Family Business ~ Insight | The Date of Acquisition of the Land

The IRD have recently released a consultation document around the sale and purchase of land. Taxpayers are often faced with having to determine the date of acquisition of the land for the purposes of land disposal provisions, in particular s CB6. Section CB6 deals with land acquired for the purpose of or with intention of disposal. Any gains derived from the disposal of the land are taxable.

The date of acquisition becomes more important for the purposes of the 10 year rule. The uncertainty arises from the timing of when the taxpayer’s intention or purpose should be determined.  Various interests and estates in land are acquired at different times throughout the acquisition process with final registration at the time of settlement.  The case law is not particularly helpful in this regard.

Incorrect determination of the time of acquisition at which point intention or purpose is determined can have serious consequences for the taxpayer.

The IRD has released a consultation document in which the following options are considered:

  • When the agreement for sale and purchase is entered into
  • When the agreement for sale and purchase becomes unconditional  and legal action for non-performance can be taken

 

This consultation is very welcome as it will provide greater certainty for the tax payers. We are of the opinion that more logical would be the second option  when the agreement becomes unconditional, as this is the true time at which point  each party can enforce its rights and obligations for non-performance.

Family Business ~ Insight | Alesco Case

The recent IRD’s win in the Alesco tax avoidance case is a clear indication how far the tax law has moved.  The case involved an Australian company Alesco, which acquired two New Zealand companies. The acquisition was financed through the use of optional convertible notes (OCN). OCN is a hybrid financial instrument that consists of debt and equity component.

Alesco could have financed the acquisition using either interest bearing debt or the OCN. Income tax legislation allows a deduction for interest should interest bearing debt be used. There is a special determination, issued by the Commissioner, which prescribes how the OCN is to be treated for tax purposes and prescribes a calculation methodology for notional interest deduction.

The alarming issue resulting from the decision is the fact that the IRD has invoked anti-avoidance in relation to a genuine commercial transaction just because Alesco has chosen the means of financing that IRD did not like, on the grounds that Alesco apparently did not suffer a real economic cost – i.e. because the interest deduction they claimed pursuant to the IRD’s own determination was notional. We find it really hard to understand the logic that was applied by the IRD and the Courts given the fact that the determination, written by the Commissioner, specifically prescribes the tax treatment of OCN and a methodology for quantifying a NOTIONAL interest deduction. Notional means fictitious.

Furthermore, the use of OCN as means of financing resulted in Alesco obtaining a lesser interest deduction than if an interest bearing debt was used.  The sad reality is that Alesco has in fact chosen a financing option in relation to a genuine commercial transaction that resulted in greater tax payable than if an alternative means of finance was used and yet was penalised for this.

Another alarming issue, besides understanding how anti-avoidance provisions can be applied to a commercial transaction where the highest amount of tax is paid, is the fact that the Commissioner or Courts did not allow Alesco the next best alternative. One would hope, in societies where the tax system is fair and just, that the taxpayer would have at least been allowed a reconstruction using next best alternative. This however was not case here.  Even though the counsel for the tax payer has clearly pointed out that higher amount of deduction would have been available for Alesco if interest bearing debt was used. The Courts have rejected this argument on the grounds that there was no documentary evidence that interest bearing debt was contemplated by Alesco.  The IRD and the courts therefore simply denied the notional deduction with no reconstruction.

What does all this mean?

This clearly indicates that the environment is more uncertain than it ever was. The Commissioner and Courts are stretching the boundaries in applying the legislation as they deem fit depending on which way the wind blows. Furthermore, this demonstrates that the Courts and the Commissioner are more interested in paper evidence (i.e. notes, minutes from directors meetings) rather than common sense and what is actually prescribed by legislation.

There is no need to highlight that our country relies heavily on foreign investment and jobs that are created as a result of foreign investment. The government should therefore stop and look at what is happening. It should put a stop to the Commissioner’s total disregard to commercial transactions and her almost unlimited power to invoke anti-avoidance legislation as and when she chooses to do so. Anti-avoidance provisions are specific provisions and should be applied where avoidance is present. It should not be used where genuine commercial transactions exist, which are structured in a way that results in a greater tax payable than if an alternative structure was used.

This total disregard creates a great uncertainty for foreign investors and may result in them choosing alternative more favourable jurisdictions. There is obviously no need to say what this would mean to our economy and our jobs. Moreover, it will make both taxpayers and their advisers question what is legitimate tax planning in this modern world.

In summary, this case resulted in a horrible outcome and a greater uncertainty for tax payers. If you are considering any transaction of sizeable value, make sure that you have a documentary evidence of alternatives you have considered. The only alternative way to obtain a certainty, in relation to a transaction you may be considering, is to obtain a ruling from the IRD.

Abusive Tax Position Penalty

The New Zealand Inland Revenue Department released an item on the 25th September which discusses whether the abusive tax position penalty under s 141D of the Tax Administration Act 1994 applies automatically where there is a “tax avoidance arrangement” under s BG 1 of the Income Tax Act 2007. The item outlines that:

“The abusive tax position penalty under s 141D does not apply automatically where there is a “tax avoidance arrangement”. This is because:

  • Section BG 1 requires the tax avoidance purpose or effect of the arrangement to be more than merely incidental. Section 141D requires the dominant purpose to be avoiding tax. Therefore, the tests in the two provisions are fundamentally different.
  • The intention expressed in the pre-legislative material was that the abusive tax position penalty would only apply to “abusive avoidance”.
  • The courts have identified that there is a different test under s 141D than under s BG 1.

