2010 - Looking Back
2010 saw a reasonably large number of changes to the taxation system in this country and legislative proposals that have been proposed in Bill form but will not take effect until 2011 if passed. The most striking change was the rate increase for GST from 12.5% to 15% and arguably the most significant prospective changes are contained in the 10 December 2010 Taxation (GST and Remedial Matters) Bill 2010 which will change the way in which land transactions are returned for GST purposes.
The thinking behind the GST rate rise was to compensate the government for the corresponding lowering of income tax rates. The transition has gone very smoothly helped in part by transitional rules.
The thinking behind the proposed change in the way land transactions are returned for GST purposes stems from a 2008 Officials Paper called Options for strengthening GST Neutrality in business to business transactions. In that paper officials explained how the tax base was being eroded through the payment of refunds to GST registered persons in circumstances were the corresponding output tax obligations were never met. On a more concrete level the following risk areas were identified as being situations were neutrality was being compromised:
- Phoenix Companies. By this it its meant companies that claim input tax credits typically on the acquisition of land for development purposes and the cost of building but then do not return the GST output tax on the sale of the land. This can occur because the vendor company deliberately winds up or is placed in a position where it has no funds. The developer may reappear trading through another company and repeat the process.
- Surrounding the transfer of businesses. In this regard the going concern provisions are complex and it often transpires that the contractual conditions necessary for zero rating to apply are subsequently found not to apply with the consequence that the transactions transpires to in fact be a taxable transactions but there are now difficulties in financing the GST obligation.
It was not that there were not remedies to these problems under the former legislation. There was obviously the ability of the Department to prosecute where there was fraud and there was the ability to turn to the general anti avoidance provisions. Ordinarily litigation can be analogised to be like a “retail” solution to a problem but where the problem is endemic a “wholesale” solution needs to be found and hence the government decided to legislate to fix the problem.
The 10 December 2010 Bill will have the following effects as mentioned from 1 April 2011 if passed. In broad terms it will require vendors who are GST Registered to charge GST at the rate of 0% on any transactions with other registered persons where the transaction involves the sale of land or a component of the transaction involves land. By classifying these transactions as taxable at 0% the purchaser is deprived of the ability to obtain a GST refund and hence the issues identified above with phoenix companies are effectively dealt with.
This rule is intended to only apply where both parties are GST registered. Where the purchaser is not GST registered the 0% rule does not apply. Rather the existing rules will apply. The other exception to the application of the proposed rules is when the purchaser acquires land to be used as a principal place of residence either by them personally or by a family member.
Clearly the definition of land is important to the application of these rules. Consequently the definition of land includes shares in flat owning or office owning companies. In this regard the wording of the definition is taken from s 121A of the Land Transfer Act 1952. Additionally, there are exclusions surrounding leases. Thus lease arrangements where the supply is made periodically and where the land concerned involves 25% or less than the consideration specified in the agreement are excluded from the definition of land.
The Finance and expenditure select committee recommended enacting a s 11(8B) which would have the effect of making it clear that the test for zero rating will apply at the date of settlement. There is also a recommendation to allow for vendors to adjust the GST to correct the position post settlement and hence recover any GST that they may owe the IRD as a result of the zero rating classification being wrong. Correspondingly the purchaser will be treated as having received a standard rated supply. These changes were proposed by the Committee and are intended to be made to s 25 and s 5 of the GST Act.
The Committee has recommended making changes to s 78F of the GST Act. This proposed change is to impose obligations on the purchaser to provide information to the vendor as to whether the zero rating is applicable. The intention is that the purchaser must provide a written statement regarding their GST status and their intended use of the land. The idea is that the vendor can then rely on this information in classifying the supply as zero rated or not. That information is intended to be provided by the time of settlement.
Another interesting aspect of the Bill is that it has provisions intended to clarify the position with respect to transactions which involve nominees. That is where say the purchaser nominates a third party to receive the land under a sale transaction. There has been ongoing discussion by commentators as to whether this situation involves one supply from the vendor to the nominee or whether there are two supplies – the first from the vendor to the purchaser and the second from the purchaser to the nominee. The proposed solution to this are rules that would determine the number of supplies by the economic substance of the transaction. In responding to this issue the Committee has recommended amending s 60B and inserting a subsection 60(5B) of the GST Act. The new subsection would apply to transactions involving land and would have the effect of treating the supply as being from the vendor to the ultimate recipient.
