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Contents

1. Introduction

2. The general anti-avoidance rules

3. Recent developments

4. What are the relevant questions and where does the avoidance analysis begin?

5. "Sham" vs avoidance

6. Specific rules vs the general anti-avoidance rule: A game of two halves?

7. A move away from rule-based jurisprudence

8. The approach set out by the Supreme Court in Ben Nevis

9. What is an arrangement

10. Compliance with specific provisions

11. The choice principle: endorsed with qualifications

12. Compliance with the general anti-avoidance rule

13. Crossing the line: permissible vs impermissible arrangements

14. When altering the incidence of tax is permitted

15. The Challenge heritage and the English purposive approach

16. Merely incidental purpose or effect of tax avoidance

17. Artificiality: tax avoidance more than merely incidental

18. Economic cost

19. Unfairness to the general body of taxpayers

20. Restructures are more likely to be classed as tax avoidance

21. Inland Revenue Revenue Alert: non-market salaries

22. Inland Revenue draft Interpretation Statement: section BG 1

23. Reconstruction

24. Shortfall penalties

25. The burden of proof lies with the taxpayer

Attached PDFs

• Printable version of this section

INTRODUCTION

1. The interpretation of the general anti-avoidance provision by the New Zealand Courts has changed significantly in recent years. The current approach, set out by the Supreme Court in Ben Nevis Forestry Ventures Ltd & Ors v C of IR; Accent Management Limited & Ors v C of IR [2008] NZSC 115 (19 December 2008); (2009) 24 NZTC 23,188, involves a two-pronged analysis concerning:

• The actual use of specific provisions based on the legal transactions; and
• Whether the specific provisions have been used in a manner that is within Parliament's purpose and contemplation when the specific provision were enacted, based on the commercial and economic outcome of the arrangement.

2. The approach distinguishes between the use of specific tax provisions in a strictly legal sense, and the manner in which those provisions have been used having regard to the overall commercial and economic outcome. The Supreme Court has explicitly acknowledged that there will be circumstances in which the use of a specific provision may be legally permitted but is beyond Parliament's purpose and contemplation when the specific provision was enacted. In that sense, the Supreme Court's approach represents an expansion of the English purposive approach (see paragraph 38(o) below).

3. The starting point, when trying to determine whether a particular arrangement constitutes tax avoidance, is an investigation into whether the specific tax provisions that are relied on are used in a manner that is within Parliamentary contemplation when the provisions were enacted. If there is a tax avoidance purpose or effect, the question becomes one of whether the tax avoidance purpose or effect is "merely incidental". In this regard, it is worth noting the Supreme Court's warning, in Ben Nevis at p. 23,213: "[114] ...It will rarely be the case that the use of a specific provision in a manner that is outside Parliamentary contemplation could result in the tax avoidance purpose or effect of the arrangement being merely incidental".

4. In Penny and Hooper v C of IR [2011] NZSC 95 (24 August 2011); (2011) 25 NZTC 20,073 the Supreme Court accepted that a tax advantage that is within Parliamentary contemplation will be permitted, when Blanchard J stated, at p. 25,649: "[49] ...what the Act does require of taxpayers is that they should not structure their transactions with a more than merely incidental purpose of obtaining a tax advantage unless that advantage was within the contemplation of Parliament".

THE GENERAL ANTI-AVOIDANCE RULES

5. The General Anti-Avoidance Rules or GAARs (following the acronym coined by the Supreme Court in Glenharrow Holdings Ltd v C of IR [2008] NZSC 116 (19 December 2008); (2009) 24 NZTC 23,236, at [34] p. 23,244) that apply for income tax purposes are contained in section BG 1 and section YA 1 (which contains the definitions of the terms used) of the Income Tax Act 2007.

6. Section BG 1(1) states that:


7. "Tax avoidance arrangement" is defined in section YA 1 as meaning:

8. An "arrangement" is defined in section YA 1 as meaning:


9. "Tax avoidance" as defined in section YA 1 includes–

1. directly or indirectly altering the incidence of any income tax:
2. directly or indirectly relieving a person from liability to pay income tax or from a potential or prospective liability to future income tax:
3. directly or indirectly avoiding, postponing, or reducing any liability to income tax or any potential or prospective liability to future income tax.

10. The general anti-avoidance rule that applies for GST purposes is contained in section 76 of the Goods and Services Tax Act 1985. Section 76(1) provides that:


11. Section 76(2) states that:

12. The definition of "arrangement" in section 76(8) of the GST Act is the same as the definition for income tax purposes set out in paragraph 8 above.

13. "Tax avoidance" is defined for GST purposes in section 76(8) as follows:

RECENT DEVELOPMENTS

14. Three anti-avoidance cases have been heard in the New Zealand Supreme Court in recent years. And another three anti-avoidance cases have been heard in the High Court. The most recent Supreme Court hearing was Penny and Hooper which concerned the salaries paid to the taxpayers by their family-owned companies. The Supreme Court's judgment in favour of the Commissioner has generated considerable discussion regarding what a commercially realistic salary might be in the context of a family owned company, when the income is derived through the taxpayer's personal exertion.

15. The most recent High Court hearing was Alesco New Zealand Ltd and Ors v Commissioner of Inland Revenue (No. 2) [2011] NZHC 1750 (12 December 2011); HC AK CIV 2009-404-2145. The case concerned interest deductions claimed on optional convertible notes (OCNs) issued by a New Zealand subsidiary to its Australian parent company. This judgment was also in the Commissioner's favour, and will influence the court proceedings of another 15 taxpayers.

16. In Penny and Hooper the Supreme Court found that the setting of salary levels by family-owned companies, which were otherwise perfectly legal and acceptable, were part of a tax avoidance arrangement. Therefore, from an anti-avoidance perspective, the relevant question is: What are the circumstances in which a legally effective series of transactions can be ignored and treated as a tax avoidance arrangement?

17. In Glenharrow a legally effective payment made by way of a promissory note was disregarded for GST purposes and the taxpayer was denied an input tax credit. The settlement of the promissory note was seen as commercially impossible and therefore, despite the legal transactions undertaken, the payment was treated, under section 76 of the GST Act, as not having been made.

18. In Ben Nevis, depreciation deductions that arose as a result of a series of legal transactions were denied because the settlement of the promissory note that gave rise to those deductions was very doubtful, given that there appeared to be no intention to make the profit necessary to finance the settlement. There was no necessary business connection between the giving of the promissory note and the timing of the settlement 50 years later. The series of legal transactions under which the depreciation deductions would have arisen were ignored under the general anti-avoidance rule.

