‘Badges of Tax Avoidance’:
Reform Options for the New Zealand GAAR
Julie Cassidy Deakin University
Australia
Introduction
Importance of an effective General Anti-Avoidance Rule (‘GAAR’):
• Sustainability of a taxation system relies on reducing effective tax avoidance
• Finding a GAAR that fairly ‘draws a line in the sand’ between legitimate commercial transactions and tax avoidance
• Nations such as South Africa, Australia and New Zealand have sought to tackle the problem of tax avoidance through GAARs, rather than relying solely on
measures that tackle very specific examples of tax avoidance
• Compare and contrast the approach taken in South Africa’s Part IIA of Chap III of the Income Tax Act 1962, Australia’s Part IVA of the Income Tax Assessment Act 1936 (Cth) and New Zealand’s ss BG1 and GA1 Income Tax Act 2007
Introduction
Differing approaches:
• The legislative goals of the Australian and South African provisions are similar
• However, the strategies underpinning each piece of legislation differ
• Australian legislation contains a number of specific prerequisites that ultimately lead to the question: was the sole or dominant purpose to obtain a tax benefit through the scheme?
• By contrast, the South African legislation begins with very broad terms that cast a wide net, but then hones in the application of Part IIA by focusing on the common attributes of tax avoidance arrangements (‘badges of tax avoidance’)
• New Zealand GAAR also revolves around broad terms but there is no legislative directive; instead this has been left to the judiciary to formulate
• Too uncertain and legislative clarification is warranted
Legislative history
South Africa:
• The courts had emasculated the existing GAAR (s 103 of the Income Tax Act 1962) and its predecessors esp CIR v Conhage (Pty) Ltd (1999)
• Inconsistency in the courts’ application also required a case by case approach
• Deterrent effect of s 103 had greatly diminished
• Could not address the sophisticated artificial tax schemes devised by promoters
• 3 November 2005 the Minister of Finance launched a discussion paper with reform proposals
• Original proposals were revised considerably
• New Part IIA of the Income Tax Act 1962 enacted, effective from 2 November 2006
• South African authorities stressed the need to balance legitimate commercial transactions against impermissible tax avoidance schemes
Legislative history
Australia:
• Courts emasculated existing GAAR, s 260 of the Income Tax Act 1936
• Barwick CJ High Court’s excessive use of literal interpretation and judicially developed exceptions to s 260 egs Mullens v FCT (1976); Slutzkin v FCT (1977); Cridland v FCT (1977)
• Revelations that the Australian tax burden was largely being borne by salaried taxpayers, led to a public backlash against tax avoidance in the 1980’s
• New Part IVA enacted, effective from 27 May 1981
• Part IVA purportedly buried the doctrines that had rendered s 260 largely ineffective
• Part IVA was introduced ‘to strike down blatant, artificial or contrived arrangements’
• Part IVA would ‘not cast unnecessary inhibitions on normal commercial transactions by which taxpayers legitimately take advantage of the opportunity available for the arrangement of their affairs’
Legislative history
New Zealand:
• Income Tax Act 2007 did not see any changes to the New Zealand GAAR
• Section BG1 remains largely the same as its predecessor (s 108 Land and Income Tax Act 1954)
• New Zealand GAAR remains substantially unaltered since s 40 Land and Income Tax Assessment Act 1891
• Mangin v CIR (1971) per Lord Wilberforce: given its source not surprising it “lacks clarity of purpose and may indeed fail of effect”
• Exception: 1974 amendment
• Deliberate policy on the part of parliament to leave it to the courts to formulate a definition of tax avoidance
• GAAR remains very broadly worded and its scope uncertain
Legislative history
New Zealand cont.:
• Reform bodies have been inconsistent in their views; some critical of the
uncertainty stemming from such a broadly worded GAAR, others suggesting judicial discretion has been effective:
• Valabh Committee (1991 and 1992)
• Tax Law Review Committee (1997)
• Committee of Experts (1998)
• Tax Review (2001)
• Tax Working Group (2010)
• Other aspects of ITA have been extensively amended over 30 years
• Yet ultimately GAAR remains the same
Legislative Framework
South Africa:
Part IIA revolves around the notion of an ‘impermissible avoidance arrangement’ (s 80A):
• Sole or main purpose (presumed under s 80G)
• Of the ‘avoidance arrangement’ (defined in s 80L)
• Must be to obtain a ‘tax benefit’ (defined in s 80L)
• One or more of the ‘tainted elements’ must exist (ss 80A-80E)
• Brief overview of these prerequisites
• Focus on the tainted elements: ‘badges of tax avoidance’
• Commissioner may determine the tax consequences for any party: ss 80B and 80H
• Commissioner must make compensatory adjustments: s 80B
Legislative Framework
Australia:
For Part IVA to apply there must be:
• A ‘scheme’ (defined s 177A)
• That provides the ‘relevant taxpayer’
• With a ‘tax benefit’ (defined primarily in s 177C)
• A person must have entered into the scheme with the sole or dominant purpose of enabling the relevant taxpayer to obtain a tax benefit: s 177D
• Brief overview of these prerequisites
• Focus on factors listed in s 177D(b)
• Commissioner may cancel the whole or part of the tax benefit: s 177F
• Commissioner may make compensatory adjustments: s 177F
Legislative Framework
New Zealand:
Section BG1 revolves around the notion of a ‘tax avoidance arrangement’ (defined in s YA1):
• The ‘arrangement’ (defined: s YA1)
• Must ‘directly or indirectly’ have
• ‘Tax avoidance’ (defined in s YA1 in inclusionary terms)
• As ‘its’ (the arrangement’s) ‘purpose or effect’ or one of its purposes or effects
• As long as ‘not merely incidental’
• ‘Tax avoidance arrangement’ is void: s BG1(1)
• The Commissioner may adjust the taxable income of a person affected by an arrangement as he ‘thinks appropriate’ in order to ‘counteract a tax advantage’
from or under the arrangement: ss BG1(2) and GA1(2)
Badges of Tax Avoidance
New Zealand
• There is no legislative direction as to the indicia of tax avoidance arrangements
• Left to the judiciary to formulate
• Development of judicial constraints has led to complexity and uncertainty: Ben Nevis
South Africa
• Distinct from the sole or dominant purpose of tax avoidance requirement: s 80A
• Additional requirement of tainted elements: ss 80A-80E Australia
• Section 177D(b) factors determining sole or dominant purpose of tax avoidance
Badges of Tax Avoidance
South Africa:
• Tainted elements under s 80A: What do tax schemes look (smell!) like?
