Tax has always been an art, not a science. It has always been about interpretation and not necessarily objective fact.
Post the cases of Penny & Hooper, Alesco and the other anti-avoidance cases, life has become very different in the tax world. Formerly we successfully argued that unless the Income Tax Act said we couldn’t do something, we were able to do it. Now we are faced with a situation where the reverse is true that unless a Tax Act clearly says that we can do something, we cannot do it.
What does parliament contemplate when it passed a piece of law? Most of the time they don’t even know themselves. Given that the IRD is also a party to the introduction of new law along with treasury, it might be better to rename “parliamentary contemplation” as “IRD desire”.
In an audit situation we are often faced with IRD auditors, often very young and inexperienced, telling us what parliament contemplated. It is very difficult to determine what parliament contemplated because the law itself often it not clear. Even a seemingly simple piece of law like the mixed asset use rules do contain complexities and are very hard to understand when you try to apply them to actual factual situations.
We all know now that you are not entitled to use companies to trade through, pay yourself a lower salary and then take the profits out by way of dividend to avoid the 6% increase in the marginal tax rate that the labour government bought in. However, you can sell your existing house to a company or LTC so that you can then get an interest deduction when you buy your new home. Clearly the only purpose for doing this transaction is to obtain an interest deduction yet in the eyes of the IRD that is not tax avoidance.
As we have seen with the Alesco case, the problem with all of this is the cost of getting it wrong. Alesco was faced with a situation of having to loan funds from a parent in Australia to a subsidiary in New Zealand and chose a structured financing option that gave a favourable tax outcome. When the IRD applied the anti-avoidance rules, it annihilated the whole transaction. The tax payer was not entitled to return to the position that it would have been in otherwise, it simply lost all of the deduction. An example of this in the real world would be if you got caught doing 115kmh in a 100kmh zone, you would get a ticket for doing 115kmh over the speed limit. While it is not a great example, it does show the absurdity of the situation.
Add to this the cost of penalties, use of money interest and the cost of fighting the IRD, it is certainly a very difficult world in which to give advice. Often it is also not about taxpayers trying to do something that is aggressive, but simply to try to find out what the position is.
In recent years I have been one of the highest users of the IRD’s binding rulings unit. The reason for this is it provides taxpayers with certainty in a given situation. The downside is that there is time and cost involved in obtaining a binding ruling but in many transactions, it is a worthwhile outcome and wait. While I can provide opinions to clients, at the end of the day there may not be certainty and by going to the IRD to obtain a binding ruling, it is certainly a sensible outcome.
The IRD recently released its interpretation statement on tax avoidance. At the end of the day, it is a very useful document and all credit to them for putting this out. What it lacks however is a significant number of examples which can be used to test situations against. It is somewhat too conceptual and academic in its composition to actually be useful at the coal face.
The next few years are certainly going to be interesting in terms of tax payers and their relative and perceived level of risk.