19. In Penny and Hooper it was found under the general anti-avoidance provision that the taxpayers' salaries, fixed using legal company structures, had been correctly increased by the Commissioner to commercially realistic levels, because the overall commercial outcome of the low salaries paid was that profits retained in the taxpayers' companies (which were taxed at a lower rate than their salaries) quite quickly ended up in the taxpayers' hands without any more tax paid.

20. On the other hand, in White v C of IR [2010] NZHC 1826 (12 October 2010); (2010) 24 NZTC 24,600, a lower than market salary had also been paid, but the legal transactions were not ignored because the commercial result was not one where the income from personal exertion ended up in the hands of the taxpayer. This was a case where a commercially unrealistic salary did not result in the legal transactions being ignored under the general anti-avoidance rule.

21. In Krukziener v C of IR (No 3) [2010] NZHC 1714 (17 September 2010); (2010) 24 NZTC 24,563, the legal transactions (loans from the companies to Mr. Krukziener) were ignored because the commercial result was that Mr. Krukziener was remunerated for his personal efforts without paying any income tax.

22. In Alesco interest deductions were denied because of the finding that the option element of the OCNs had no real value and that therefore, an interest-free loan had in effect been provided at the commencement of the arrangement. Notably, compliance with the relevant international accounting standards, which resulted in a discounted fair value of the loan at commencement, was held to be an insufficient basis for claiming the deductions.

WHAT ARE THE RELEVANT QUESTIONS AND WHERE DOES THE AVOIDANCE ANALYSIS BEGIN?

23. The question, suggested in paragraph 16, is: When will a New Zealand Court ignore a series of legal transactions and focus on the commercial outcome for tax avoidance purposes? The answer is: When the commercial outcome is beyond the scope and contemplation of Parliament when the relevant tax provisions were enacted.

24. As Blanchard J stated in the Supreme Court in Penny and Hooper:


25. The question then becomes: When will the commercial outcome be regarded as being beyond Parliamentary intention when the tax provisions were enacted? The answer to this question lies in the approach adopted by the Court when reviewing the facts of a case and the application of the relevant specific provisions and the general anti-avoidance provision to those facts.

26. The conclusion by a taxpayer or a tax advisor as to whether or not a particular plan of action constitutes tax avoidance must be based on a thought process that follows the likely legal analysis that would be undertaken by a Court.

27. Assuming the specific transactions stack up and are legally effective (i.e. they are not a "sham" – see paragraphs 28-30 below), the legal analysis must begin with a recognition of the distinction drawn by the Supreme Court between the specific provisions and the general anti-avoidance provision and the necessity to reconcile their potentially conflicting nature.

"SHAM" VS AVOIDANCE

28. First of all, the legal documentation must "stack up" – i.e. it must not be a sham. In Ben Nevis the Supreme Court described the concept of a "sham" at [33]-[34] as follows:

29. The Supreme Court distinguished a "sham" from "avoidance" as follows:


30. If the documents evidencing the legal arrangements are not a sham, the next step is to review the use of the specific provisions in the light of those legal arrangements.

SPECIFIC RULES VS THE GENERAL ANTI-AVOIDANCE RULE : A GAME OF TWO HALVES?

31. In Ben Nevis the Supreme Court noted that the central issue was the difficulty in discerning the relationship between specific rules that allow tax concessions for certain arrangements and the general anti-avoidance rule. The Supreme Court referred at [82] to the following statement by Lord Wilberforce in Mangin v C of IR [1970] UKPC 23 (21 October 1970); (1970) NZLR 591 at p. 662:


32. The Supreme Court in Ben Nevis referred to:


33. The Supreme Court then stated:


34. The Supreme Court went on to state that specific tax provisions and the general anti-avoidance provision are meant to work in tandem:


A MOVE AWAY FROM RULE BASED JURISPRUDENCE

35. Hammond J in his concurring judgment in the Court of Appeal in C of IR v Penny and Hooper [2010] NZCA (4 June 2010); (2010) 24 NZTC 24,287 noted at p. 24,312 that:


36. Hammond J went on at [146]-[147] to discuss a statement by the American judge Learned Hand J in Gregory v Helvering 69 F 2d 809 (2nd Cir. 1934) denying the taxpayer in that case the tax benefits that should have arisen as a result of a share reorganisation:


37. The rigorous approach required is the legal analysis likely to be followed by the Courts to discern Parliamentary intention. In Ben Nevis, the Supreme Court's rationale for setting out the approach to be followed in tax avoidance cases was stated as follows:


THE APPROACH SET OUT BY THE SUPREME COURT IN BEN NEVIS

38. The approach set down by the Supreme Court In Ben Nevis at [102-[112] and [46]-[48] is as follows:

1. The Courts must apply a principled approach that gives proper overall effect to statutory language that expresses different legislative policies. The approach must ensure that the particular case before the Court is examined by reference to the respective legislative policies.
2. The approach must enable decisions to be made on individual cases through the application of a process of statutory construction focusing objectively on features of the arrangements involved, without being distracted by intuitive subjective impressions of the morality of what taxation advisers have set up.
3. Neither specific tax provisions nor the general anti-avoidance provision should be regarded as overriding. They must be construed so as to give appropriate effect to each. They are meant to work in tandem. Each provides a context that assists in determining the meaning and, in particular, the scope of the other. They work together.
4. The purpose of specific provisions must be distinguished from that of the general anti-avoidance provision. The presence in the New Zealand legislation of a general anti-avoidance provision suggests that Parliament meant it to be the principal vehicle by means of which tax avoidance is addressed. The general anti-avoidance regime is designed for that purpose, whereas individual specific provisions have a focus that is determined primarily by their ordinary meaning, as established through their text in the light of their specific purpose.
5. Ascertaining when the "line is crossed" should be firmly grounded in the statutory language of the provisions themselves. Parliament must have envisaged that the way a specific provision was deployed would, in some circumstances, cross the line and turned what might otherwise have been a permissible arrangement into a tax avoidance arrangement. Judicial attempts to articulate how the line is to be drawn have in the past too often been seized on as if they were equivalent to statutory language. Judicial glosses and elaborations on the statutory language should be kept to a minimum.
6. A tax avoidance arrangement can be found in individual steps or in a combination of steps. Even if all the steps in arrangement are unobjectionable in themselves, their combination may give rise to a tax avoidance arrangement.
7. A permissible tax advantage must be distinguished from an impermissible tax advantage. At the highest level of generality, a specific provision is designed to give the taxpayer a tax advantage if its use falls within its ordinary meaning. That will be a permissible tax advantage. The general anti-avoidance provision is designed to avoid the fiscal effect of tax avoidance arrangements having a more than merely incidental purpose or effect of tax avoidance. Its function is to prevent uses of the specific provisions that fall outside their intended scope in the overall scheme of the Act. Such uses give rise to an impermissible tax advantage that the Commissioner may counteract.
8. The taxpayer must satisfy the Court that the use made of the specific provision is within its intended scope.
9. The Court must construe the relevant documents in their commercial context, to ascertain the parties' obligations to each other, as if it were determining a dispute between them over the meaning and effect of their contractual arrangements.
10. In proceeding in this way, the Court must also respect the fact that frequently in commerce there are different means of producing the same economic outcome which have different tax consequences. When considering the application of a specific tax provision, before reaching any question of avoidance, the Court is concerned primarily with the legal structures and obligations the parties have created and not with conducting an analysis in terms of their economic substance and consequences, or of alternative means that were available for achieving the substantive result.
11. However, it is the true meaning of all provisions in a contract that will determine the character of a transaction rather than the label given to it.
12. The next question is whether, when viewed in the light of the arrangement as a whole, the taxpayer has altered the incidence of income tax by use of the specific provision in a way which cannot have been within the contemplation and purpose of Parliament when it enacted the provision. If that is so, the arrangement will be a tax avoidance arrangement.
13. The Court is not confined as to the matters which may be taken into account when considering whether a tax avoidance arrangement exists under the general anti-avoidance provision. The Commissioner and the Courts may address a number of relevant factors, the significance of which will depend on the particular facts. It will often be the combination of factors such as these in an arrangement that will be significant:
    • The manner in which the arrangement is carried out will often be an important consideration.
    • So will the role of all relevant parties and any relationship they may have with the taxpayer.
    • The economic and commercial effect of documents and transactions may also be significant.
    • Other features that may be relevant include the duration of the arrangement and the nature and extent of the financial consequences that it will have for the taxpayer.
    • A classic indicator of the use being outside Parliamentary contemplation is the structuring of an arrangement so that the taxpayer gains the benefit of the specific provision in an artificial or contrived way. It is not within Parliament's purpose for specific provisions to be used in that manner.
14. The Courts are not limited to purely legal considerations. They should also consider the use made of the specific provision in the light of the commercial reality and the economic effect of that use. The ultimate question is whether the impugned arrangements, viewed in a commercially and economically realistic way, makes use of the specific provision in a manner that is consistent with Parliament's purpose. If that is so, the arrangement will not, by reason of that use, be a tax avoidance arrangement. If the use of the specific provision is beyond Parliamentary contemplation, its use in that way will result in the arrangement being a tax avoidance arrangement.
15. Care must be taken when applying English cases in the New Zealand context. To the extent that they have, over recent decades, adopted a more purposive approach to interpretation of tax legislation, English decisions, although not concerned with the reconciliation of potentially conflicting provisions, can provide helpful insights. The purposive approach is, however, limited in the extent to which it can avoid arrangements on its own. Such an approach is reinforced in New Zealand by the presence of the general anti-avoidance provision.

39. The Supreme Court noted that Courts should not strive to create greater certainty than Parliament has chosen to provide. Parliament has left the general anti-avoidance provision deliberately general. The approach outlined, in the Supreme Court's view, gives as much conceptual clarity as can reasonably be achieved. The Supreme Court felt that in most cases it will be possible, without undue difficulty, to decide on which side of the line a particular arrangement falls.

40. The detailed approach set out above was summarised as follows by Heath J in Alesco at [86]:

1. An "arrangement" must exist, into which a taxpayer has entered;
2. The "arrangement" must use specific provisions of the tax legislation to effect its purpose;
3. The purpose or effect for which the specific provisions of the legislation have been used must fall outside those contemplated by Parliament; (Justice Heath stated that this third element appears to be derived from the definition of "tax avoidance arrangement");
4. The use of the specific provisions for a purpose or effect outside Parliament's contemplation must result in a tax advantage producing purpose or effect that is more than "merely incidental".

WHAT IS AN ARRANGEMENT

41. The statutory definition of "arrangement" has been set out in paragraph 8.

42. There does not need to be an enforceable contract in order for there to be an arrangement. The Court of Appeal in Penny and Hooper had this to say about "arrangement":


43. An arrangement can consist of an individual step in a series of steps. In Ben Nevis the Supreme Court, described a tax avoidance arrangement as follows:


44. An arrangement remains so even if the decisions and steps constituting it are varied from year to year. On behalf of the majority in the Court of Appeal in Penny and Hooper, Randerson J stated:


45. The Supreme Court stated in Penny and Hooper that there could be a tax avoidance arrangement in one year and not in another, depending on the purpose or effect on each occasion:


46. In Penny and Hooper, the essential elements relied on by the Commissioner as constituting the tax avoidance arrangement were stated in the Court of Appeal judgment at [71] as follows:

1. The decisions of the taxpayers in the relevant income years to operate their private practices through the company and family trust structure.
2. The decisions by the relevant companies and the individual taxpayers to pay the respondents a salary that was substantially less than a commercially realistic salary.
3. Channelling the company profits to the trusts and allowing the taxpayers to have the benefit of those funds without deriving such funds as their personal income.
4. In Mr. Penny's case, the decision to advance funds to him from the trust which enabled him to access those funds for his personal benefit.

47. In Krukziener it was held that there was an arrangement resulting from the loans to Mr. Krukziener from various trusts and companies. Courtney J observed:


COMPLIANCE WITH SPECIFIC PROVISIONS

48. Where there is found to be an arrangement, the general anti-avoidance analysis proceeds to determining whether the use of the specific tax provisions (that have been relied on) is within the intended scope of those provisions. This was the rule set down by the Supreme Court in Ben Nevis:


49. When considering whether the specific provisions have been complied with, the approach set down by the Supreme Court in Ben Nevis is as follows:


50. In Glenharrow the Supreme Court accepted that the specific provisions of the GST Act were satisfied because the parties were at arm's length:


51. In Ben Nevis the requirements of the specific provisions that allowed depreciation of the license premium were satisfied:



52. In Penny and Hooper the requirements of the specific provisions that allowed the taxpayers to determine the salaries they received from their private companies were satisfied. The Supreme Court stated:


53. Similarly, in White both the Taxation Review Authority and the High Court accepted that the specific provisions were met. In the High Court Heath J stated:


54. In Krukziener also it was undisputed that the specific provisions had been complied with:


55. And similarly, in Alesco:


THE CHOICE PRINCIPLE: ENDORSED WITH QUALIFICATIONS

56. As noted previously in paragraph 49, in Ben Nevis the Supreme Court accepted that there may be different ways of achieving the same economic outcome, and the review of adherence with specific provisions should look at the actual means adopted:


