to reinstate legitimate tax benefits; and
  • The Parliamentary Contemplation test has also been amended in an attempt to make it more comprehensible

The three examples have been included in order to illustrate how the Commissioner’s approach is used to reach a view on whether an arrangement is a tax avoidance arrangement.  The examples are straightforward and have been drafted with the intention of demonstrating the application of the new framework rather that providing any precedential value. These examples will not assist taxpayers in determining where to the draw the line between legitimate tax planning and tax avoidance.

The amended reconstruction section is important as it confirms that Inland Revenue is obliged to reinstate legitimate tax consequences where they have been rendered void by the application of the general anti-avoidance provision.

The order of analysis when applying the Parliamentary contemplation test has been clarified. The test is two-fold and commences with Parliament’s purpose regarding the relevant tax provisions. The test then considers the commercial reality and economic effects of the arrangement.  The reversal of these two steps from the previous draft should prevent an arrangement being reduced to its economic effect prior to consideration of the relevant tax provisions.

What does this mean for SMEs?

Guidance from the Commissioner has been highly anticipated by SMEs since the Supreme Court indicated it intended to settle the approach to the relationship between the anti-avoidance section and the rest of the Income Tax legislation in the 2008 Ben Nevis Forestry Case.

The consultation process means that the finalised draft statement has been substantially amended in parts.  Most of the amendments are designed to assist SMEs and other taxpayers to better understand the Inland Revenue’s approach.

Unfortunately, the most troublesome part of the new approach remains the Parliamentary Contemplation test.  The clarification of the order of analysis is beneficial. However, there is a risk that this test will become retrospective in focus i.e. what the law would have been had Parliament had the opportunity to consider a particular arrangement before the legislation was introduced. This retrospective focus is objectionable on a constitutional basis as Inland Revenue officers and the Courts will be required to fill, actual or perceived, legislative gaps and essentially re-write defective tax policy.

For SMEs the release of the draft interpretation statement may be viewed as a positive development in that it provides certainty of the framework that the Inland Revenue will apply when analysing an arrangement for tax avoidance.

However because the statement provides no definitive guidance on how the Inland Revenue will apply the GAAR in practice, the statement remains inadequate in terms of providing the certainty SMEs need to continue legitimate tax planning without crossing the fluid boundary into tax avoidance.

Unfortunately Inland Revenue’s most recent attempt to describe its view of what constitutes tax avoidance has not resolved the high level of uncertainty currently faced by SMEs. It seems clear that in terms of judicial application SMEs will have to wait for a ‘borderline’ case to be decided in order obtain more meaningful guidance on where the tax avoidance boundary may be drawn.

For more information please contact our Tax Team:

Shelley-ann Brinkley Senior Tax Manager
T +64 9 414 5444
E shelley-ann.brinkley@hayesknight.co.nz

Phil Barlow Tax Director T + 64 9 414 5444
E phil.barlow@hayesknight.co.nz