This proposal also needs to work in with the obligations on purchasers to provided GST registration status information to the vendor. Hence it is proposed that the purchaser could provide information to the vendor in relation to the nominee on a prospective basis. Thus if it was intended that a company yet to be incorporated was to be the nominee then the purchaser could supply the vendor the relevant GST registration status information prior to the company being incorporated.
On the income tax front the most significant change was the axing of the ability to obtain a depreciation allowance, with respect to a building with a life of 50 years for more. This was a budget night announcement following a certain amount of speculation that the government might act to stop what was widely seen in the popular media as a tax break for owners of rental accommodation.
This has lead to some probably unintended consequences in terms of accounting. In this regard Mark Hucklesby of Grant Thornton has noted that this change does not gel with the new accounting standards dealing with income tax. He has explained that paradoxically there is a requirement for taxpayers using the standard to account for an additional tax expense and deferred liability. This is because the written down tax value of the buildings will be lower than the carrying value of the building. None of that was anticipated by the Government when it made its budget announcements.
The 2010 year saw more litigation in the tax avoidance space. The most interesting case in my opinion was the June Judgment of the Court of Appeal in CIR v Penny and Hopper (2010) 24 NZTC 24, 287. That case was the first of a string of cases dealing with tax avoidance by individuals and small business people as opposed to large corporates like the Banks litigation, which featured so prominently in the 2009 year.
The Penny and Hooper case has been given leave to appeal to the Supreme Court. It will be interesting to what transpires. One school of thought had been that the Supreme Court would be unlikely to grant leave on avoidance case having so recently clarified the law in Ben Nevis Forestry Ventures Ltd v C of IR (2009) 24 NZTC 23,188. The thinking being that because the high level principles had been set each subsequent avoidance case could be seen as merely a situation where the principles had to be applied to the particular facts and hence could not be said to be of major commercial significance.
The other school of thought was simply that the Court of Appeal judgment was wrong and justice required an appeal. Only time will tell whether this view is correct or not.
Whereas the Penny and Hopper case involved Doctors transferring their businesses to companies which were owned by trusts the case of Krukziener v Commissioner of Inland Revenue (No 3) (2010) 24 NZTC 24,563 involved a taxpayer receiving loans from trusts through which he conducted his property development activities. These loans were considered by the Taxation Review authority and the High Court to be in substance salary and part of a tax avoidance arrangement. The taxpayer filed an appeal against the High Court judgment but subsequently was declared bankrupt. Whether the appeal will proceed given the bankruptcy is a matter of some speculation.
While the Penny and Hooper and the Krukziener cases are both examples of the Commissioner successfully asserting the existence of tax avoidance the avoidance cases in 2010 did not all go the Commissioner’s way. For example the taxpayer won in White v CIR. The case before Heath J was an appeal from the decision of Judge Barber reported as Case Z24 (2010) 24 NZTC 14,354. It involved a anaesthetist who worked part time at the hospital and also had a private practice. The anaesthetist had a trust, which owned and operated an orchard. The anaesthetist and her husband obtained tax advice and restructured their businesses and assets. This restructure coincided with the purchase of a second orchard. As a result of the restructure the following situation emerged:
- The trustees of the trust became owners of both orchards.
- A new company, Wharfedale was incorporated and acquired the medical and other equipment needed for the operation of Dr White’s practice.
- Wharfedale obtained a licence to occupy the two orchard sights until it became a lesee from 1 April 2003 and was responsible for the operation of the orchards.
- Wharfedale leased the equipment needed for the conduct of Mr Foster’s business and was responsible for carrying on that business.
- Wharfedale employed Dr White and Mr Foster and they provided the personal services that they had previously provided in their own right but did so now as employees of the company.
This structuring was not held to amount to tax avoidance by the High Court despite the fact that the consequence of the restructure was that the income of the anaesthetist from her personal exertion as a medicinal professional went “un-taxed”. The income went “untaxed” only from a broad brush substance perspective, however. Dr White’s income was in fact absorbed by the losses that the orchard was making. The primary reason why the High Court judge held that the arrangement did not constitute tax avoidance was because it was not contrived or artificial. He accepted the evidence lead to the effect that the events which subsequently lead to no tax being paid were not in fact anticipated, and to the effect that the transaction was explicable in ordinary commercial terms and in terms of family dealing.
The case is a good example of the fact based approach being used to deciding if tax avoidance is present or not. As a consequence of this approach if a judge decides that the arrangement as a matter of fact is not contrived or artificial - that is - that it has legitimate business objectives, then that is the end of the inquiry – avoidance is not present.
This case is being appealed by Inland Revenue. One suspects that the outcome in Penny and Hooper will be influential in whether the appeal is maintained.