57. However, further in Ben Nevis the Supreme Court cautioned that the taxpayer's choice may be curtailed by the general anti-avoidance provision:


58. In MacNiven v Westmoreland Investments Ltd (HMIT) [2001] UKHL 6; (2001) BTC 44, Lord Hoffman in the House of Lords judgment quoted the 'celebrated passage' by Lord Greene MR in IR Commrs v Wesleyan and General Assurance Society (1946) 30 TC 11 p. 16, at [60]:


59. In Ben Nevis the Supreme Court referred at [193]to Richardson J's famous dictum in the Court of Appeal judgment in Challenge Corporation v C of IR (1986) 8 NZTC 5,001:


60. Similarly, in the context of the GST Act, Robertson J in the Court of Appeal judgment in Glenharrow Holdings Limited v C of IR (2007) 23 NZTC 21,564 stated:


COMPLIANCE WITH THE GENERAL ANTI-AVOIDANCE RULE

61. Where the specific provisions have been properly complied with, following the Supreme Court's approach in Ben Nevis:


62. The Supreme Court made it clear in Ben Nevis that the Courts are not limited to purely legal considerations when considering general anti-avoidance:


CROSSING THE LINE: PERMISSIBLE VS IMPERMISSIBLE ARRANGEMENTS

63. The distinction between a permissible arrangement and a tax avoidance arrangement depends on the way in which the specific provision is used. In Ben Nevis the Supreme Court said:


64. In the Court of Appeal judgment of C of IR v BNZ Investments Limited [2001] NZCA 184; (2001) 20 NZTC 17,103, Richardson P stated:


65. Crossing the line in a GST context was considered by the Court of Appeal in Glenharrow:


66. Hammond J, in his judgment concurring with the majority Court of Appeal judgment in Penny and Hooper referred at [156] to "another of the succinct observations of (American judge) Learned Hand J in Gregory v Helvering as to the choice principle" as follows:


67. The Supreme Court in Penny and Hooper defended the taxpayers' right to choose as follows:


68. The problem in Penny and Hooper was stated as follows by Hammond J in the Court of Appeal:


69. In Alesco Heath J commented on the use of the OCNs as follows:


70. Taxpayers are therefore free to choose how they structure their arrangements and they are free to alter the incidence of their tax liability as a result of doing so. They are not, however, allowed to "cross the line" which can be drawn between the use of specific provisions that are within the purpose and contemplation of Parliament and those that are not.

71. The limitation of the choice principle was nicely summarised by Hammond J in the Court of Appeal in Penny and Hooper when he described the approach adopted by the US Federal Courts:


WHEN ALTERING THE INCIDENCE OF TAX IS PERMITTED

72. The Supreme Court in Ben Nevis stated at [113]-[114] that the use of specific provisions that alter the incidence of tax is permitted in two situations:

• The first situation where an alteration in the incidence of tax is permitted is when the specific provision is used in a manner that is within Parliamentary contemplation.
• The second situation where an alteration in the incidence of tax is permitted is when the tax avoidance purpose or effect of the arrangement is "merely incidental" (following paragraph (b) of the definition of a "tax avoidance arrangement" – see paragraph 7 above). If that is so, the arrangement is not a tax avoidance arrangement.

73. As already noted in paragraph 3, the Supreme Court took the view that it will rarely be the case that the use of a specific provision in a manner which is outside Parliament contemplation could result in the tax avoidance purpose or effect of the arrangement being merely incidental.

THE CHALLENGE HERITAGE AND THE ENGLISH PURPOSIVE APPROACH

74. The Supreme Court in Ben Nevis commented on the use of the English purposive approach to identify a permissible tax advantage when a specific provision is used in a manner that is within Parliamentary contemplation:


75. In reading down the English purposive approach and identifying a clear distinction between compliance with specific provisions and compliance with the general anti-avoidance rule, the Supreme Court appears to have been significantly influenced by the purposive approach apparently adopted by the Court of Appeal in Challenge Corporation v C of IR (1986) 8 NZTC 5,001 and the subsequent different interpretation placed on the purposive approach by the Privy Council in the same case: C of IR v Challenge Corporation [1986] UKPC 45 (20 October 1986); (1986) 8 NZTC 5,219. The Court of Appeal held that the general anti-avoidance section was not applicable because the specific provisions had been properly complied with. The Privy Council's view was that the general anti-avoidance section overrode compliance with the specific provisions, and legal compliance with the specific provisions did not exclude the application of the general anti-avoidance section if, when an arrangement is viewed in the light of its overall commercial outcome, a tax avoidance purpose or effect is more than merely incidental.

76. In Ben Nevis the Supreme Court referred, at [87], to the following famous dictum of Richardson J in the Court of Appeal judgment in Challenge:


77. The problem with the approach adopted by Richardson J in Challenge, as the Supreme Court noted in Ben Nevis, was that:


78. The Supreme Court noted with approval, at [92], the rejection of this argument by the Privy Council and quoted Lord Templeman as follows:


79. The crucial aspect of the Privy Council's judgment in Challenge in the Supreme Court's view was the finding that there was a failure to construct the transaction in a way that met the purpose of the specific provision of the legislation. That element of the transaction meant that the general anti-avoidance section applied to strike down the arrangement which otherwise complied with the specific provision. The Privy Council in Challenge did not accept that on a purposive approach the application of (the general anti-avoidance provision) could be limited in a way that ignored the economic reality of the transaction as contemplated by the specific provision. In essence, the reasoning of the Privy Council in Challenge required the commercial reality of a transaction to be consistent with its legal form.

80. The Supreme Court appears to have reconciled these conflicting views by elevating Lord Templeman's views in the Privy Council in Challenge Corporation to the second stage of the general anti-avoidance analysis.

81. There are two conclusions that can be drawn here:

1. First, a purposive approach can be helpful in determining whether an arrangement is within the purpose and contemplation of Parliament insofar as adherence to the relevant specific provisions is concerned. The Supreme Court referred to the approach being reinforced by the presence of the general anti-avoidance provision.
2. Second, an arrangement that may not be tax avoidance based on the purposive approach alone, could be found to be tax avoidance under the general anti-avoidance provision. This will be so when the tax avoidance purpose or effect of the arrangement is more than merely incidental. English case precedents cannot be used per se to argue that there has been no tax avoidance.

82. The English purposive approach focuses solely on the purpose for which a particular provision was enacted, given that there is no separate general anti-avoidance provision in the English legislation. Hence the limitations referred to by the Supreme Court, which implies that the English purposive approach does not go far enough when considering the overall economic effects of an arrangement. The various doctrines and rules developed over the years by the English Courts limit the extent to which the overall commercial outcome of an arrangement can be examined in the light of Parliament's contemplation and purpose when the specific provision was enacted.