• Abnormality test: When arrangement entered into or carried out by a means not normally employed
•Tax avoidance schemes are often contrived and artificial and do not accord with norms of commercial practice; or
• Lack of commercial substance test: s 80C factors
• General rule: Significant tax benefit without significant business risks or net cash flows: s 80C(1)
• Tax avoidance schemes often create a facade of substantial investments, which are largely illusory, and insulate the taxpayer from economic risk
Badges of Tax Avoidance
South Africa cont:
Lack of commercial substance: s 80C(2) factors:
• Legal substance of arrangement as a whole is inconsistent with, or differs significantly from, the legal form of its individual steps
• Creating a legal façade that is contrary to the substance of the arrangement, in particular unnecessary and artificial steps inserted in a broader arrangement
• Round trip financing (as described in s 80D)
• Money is simply re-routed to ensure no money is actually paid
• Accommodating or tax indifferent party (as described in s 80E)
• Artificial parties used as conduits to create the illusion of arm’s length transactions
• Use of parties such as charities, entity with accumulated losses and/or foreign entities that are not subject to ‘normal’ tax and often transitory use
• Elements that have the effect of offsetting or cancelling each other
• Tax avoidance schemes often include steps that have no commercial purpose other than tax avoidance
Badges of Tax Avoidance
South Africa cont:
• Alternative ‘tainted element’: arrangement results directly or indirectly in the misuse or abuse of the provisions of the Act (including the GAAR): s 80A(c)
• Will require South African courts to adopt a purposive interpretation
• Targets arrangements that frustrate the statutory purpose of any provision of the Act, including Part IIA
• This is designed to ensure scheme promoters cannot misconstrue provisions in a bid to find unintended loopholes
Badges of Tax Avoidance
Australia
Section 177D requires an objective conclusion, drawn on the basis of s 177D(b) factors only, to determine if sole or dominant purpose of tax avoidance:
• Manner scheme entered into and carried out
• Form and substance
• Time scheme was entered into and duration
• Tax result but for Part IVA
• Any change in the taxpayer’s financial position
• Any change in the financial position of a person connected with the taxpayer
• Any other change for the taxpayer or a person connected with the taxpayer
• Nature of any connection (business, family or otherwise) between taxpayer and the other person
• Note, ‘global assessment of purpose’
Conclusion
• Recent changes in judicial approach (Ben Nevis) in New Zealand are welcomed by those seeking to protect the tax base and the integrity of the taxation system
• Question remains, where will the courts draw the line between legitimate commercial structuring and tax avoidance?
• In “most cases ... it will be possible, without undue difficulty, to decide on which side of the line a particular arrangement falls”: Ben Nevis at [112]
• There will be “difficult cases at the margins”: Ben Nevis at [112].
• Too uncertain?
• Legislative clarification is warranted
• Badges of tax avoidance to guide the judiciary
• Protects courts from claims of judicial law making
• Also used by taxpayers and their advisors when determining if the subject
arrangement crosses the line between legitimate structuring and a “tax avoidance arrangement”
Questions?
Judicial Approach to NZ GAAR
Interpretation and application of GAAR
• A “classic indicator”: “where a taxpayer gains the benefit of the specific provision in an artificial or contrived way”
• Lack of commercial reality another important consideration
• Inclusionary list of factors:
• “the manner in which the arrangement was carried out”;
• “the role of all relevant parties and any relationship they may have with the taxpayer”;
• “the economic and commercial effect of documents and transactions”;
• “the duration of the arrangement”; and
• “the nature and extent of the financial consequences for the taxpayer”
• Particularly a combination of such factors
• Significance of each factor will depend on the facts of the particular arrangement
• Provides the link to the “parliamentary contemplation test” and the generic notions of (i) commercial reality and economic substance and (ii) “artificial [and] contrived”
schemes