To determine whether the abusive tax position penalty applies it is necessary to decide whether the dominant purpose of the arrangement is avoiding tax. In order to determine that, the tax purposes must be weighed against any other purposes of the arrangement (such as commercial or family purposes) with reference to the specific structure of the arrangement. The factors that may be considered may include artificiality, contrivance, circularity of funding, concealment of information and non-availability of evidence, and spurious interpretations of tax laws”.

For more information refer to: http://www.ird.govt.nz/technical-tax/questions/questions-shortfall/

Deduction of Shareholder Employee’s Salary of an LTC

Recently we have been asked whether a shareholder employee’s salary is deductible for a LTC (Look Through Company) and whether it can be paid without having to deduct PAYE.

There are two parts to the question one being the deductibility of the shareholder employee’s salary and another being the PAYE withholding.

  • SHAREHOLDER SALARY
    • The LTC is allowed a deduction for the shareholder salary, insofar as the shareholder is a working owner employed by a LTC.
    • There must be an employment contract pursuant to which salary is paid for services performed by the working owner.
    • The employment contract must specify the amount of salary to be paid and terms and services to be performed by the working owner.
    • The available deduction is limited to the salary payments authorised by the contract of employment. A bonus is also deductible even if not specifically provided for in the employment contract.
    • The working owner status is not achieved if the LTC is wholly or mainly engaged in investing, holding or dealing in shares, securities or land.  The LTC must derive an active as opposed to passive income.
    • The working owner providing services to the LTC is therefore classified as an employee.
  • PAYE
    • PAYE has to be deducted from the salary paid to the working owner.
    • The definition of a PAYE income payment includes salary, wages, extra pay, etc (this would cover bonuses as well)
    • The term salary and wages specifically includes payments to the working owner of a LTC

In Summary:

  • The LTC is allowed a deduction for salaries, wages and bonuses paid to the working owner pursuant to the employment contract.
  • PAYE must be deducted.

 

IRD Issues Statement on R&M plus Leaky Buildings

The IRD recently released an interpretation statement on the often vexed issue of what costs are deductible on repairs and maintenance (R&M).  In short the statement is both a good and accurate summary of the New Zealand and international case law on the topic.  It acknowledges that often two cases with almost identical facts can result in opposing answers.

Of particular benefit however is that the IRD at long last considers the significant national issue of leaky building claims.  There is both relevant case law discussion, as well as three very useful examples.

In summary for a rental asset:

1   If the repairs are to make good the leaky building issues, but not to improve the building, then it will be a deductible repair.

2   If there are new or better components (eg double glazing over single, additional rooms added), there will be capital costs.

3   If the repair is so extensive that the asset is significantly replaced, even if not improved, this will be capital as it is no longer a repair but a replacement.

As always it will be a question of degree, but at least we have some points to measure it against.

Refer www.ird.govt.nz – key word IS 12/03

IRD Attack Mixed Use Assets as Tax Avoidance

Following the Penny & Hooper case on tax avoidance the IRD has been far more aggressive on what it now considers to be tax avoidance.  While it has released a discussion document on how the tax rules, and in particular for apportionment of costs, should apply to mixed use assets such as baches, boats and planes, it has also been aggressively auditing or risk reviewing these.

The IRD is focusing on 2 areas:

1    Denying the part of any resulting tax loss that arises from the private use even where market rates have been paid; and

2    Questioning whether the activities constitute a business at all, with any resultant tax loss being denied in total, often also with adverse GST consequences when the IRD then seeks to retrospectively deny GST registration.

In either case the IRD will look for shortfall penalties of at least 20%, but often 100% of the extra tax bill plus use of money interest.

IRD Targets CA Firms for Tax Avoidance

Not surprisingly the IRD has commenced targeting CA firms and other professionals following the Penny & Hooper decisions.

The principle argument is that partners avoided the 39% tax rate by lowering their salaries and paying out profits as dividends to family trusts suffering only 33% maximum tax. In effect, CA firm partners were doing what Messrs Penny & Hooper were doing.The IRD has been auditing many CA firms. The surprising part however is their pre-conceived belief that regardless of the size of the firm, the number of staff and a host of relevant other factors, that the partners should have drawn out 80% of the profits as salaries, subject to tax at 39%.

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IRD Targets the Rich

For a number of years the IRD has targeted high wealth individuals and families in an effort to ensure that they have paid their fair share of tax, at least in the IRD’s eyes. Those (un)fortunate enough to make the annual NBR Rich List usually receive a bonus of being allocated their own personal IRD auditor to review and watch over their affairs.
With the Christchurch earthquake and economic downturn, the government’s need for revenue has translated itself into the muzzle being taken off the IRD, who are now much more aggressive in reassessing high wealth targets. Many recipients of the IRD’s attention feel they have complied with the relevant tax laws in filing their returns, only to find that the IRD takes a particularly aggressive position. Recent cases like Penny and Hooper have only added to the IRD’s arsenal of powers by allowing them to label anything they don’t like as simply being tax avoidance or black letter compliance.

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