83. The issue that the Supreme Court wants Courts at first instance to address is: what did Parliament intend when enacting a particular provision, which will determine whether a series of legal transactions will be ignored on the basis of the commercial outcome. Where the specific tax provision relates to a commercial outcome, Parliamentary intention should be discerned on the basis of the commercial outcome. In this regard, the more recent English cases remain useful as a first point of reference. As Lord Hoffman said in Westmoreland Investments:


84. A New Zealand example of this is the circumstances in which a tax liability arises upon the forgiveness of debt under the financial arrangements rules. In a commercial sense, there is no income in such circumstances. However there will be a tax liability that is unrelated to the commercial outcome. If there is no forgiveness of debt there will be no tax even if the debt remains unpaid and may not be able to be repaid.

85. In Westmoreland Investments , Lord Nicholls of Birkenhead referred to the decision in Ramsay (WT) Ltd v IR Commrs [1981] UKHL 1 (12 March 1981); (1982) AC 300 and noted at paragraphs 2 - 5 that Ramsay brought out three points in particular:


86. Lord Nicholls went on to state:


87. Also in Westmoreland, Lord Hoffman when discussing the Ramsay case stated:


88. Lord Hoffman then discussed Lord Wilberforce's judgment in Ramsay as follows:


89. Further on in Westmoreland at [36] Lord Hoffman quoted the judgment of Learned Hand J in Helvering v Gregory when, in holding that the transfer of shares from a company to its subsidiary in that case did not fall within the terms of the statutory exemption, he stated:


90. The English purposive approach can be reconciled with the New Zealand Supreme Court's approach to some extent by reference to Lord Hoffman's comments later in Westmoreland when he discusses the McGuckian case. In McGuckian the right to receive a dividend was assigned in consideration of the payment of a sum equal to 99% of the expected dividend. Lord Hoffman stated:


91. In Glenharrow and Ben Nevis the giving of the promissory notes failed to create a payment that was effective for GST and tax depreciation purposes, respectively. In Penny and Hooper the reduced salaries were not recognised as legitimate means of increasing the companies' profits and in Krukziener income was derived as a result of the interest-free loans. In Alesco the option element of the OCNs failed to create a loan advanced at a discount. However, the reason advanced by the Courts in all of these cases was the application of the general anti-avoidance provision, and not the specific fiscal concept involved.

92. The limits of the English purposive approach can be discerned from the following statements by Lord Hoffman in Westmoreland:


in Norglen Ltd v Reeds Rains Prudential Ltd (1999) 2 AC 1, at pp. 13-14:


93. The Supreme Court effectively endorsed the focus on "the true construction of the statute" in Ben Nevis:


94. However, it is the last sentence in the quote from Lord Hoffman (emphasised) above where the New Zealand Supreme Court has decided that the New Zealand legislation diverges from the UK legislation. The Supreme Court has made it clear that in New Zealand we do have a penumbral spirit in the form of a general anti-avoidance provision. In effect, the Supreme Court has required a purposive approach to be taken in relation to the application of the general anti-avoidance provision itself – i.e. a review of the economic and commercial outcome of an arrangement in light of Parliament's purpose in enacting section BG 1 read in the context of the scheme and purpose of the tax legislation as a whole.

MERELY INCIDENTAL PURPOSE OR EFFECT OF TAX AVOIDANCE

95. The second situation where an alteration in the incidence of tax is permitted is when the tax avoidance "purpose or effect" of the arrangement is "merely incidental" (following paragraph (b) of the definition of a "tax avoidance arrangement" – see paragraph 7 above). If that is so, the arrangement is not a tax avoidance arrangement.

96. The converse of this proposition was stated by the Supreme Court in Ben Nevis:


97. The phrase "merely incidental purpose or effect" requires there to be a "purpose or effect" of tax avoidance which must be "merely incidental".

98. It is generally accepted that "merely incidental" is not a reference to the scale of the tax benefit obtained. There is a useful discussion by Willy DCJ in Case X1 (2005) 22 NZTC 12,001 of what the words "merely incidental" mean in the context of the definition of "tax avoidance":


99. "Purpose or effect" was considered by the Supreme Court in Glenharrow in the context of section 76 of the GST Act:


100. What is required of the Commissioner and the Court is to ask what objectively was the purpose of the arrangement, which in turn requires examination of the effect of the arrangement. In Glenharrow the Supreme Court referred to Newton v Commissioner of Taxation of the Commonwealth of Australia (1958) AC 450 at p 465 where Lord Denning said that in the phrase "purpose or effect", in the Australian general anti-avoidance provision of that time, the word "purpose" meant not motive but the effect which it was thought to achieve – the end in view:


101. Among the recent cases reviewed: Glenharrow, Ben Nevis, White, Krukziener, Penny and Hooper and Alesco, the only case in which the tax avoidance purpose or effect was held to be merely incidental was in White, where Heath J stated:


102. As a final note, it is worth mentioning that the distinction between tax mitigation and tax avoidance has no bearing on the analysis. In noting that the distinction is now seen as conclusory and unhelpful, the Supreme Court appears to have adopted the reasoning of Lord Hoffman in Westmoreland:


ARTIFICIALITY: TAX AVOIDANCE MORE THAN MERELY INCIDENTAL

103. If an arrangement has a purpose or effect of tax avoidance, the question is whether such a purpose or effect is merely incidental. It is when looking at this aspect that the Supreme Court has sanctioned the Courts going beyond purely legal considerations, and looking at the commercial reality and the economic effect of the use of specific provisions. Other non-tax avoidance purposes or effects will be important. But the artificiality of the arrangement, if any, will be a crucial determinant of whether the arrangement amounts to tax avoidance.

