Privy Council allows IRD appeal

Press, 22 October 1986, Page 39

Privy Council allows IRD appeal

PA Wellington In a milestone decision likely to affect other corporate take-overs, the Privy Council in London has allowed an appeal by the Commissioner of Inland Revenue against Challenge Corporation, Ltd, for avoiding tax through a take-over in 1978. The decision — by a majority of the Lords of the Judicial Committee of the Privy Council — was delivered to the Inland Revenue Department. It reverses decisions by both the High Court and Court of Appeal in New Zealand, which had found in favour of Challenge. The law lords’ decision restores tax assessments made on Challenge in March, 1980, and awards costs to the Commissioner of Inland Revenue The decision was welcomed by the Commis.sioner of Inland Revenue, Mr John Simcock, as good news for taxpayers, which was likely to be helpful. The Challenge case was a perfect example of where a “shell” company was taken over for the purposes of tax avoidance, Mr Simcock said. The department had a few other cases in the pipeline it would now have to consider in the light of the. decision. “Where we go from here has yet to be decided,” he said. Fletcher Challenge’s Group taxation manager, Martin Farell, said the company was naturally disappointed at the decision, having earlier won the case in the High Court and Court of Appeal. He said he could not comment any further because Fletcher Challenge, Ltd, had not yet received a copy of the full decision. The Parliamentary under-secretary to the Minister of Finance, Mr Trevor de Cleene, welcomed the decision and its dealing with “share machinations” and the purchase of tax losses. Regardless of the actual case, the practical effect of the ruling was farreaching, he told NZPA. Successive court decisions in Australia and New Zealand had begun to “whittle away” the section of the Income Tax Act dealing with tax avoidance. But the Privy Council decision showed a swing back to the position that Parliament had intended when passing the legislation, making clear that technical arrangements which had no reality in commercial practice should not be used for tax

avoidance purposes. The Challenge case revolved around the take-over on February 28, 1978, of Perth Property Developments, Ltd, by Challenge Corporation. Challenge paid Merbank Corporation, Ltd, $lO,OOO for Perth, which was then carrying a tax loss of $5.8 million. The purpose of the agreement, according to the Privy Council decision, was to reduce Challenge’s tax liability by $2.85 million. But Inland Revenue contended that section 99 of the Income Tax Act 1976 applied, making the contract between Challenge, Perth and Merbank void. Section 99, previously untested this far in law, says any contract shall be void if its purpose is to reduce any liability to income tax. Challenge argued, however, that section 191 — which allows losses to be transferred within a group of companies — applied, notwithstanding section 99. The majority decision described the facts of the case as “starkly simple.” “Perth appears to have had no assets and no debts. The only purpose of the agreement dated February 28, 1978, was <tax avoidance.” “... Whatever the circumstances or complications, if a taxpayer asserts a reduction in assessable income, or if a taxpayer seeks tax relief without suffering the expenditure which qualifies for such relief, then tax avoidance is involved and the Commissioner is entitled and bound by section 99 to adjust the assessable income of the taxpayer so as to eliminate the tax advantage sought to be obtained.” A dissenting opinion by one of the five lords who considered the case, concurred with the earlier Court of Appeal decision, which found in favour of Challenge. Challenge offered three defences. The first was to argue that section 191 conferred a specific exemption on a group of companies which fulfilled the conditions of section 191 at the end of an income year. Challenge included Perth and satisfied the specific conditions at the end of the income year ended March 31, 1978. Section 99 therefore did not apply. Challenge had argued. The decision found this argument could not be correct. “Tax avoidance schemes largely depend on the exploitation of one or more exemptions or reliefs or provisions or principles of tax legislation,” the decision states. “Section 99 would be useless if a section of the Act were sufficient to oust section 99.” Secondly, Challenge argued that section 191 contained its own particular tax avoidance provision, and by necessary implication excluded the general anti-tax avoidance provisions of section 99. Parliament must have intended that section 99 should not apply to a group of companies seeking to operate section 191. But the lords rejected this argument.

“In the opinion of the board (of the Privy Council) this argument attributes to Parliament a benevolent attitude towards tax avoidance by companies which is unlikely and unnecessary.” It was more likely, they said, either that Parliament was indifferent to or unmindful of any overlap between the general provisions of section 99 and the particular provisions of section 191 (1) (c) (i), or that Parliament thought any overlap might be useful and could not be harmful. The lords found that the provisions of section 99 were of genera! applications, and, in the absence of an express direction by Parliament excluding section 191 from the ambit of section 99, then section 99 must be applied in this case. Challenge’s third argument was to advance “the threat” that if their chosen method of tax avoidance was not accepted by the courts, then any commercial transaction or family arrangement would be fraught with uncertain, capricious or harsh fiscal consequences, and would be vulnerable to action by the Commissioner under section 99. The lords agreed there were distinctions between a transaction that was a sham, or an evasion of tax, nor one which mitigated tax, and one which avoided tax. They considered the Challenge case was not a sham; or did it involve tax evasion, as the company had fully informed the Commissioner of all relevant facts. Nor was it a case of tax mitigation, as this would have involved a tax advantage gained from a reduction of income which the taxpayer accepted, or from expenditure which he incurred. Tax statutes allowed a reduction of tax liability in cases of certain expenditure or reduced income. The lords found this did not apply in Challenge’s case. “It is true that Challenge expended $lO,OOO in purchasing the shares in Perth but this purchase price is not deductible against Challenge’s assessable income. “Apart from the risk of losing $lO,OOO, the Challenge group never risked anything, never lost anthing and never spent anything, but now claimed to deduct a loss of $5.8 million. “Challenge have practised tax avoidance to which section 99 applies.” The Privy Council board which considered the case was: Lord Keith of Kinkel, Lord Brightman, Lord Templeman, Lord Goff of Chieveley, and Lord Oliver of Aylmerton who alone presented a dissenting opinion. Lord Aylmerton said it was inevitable that sections 99 and 191 should be considered together. Along with section 188, section 191 deliberately conferred on corporate taxpayers an option to regulate their affairs in a way that would reduce their tax liability. That was, by definition, tax avoidance, he said.