Challenge wins S2.8M tax appeal

Press, 26 December 1985, Page 15

Challenge wins S2.8M tax appeal

PA Wellington The Court of Appeal, in a majority decision, has allowed transactions by the Challenge Corporation, Ltd, in which the tax saving will benefit Challenge and the vendor by about ?2.85M, to stand for tax purposes. The Court, in accord with the judgments of Mr Justice Cook and Mr Justice Richardson, dismissed an appeal by the Commissioner of Inland Revenue. The President of the Court, Sir Owen Woodhouse, in a dissenting judgment, said he was of the opinion that the appeal should be allowed and the assessment of the Commissioner reinstated.

In his judgment, Sir Owen said that on February 28 Challenge Corporation knew that the group of companies it owned would achieve a substantial profit for the income tax year about to

end on March 31. So it purchased from Merbank, Ltd (in liquidation), all the shares in a commercially moribund company called Perth Property Consultants, Ltd.

It did so because earlier in the same year Perth had suffered an income loss exceeding SS.BM. Challenge’s stated and only purpose in acquiring the shares was to make use of section 191 of the Income Tax Act, 1976, to put the large loss of the interposed company as a deduction against the Challenge Group profit and so reduce the income tax that otherwise would become payable.

Sir Owen said that immediately before the purchase, and as a condition of it, the £S.BM, which was owed by Perth to Merbank, was expunged as a debt by set-off against an equivalent though valueless increase in

Perth’s share capital, the new shares being allocated to Merbank and then included in the purchase by Challenge. The price Challenge paid was 510,000 in cash together with an undertaking to share equally with the ven : dor the net tax benefits expected to arise, “that is after deducting the $lO,OOO and one half of any legal or other costs which might have to be expended in establishing the right to make the deduction when calculating the group’s assessable income.”

Sir Owen said a similar transaction was entered into affecting all the shares of a sister company of Perth. Like Perth, this other company was in liquidation but had incurred the lesser income loss for the year of about $484,000. In the ordinary or conventional sense neither com-

pany had any commercial value at the time of the transaction , nor any prior association with Challenge. “Nor was any attempt made to bring either to life as a commercial reality after the transaction,” Sir Owen said. “In each case, rather like the grin left behind by the Cheshire cat, all that remained was the record of a handsome loss.” Sir Owen said the question was whether these transactions could stand for tax purposes, in which case the tax saving would benefit Challenge and the vendor by about $2.85M, or whether by reason of section 99 of the Income Tax Act (the tax avoidance provision) the arrangements were to be regarded as absolutely void against the Commissioner of Inland Revenue. “For the reasons which follow I am satisfied that they are caught by the provision,” Sir Owen said. “It is right to add that the transactions themselves and the uncomplicated tax purpose for embarking upon

them were brought at once to the direct attention of the commissioner by Challenge itself.” Sir Owen said that clearly section 191 of the Income Tax Act was a specialised provision of the act designed as part of the statutory accounting processes which were to be used or made permissible when calculating the nature and extent of deductions to be set against gains for the purpose of calculating the assessable income upon which tax would be payable. “The broad submission made in the present case is that the tax benefit sought by Challenge is justified because the transaction which brings it about is the result of meticulous attention to section 191 and so within its express contemplation,” he said. “It is said as well, that based simply on the tax to be saved the purchase of the loss-making company by itself gives a commercial meaning to the transaction, that without more, such an arrangement had not merely a tax saving but a truly business purpose.” At the end of his 27-page judgment, Sir Owen said he was of the opinion that the appeal should be allowed and the assessment of the Commissioner reinstated. But, in accord with the decision of the majority, the appeal was dismissed with costs to the Challenge Corporation of $2500. Mr Justice Cooke, in his judgment, said he thought that the short answer to the present case was that section 191 itself contained what counsel for the Commissioner described, “accurately in my opinion,” as an anti-avoidance provision. “The section enables the horizontal" spreading of losses within a group of companies,” he said. “Broadly- speaking, it gives a company within a group a right to elect that losses incurred by it be deducted from the assessable income derived by other companies in the group. “In its form at the material time, and still

material time, ana stui more so in the form in which it now stands, the section defines the circumstances in which such an election can be made with considerable elaboration.”

Mr Justice Cooke said that where a particular section conferring tax concession dr rights had its own anti-avoidance provision (and there were other instances in the Income Tax Act) the preferable inference seemed to him to be that the special provision was exhaustive in its own field.

“Within that field a taxpayer is entitled to assume that he has a right to order his affairs to take advantage of the benefits conferred by the section, provided only that he does not fall foul of the special provision,” he said. Mr Justice Cooke said he would dismiss the appeal. Mr Justice Richardson, in his judgment, said section 191 reflected a particular tax concept and it established tax norms by which the statutory liability to income tax in the specific area of its application was to be determined.

In particular, and as it stood in 1978, it specified the membership of a group fixed as at the end of the year as the yardstick and it contemplated that changes in the tax position of the group might be achieved by the taking of steps to bring a loss company with the group by and on that particular day.

“In allowing the Commissioner to ignore such a change in shareholding only if it were ‘of a temporary nature’ the legislature must be taken to have accepted that permanent changes in shareholding which resulted in compliance with the section were not susceptible to independent challenge,” Mr Justice Richardson said.

“On this analysis of the role of section 191 in the statutory scheme and of the terms of the provision itself I am satisfied that to treat the arrangements carried through in this case as tax avoidance within section 99(1) would defeat, not promote the legislative purposes involved.”

Mr Justice Richardson said the tax changes achieved in the transactions did not alter the incidence of income tax which the act itself contemplated or affect Challenge’s liability for income tax in the sense indicated by the statute.