104. The focus is on contrivance, as the Supreme Court noted in Penny and Hooper:


105. In this respect, the Supreme Court's approach is not significantly different from Lord Brightman's statement in Furniss v Dawson & Ors (1984) BTC 71; (1984) AC 474, at 527, of the conditions under which the commercial nature of a transaction as a whole would transcend the juristic individuality of its parts:


106. In Westmoreland Investments Lord Hoffman discussed Furniss v Dawson and noted at [49] that before one can apply Lord Brightman's words, "it is first necessary to construe the statutory language and decide that it refers to a concept which Parliament intended to be given a commercial meaning capable of transcending the juristic individuality of its component parts." (emphasis added)

107. In Glenharrow the Supreme Court stated:


108. In Ben Nevis the Supreme Court stated:


109. And in Penny and Hooper the Supreme Court said:


110. In Alesco Heath J noted that:


111. In Ben Nevis the Supreme Court at [96] quoted the joint judgment of Richardson P, Keith and Tipping JJ in C of IR v BNZ Investments Limited [2001] NZCA 184 (22 May 2001); (2001) 20 NZTC 17,103:


112. The Supreme Court then stated:


113. In Glenharrow, after noting that the arrangement "produce(d) an artificial effect with consequent tax advantage, contrary to all economic reality", the Supreme Court concluded that:


114. In Ben Nevis the Supreme Court after noting that "the giving of the promissory note had no necessary business connection with (the 50 year) period" stated:


115. In Penny and Hooper the Supreme Court stated:


116. In Alesco Heath J stated:


ECONOMIC COST

117. The question of the actual economic cost to the taxpayer(s) features strongly in all of the recent tax avoidance cases. As Lord Templeman stated in the Privy Council in Challenge Corporation:


118. In Glenharrow a GST input tax deduction was denied because the price payable "[53]… had no.. reality as a 'cash' transaction despite being structured as if it were".

119. In Ben Nevis:


120. In Penny and Hooper:


121. In contrast, White "[71]… was a case in which salary was not paid because the company lacked funds to do so".

122. In Krukziener Courtney J stated:


123. In Alesco Heath J stated:


UNFAIRNESS TO THE GENERAL BODY OF TAXPAYERS

124. In the Privy Council judgment in Challenge Lord Templeman said:


125. A little further on in Challenge, Lord Templeman said:


126. Lord Templeman then compared the advantage gained by tax avoiders over other taxpayers as follows:


127. The reasoning of the Supreme Court in Penny and Hooper followed similar lines when comparing the situation in that case to that in Hadlee and Sydney Bridge Nominees Ltd v Commissioner of Inland Revenue (1991) 13 NZTC 8,116 (CA):


RESTRUCTURES ARE MORE LIKELY TO BE CLASSED AS TAX AVOIDANCE

128. New Zealand Courts have historically been much more inclined to treat restructuring of existing business arrangements which result in a lower income burden because of rate differentials (giving rise to "income splitting") as avoidance. The line of cases in this area include Elmiger v CIR (1967) NZLR 161, Marx and Carlson v CIR [1970] NZLR 182, Mangin v CIR [1971] NZLR 591, Wisheart McNabb and Kidd v CIR [1972] NZLR 319, Udy v CIR [1972] NZLR 714, McKay v CIR [1973] 1 NZLR 592, Gerard v CIR [1974] 2 NZLR 279, Ashton and Wheelans v CIR [1975] 2 NZLR 717, Halliwell v CIR (1977) 3 NZTC 61,208, and of course, most recently Penny and Hooper (reference in paragraph 4).

129. Marx and Carlson, Mangin and Gerard are "paddock trust" cases where the farmer leased off valuable crop land to the family trust while no "real" change occurred to how the farm, including the crop production itself, was operated by the farmer. The Wisheart and McKay cases concerned lawyers who restructured their practices so that assets formerly belonging to the law firm or partner became owned by a family trust. Halliwell's case involved a restructure of a dentistry practice into ownership by a family trust.

130. Noteworthy however, is that there was no tax avoidance despite a restructure in White because, as Heath J noted:


INLAND REVENUE REVENUE ALERT: NON-MARKET SALARIES

131. On 1 September 2011 Inland Revenue released Revenue Alert RA 11/02. The issue addressed was: Diverting personal services income by structuring revenue earning activities through an associated entity such as a trading trust or a company: the circumstances when Inland Revenue will consider this arrangement is tax avoidance.

132. Inland Revenue states that:


133. Inland Revenue states that where income is generated from the supply of services provided by individuals a combination of some or all of the following factors may result in an investigation:

1. The controllers of a business arrange for an entity, such as a trading trust or company, to operate and own their business. The operating entity engages or employs them (or contracts for their services).
2. Where the business has been transferred, the business operates substantially as it did before its transfer to the operating entity.
3. The business may not in substance be operated according to the terms of the arrangements entered into. This includes examining the agreements themselves, the manner in which they are actually implemented and also whether the overall arrangement is commercial having regard to a comparison with relevant standard business practices.
4. The degree to which the individual service providers or their families ultimately control the entity, its economic product and cash flows from the business.
5. Whether there is a redistribution of the underlying income from the entity to the person or to family members, usually via a trust but there are other mechanisms, for example, by way of employment of the family members perhaps at inflated salaries, or related party loans or the payment of management and other service fees to associates.
6. The extent to which, as a consequence of the arrangement, significant tax benefits are obtained e.g. where the entity and/or any beneficiaries or shareholders pay lower marginal tax rates than would have been payable by the taxpayer, but for the arrangement.

134. Inland Revenue agrees that there may be particular reasons as to why the controllers of the business may not be adequately remunerated in a particular year. Examples of this include:

• Adverse business conditions mean that the business profits are down but most of those profits are still paid out to the individual service providers.
• It is financially prudent to retain some profits in the business because it is anticipated that the business may experience financial difficulties in the future.
• The profits are set aside to acquire business assets in the next financial year.
• The business relates to a charity and the individual receives less to ensure the charity's return is maximised.

135. These examples follow the exceptions discussed by Randerson J in the Court of Appeal in Penny and Hooper:


136. The reasons discussed at [98] to which Randerson J referred were as follows:


137. Inland Revenue accepts there may be other non-tax reasons why a business may pay the individual less than an arm's length party would receive over the short term. However, in those circumstances, Inland Revenue would accordingly expect to see no significant distributions being made to entities associated with the individual.

138. The full text can be accessed at: Revenue Alert RA 11/02

INLAND REVENUE DRAFT INTERPRETATION STATEMENT: SECTION BG 1

139. In February 1990 Inland Revenue released its Policy Statement on the predecessor to section BG 1, section 99 of the Income Tax Act 1976 ("the 1990 Policy Statement"). In September 2004 Inland Revenue released a paper entitled "Interpretation of sections BG 1 and GB 1 of the Income Tax Act 2004 – Exposure Draft for External Consultation". On 16 December 2011 Inland Revenue released its latest Draft Interpretation Statement on the application of sections BG 1 and GA 1.

140. The 1990 Policy Statement employed a four-step approach to determining whether section 99 should apply. That involved:

• Consideration of the transaction in the context of the scheme and purpose of the tax legislation.
• Evaluating the purpose of the arrangement.
• Inferring whether the tax saving is an incidental purpose or effect.
• Deciding whether the scheme and purpose of the Act has been frustrated by the arrangement.

