Tax Avoidance Process and legislation
Since the introduction of anti-avoidance provision in 1878, the legislation has been twisted many times to ensure interpretation and application is well guarded against potential threats of tax avoidance.
Elmiger was the first case on tax avoidance which was decided in the favour of Commissioner of Inland Revenue, the case itself provided guidance to many New Zealand tax cases. Despite the age of this case the framework is robust and still in use. It was evidenced in Elmiger framework of tax avoidance will apply to all personal and family dealings, and arrangement as a whole will come under the framework to test purpose or effect of tax avoidance.
The general anti-avoidance provisions are contained in s BG1, GA1, and YA1 of the Income Tax Act 2007. These can be contrasted with the specific anti-avoidance provisions collected in subpart GB of the Income Tax Act.
BG1 Tax Avoidance
BG 1(1) Avoidance arrangement void
A tax avoidance arrangement is void as against the Commissioner for income tax purposes.
BG 1(2) Reconstruction
Under Part G (Avoidance and non-market transactions), the Commissioner may counteract a tax advantage that a person has obtained from or under a tax avoidance arrangement.
YA 1 Definition
Arrangement means an agreement, contract, plan, or understanding, whether enforceable or unenforceable, including all steps and transactions by which it is carried into effect
Tax avoidance includes—
(a) directly or indirectly altering the incidence of any income tax:
(b) directly or indirectly relieving a person from liability to pay income tax or from a potential or prospective liability to future income tax:
(c) directly or indirectly avoiding, postponing, or reducing any liability to income tax or any potential or prospective liability to future income tax
Tax avoidance arrangement means an arrangement, whether entered into by the person affected by the arrangement or by another person, that directly or indirectly—
(a) has tax avoidance as its purpose or effect; or
(b) has tax avoidance as 1 of its purposes or effects, whether or not any other purpose or effect is referable to ordinary business or family dealings, if the tax avoidance purpose or effect is not merely incidental
In Newton lord Denning described arrangement, purpose and effect
“Arrangement” is something less than a binding contract or agreement, something in the nature of an understanding between two or more persons - a plan arranged between them which may not be enforceable at law. But it must in this section comprehend, not only the initial plan but also all the transactions by which it is carried into effect - all the transactions, that is, which have the effect of avoiding taxation, be they conveyances, transfers or anything else.
The word “purpose” means, not motive but the effect which it is sought to achieve - the end in view.
The word “effect” means the end accomplished or achieved. The whole set of words denotes concerted action to an end - the end of avoiding tax.
In Elmiger, Justice Woodhoue considered that the meaning s 108 ought to be determined by the general principles set down in the Newton case. Elmiger analyses were directed to whether the arrangement as a “whole” has a purpose or effect of tax avoidance .
Based on the judgement of Newton and Elmiger, the parliament amended s 108 in 1974 and following summary of those amendments shows there was a strong link between amendments and these cases -
1. The definition of the word “arrangement”, extended to the concept of “arrangement” by adding the words “plan” or “arrangement” and by explicitly including the words “whether “enforceable’ and ‘unenforceable”
2. Added two tests for the application of the section 108. Tax avoidance had to be either the purpose or effect or one of the purposes or effects of the arrangement as long as it was not merely incidental.
3. And a power was given to the commissioner to adjust the income in a manner that the commissioner considered appropriate to counteract the tax advantage.
This amendments made were identical to what would become s 99 of the income tax act 1976. This was followed through to current tax avoidance legislation s BG1 of ITA 2007.
Step by step identification process of tax avoidance
Remember one thing BG1 is not a charging provision it does not give powers to the commissioner to act arbitrarily and charge you, it only gives powers to rearrange the whole transaction and calculate the shortfall of tax, and then it comes to you to accept it or challenge it.
We believe despite the robust legislation there will always be tax avoidance cases in New Zealand. Parliament deliberately creates structural inequalities in the legislation to fulfil the socioeconomic needs of the country. Problem starts when some taxpayers push the boundaries of tax avoidance to attain tax benefits.