141. The 1990 Policy Statement included a series of examples.

142. The Exposure Draft issued in 2004 was never finalised, and essentially traversed familiar ground in setting out the analysis likely to be undertaken by Inland Revenue in deciding whether or not a transaction should be attacked under section BG 1. The discussion in the 2004 Exposure Draft has been superceded by the judgments of the Supreme Court in recent years that have already referred to above.

143. On 16 December 2011 Inland Revenue issued Draft Interpretation Statement INS0121 Tax Avoidance and the Interpretation of Sections BG 1 and GA 1 of the Income Tax Act 2007 with a comment deadline of 31 March 2012. Inland Revenue states:


144. The Commissioner takes the view that the relevance of certain previous judicial approaches is limited:

• The "scheme and purpose" approach, to the extent that it is taken to mean that compliance with specific provisions satisfies Parliament's purpose, is not the law.
• The choice principle does not provide immunity from section BG 1.
• Lord Denning's predication test in Newton v FC of T [1958] AC 450 has been dispensed with by legislative amendments and the decision in Ben Nevis.
• The 'new source" doctrine discussed by Lord Diplock in Europa Oil (No 2) v CIR (1976) 2 NZTC 61,066, that the anti-avoidance provision does not apply to a new source of income, will not, of itself, apply to excluded a new source of income from the potential application of section BG 1.
• There is no place in avoidance law for any principle taken from IRC v Duke of Westminster [1936] AC 1 (HL) that a structure that complies with specific provisions cannot be tax avoidance.

145. The Commissioner's approach, following Ben Nevis, to applying sections BG 1 and GA 1 is summarised as follows.

146. Specific provisions are applied first: Section BG 1 is only considered after reaching a view on whether the other provisions of the Act apply or do not apply. Section BG 1 will apply to arrangements that use specific provisions and also arrangements that circumvent provisions. This applies to both general provisions, such as the general deductibility provision, and to specific detailed provisions in the Act.

147. There must be an arrangement: An action or transaction undertaken by one person cannot, by itself, constitute an "arrangement". Two or more documents or transactions may constitute an "arrangement" if they are sufficiently inter-related and/or interdependent. A part of an "arrangement" will be considered separately under section BG 1 only if that part, by itself, satisfies the definition of "arrangement". A taxpayer may be considered party to an arrangement even if the taxpayer did not know some of the details of the arrangement. A taxpayer who is not party to an arrangement may still be subject to the Commissioner's powers of reconstruction. Section BG 1 can apply whether or not the arrangement is carried out or brought into effect in New Zealand.

148. The definition of "tax avoidance" is not exhaustive: The function of the statutory definition is to confirm that certain defined circumstances are not excluded. It is quite possible, for example, for an arrangement that results in payment of more New Zealand tax than would otherwise have been paid, to be a tax avoidance arrangement.

149. It is the objective purpose or effect of the arrangement that matters: Motives and intentions are not relevant. Oral evidence related to the purpose of the parties is irrelevant. In almost all cases the "purpose" and "effect" of the arrangement will be the same.

150. The Parliamentary contemplation test is then applied: Does the arrangement, viewed in a commercially and economically realistic way, make use of the Act in a manner that is consistent with Parliament's purpose? Applying this test involves identifying:

• The tax treatment claimed: The taxpayer will assert that the provisions of the Act apply in certain ways, and it is these outcomes that are tested under section BG 1. The tax outcomes claimed by the taxpayer may relate to provisions that are used, or to provisions it is argued do not apply.
• The commercial reality and economic effect of the arrangement: This requires a complete understanding of the facts and a thorough grasp of the detail and workings of the arrangement as a whole. Suggested matters to be examined closely are cash flows, changes in the parties' economic positions, rights and obligations of the parties and the risks assumed by them. Steps in the arrangement that disguise the actual consequences for the parties, particularly steps that seem artificial or that involve pretence or circularity, are ignored. Commercial reality involves such things as profitability, the viability of a transaction when tax is ignored, and whether anything is obtained in return for a payment. The economic effects concern whether the taxpayer has actually sustained the economic changes claimed. The factual matters that may be taken account of are essentially those identified by the Supreme Court in Ben Nevis (refer to paragraph 38(m)).
• Parliament's purpose regarding the relevant provisions: With some arrangements understanding what Parliament would have contemplated for particular tax provisions may not require a great deal of analysis of the Act itself. With other arrangements, for example where there are a number of parts to the transaction and a number of sections of the Act involved, there would need to be an in-depth analysis of the provisions of the Act and their inter-relationship. The form of the arrangement can be ignored and Parliament's purpose is tested against commercial reality. The test is not to establish what the actual Parliament that enacted the legislation had in mind, but to ask whether, if Parliament had foreseen transactions of this type when enacting the specific provisions used, it would have viewed them as within Parliament's.

151. The relevance of non-tax purposes is considered: Commercial justifications will not displace the section BG 1 inquiry at the stage of considering the Parliamentary contemplation test. Commercial purposes will be relevant:

• Initially when understanding an arrangement.
• When considering whether the arrangement is within Parliamentary contemplation if they are of the nature or within the circumstances Parliament intended for the tax provisions to apply.
• When considering whether a tax avoidance purpose is merely incidental to a commercial or other non-tax purpose of the arrangement.

152. Whether the tax avoidance purpose or effect is merely incidental: A tax avoidance purpose will only be merely incidental if the adoption of the particular structure for the arrangement, including the detail of that structure, can be explained by a non-tax purpose and the tax avoidance purpose follows as a natural concomitant. The magnitude or significance of the tax advantage may be relevant but will not be determinative. Where an arrangement that uses specific provisions in a way not contemplated by Parliament has been structured to gain a tax advantage in an artificial and contrived way, this will also often indicate that the tax advantage has been pursued as a goal in itself and does not naturally follow from another purpose or effect of the arrangement. The fact that an arrangement has the effect of obtaining a tax advantage from another country may be relevant in deciding whether the New Zealand tax advantage is merely incidental.

153. Adjustment under section GA 1: Section GA 1 is a discretionary provision. If voiding an arrangement under section BG 1 is sufficient to negate the tax advantage, it may not be necessary to apply section GA 1. In any case, the adjustment is one the Commissioner thinks is appropriate, and the Commissioner is not under a duty to precisely describe the alternative factual basis for such an adjustment.

154. The Commissioner is not dictating how taxpayers do business: The Commissioner is reaching a view on the real outcomes under an arrangement so that the tax outcomes can be considered against that reality.

155. The Commissioner's view is that certainty is neither possible nor desirable: The Supreme Court in Ben Nevis said that the courts should not strive to create greater certainty than Parliament has chosen to provide. The Commissioner agrees with the statement in Ben Nevis that the approach outlined in that case gives as much conceptual clarity as can reasonably be achieved.

156. There are no examples included, as there were in the 1990 Policy Statement. A very simplistic flowchart is included as the last page. The full text can be accessed at: Interpretation Statement INS0121

RECONSTRUCTION

157. Section BG 1(2) allows reconstruction where there is tax avoidance and provides that:


158. Section GA 1 sets out the Commissioner's adjustment power if an arrangement is void under section BG 1. Section GA 1(2) sets out the Commissioner's general power of adjustment as follows:


159. Section GA 1(3) provides the Commissioner with the specific power to disallow a tax credit of a person affected by an arrangement, or allow some other person to benefit from the tax credit.

160. Section GA 1(4) allows the Commissioner to identify the hypothetical situation which would have arisen in the absence of the arrangement. The Commissioner is allowed to adjust a person's income, deductions, tax loss and/or tax credit based on what, in the Commissioner's opinion, had the arrangement not occurred, the person -

1. would have had; or
2. would in all likelihood have had; or
3. might be expected to have had.

161. The Court has the power to vary an assessment made by the Commissioner as a result of reconstruction, under section 138P of the Tax Administration Act 1994. In Alesco Heath J noted that this power of the Court applies whether or not a formal reconstruction has been undertaken by the Commissioner.

162. Reconstruction was considered in Ben Nevis. In that case, the Commissioner disallowed the whole of the license premium as a deduction. The taxpayers argued that the Commissioner was, in effect, treating the land as if it had been acquired cost-free. The Supreme Court held that the investors had already effectively paid for the land and as the Commissioner was merely disallowing the deduction claimed, the reconstruction was within the scope of the Commissioner's powers.

163. In Glenharrow the Commissioner refunded only the GST fraction of the deposit and further instalments that were paid later. The Supreme Court approved the Commissioner's approach and agreed that no GST fraction was refundable on the portion of the price paid by way of the promissory note.

164. In Krukziener the Commissioner assessed the loans made to Mr. Krukziener as his income and the assessment was upheld by the High Court.

165. In Penny and Hooper the Commissioner made assessments increasing the taxpayers' taxable incomes for the relevant years by the amount equal to the difference between the salaries actually paid and what the Commissioner assessed as commercially realistic salaries for their services. The Supreme Court reached the conclusion that the taxpayers failed to show that the Commissioner had acted incorrectly.

166. In White there was no tax avoidance found so there was no reconstruction.

167. In Alesco there was a question about whether the Commissioner had based his assessment on a reconstruction of the taxpayer's affairs, or as a natural consequence of his assessment. Heath J addressed the question of reconstruction under both heads, but did not determine whether a "reconstruction had actually occurred because there was an insufficient evidential foundation to make that factual determination".

168. In Alesco the taxpayers questioned the approach to reconstruction adopted by the Commissioner. Heath J noted:


169. Heath J's response was as follows:


170. Heath J noted that the Commissioner's decision to reconstruct is to "counteract any tax advantage":


SHORTFALL PENALTIES

171. In Ben Nevis the Supreme Court addressed the question of shortfall penalties in the context of tax avoidance:


172. The Supreme Court considered the nature and purpose of the regime of civil penalties applicable to taxpayers:


173. The Supreme Court noted that there are three requirements to be met before a taxpayer will be found to have adopted an "abusive tax position":

• Firstly, a taxpayer must have taken a tax position which involves an "unacceptable interpretation of a tax law". An unacceptable interpretation is an interpretation or application of that tax law which "fails to meet the standard of being… about as likely as not to be correct" when viewed objectively. Whether an interpretation is unacceptable is determined at the time the tax position is taken by the taxpayer. In the case of positions taken in tax returns, the tax position is taken when the taxpayer provides the return.
• Secondly the tax position must be one that, viewed objectively, is taken by the taxpayer in respect, or as a consequence, of an arrangement that is entered into with a dominant purpose of avoiding tax, whether directly or indirectly. Alternatively, where there is no arrangement, the tax position itself must be taken by the taxpayer for that dominant purpose.
• Thirdly, the provision imposing a penalty for taking an abusive tax position applies only if the tax shortfall arising from the taxpayers tax position exceeds $10,000.

174. In considering whether the taxpayers had taken an "unacceptable tax position" the Supreme Court discussed whether the taxpayers' incorrect interpretation in Ben Nevis failed to meet the standard of, objectively, being "about as likely as not to be correct":


175. As Heath J noted in Alesco, under section 141B(7) of the Tax Administration Act 1994 the Court is required to have regard to all relevant tax laws and any judicial decisions interpreting them issued up to one month before the taxpayer took its tax position.

176. In both Ben Nevis and Alesco, the Courts found that the taxpayers had taken unacceptable tax positions because their interpretations failed to meet the standard of being about as likely as not to be correct if the potential application of the general anti-avoidance rule had been taken into account.

177. The taxpayers' defence in both cases centred around what is referred to as "the Europa 2 principle" (stemming from a statement by Lord Diplock in Europa Oil (NZ) Ltd v Commissioner of Inland Revenue [1976] 1 NZLR 546 (PC)) to the effect that a "legal entitlement gained under a contract from expenditure qualifies that expenditure for deductibility under a tax law" and "a general anti-avoidance provision cannot apply to bar the deduction".

178. The Supreme Court stated that the Courts have since adopted a narrow view of Lord Diplock's observations and based on subsequent cases, it was extremely unlikely that an argument based on the Europa 2 principle could succeed. Consequently, it was more than likely that the general anti-avoidance provision could apply to deny the deductions.

179. In the Supreme Court's view, an accurate summary of the legal position was made by Baragwanath J in Miller v Commissioner of Inland Revenue (1997) 18 NZTC 13,001 (HC) when he said:


180. In both Ben Nevis and Alesco the taxpayers where considered to have taken an abusive tax position because the arrangement in each case was entered into with a dominant purpose of avoiding tax.

THE BURDEN OF PROOF LIES WITH THE TAXPAYER

181. In Ben Nevis the Supreme Court stated:


182. Similarly, in Glenharrow in relation to the operation of section 76 of the GST Act, the Supreme Court stated:


183. Section 149A(2) of the Tax Administration Act 1994 states that:


184. It should be clear from the above that if the Commissioner alleges that there has been tax avoidance, it is always up to the taxpayer to convince the Commissioner otherwise. Where the Commissioner remains unconvinced, the taxpayer must either reach an agreement with Inland Revenue or will end up having to prove in Court that there has been no tax avoidance.

185. The onus is also on taxpayers to demonstrate that a reconstruction was wrong and by how much it was wrong. In Ben Nevis the Supreme Court noted: