1. Briefly outline the key findings of the Supreme Court decision of Penny and Hooper v Commissioner of Inland Revenue [2011] NZSC 95. In particular, comment on whether a market salary must be paid in all circumstances if a company employs a person who primarily earns the company’s income?

Both Penny and Hooper were orthopaedic surgeons from Christchurch. Each seperately restructured their businesses so that they traded as a company, with shares being held by their family trusts. The practices were sold to the company and each surgeon then became an employee of the company. To parties outside, the businesses continued to operate as normal. Salaries were declared of $120,000 for Hooper, and $100,000 for Penny, however their companies had income of $567,000 and $832,000 respectively. This had the effect of saving 6 cents per dollar, as the top marginal tax rate was 39 cents, and the company tax rate was 33 cents. The Supreme Court held that the predominant purpose of this arrangement was tax purpose, due to the low fixed salaries. A market salary for a surgeon was much higher than what was paid. Shortly after this landmark case, a Revenue Alert summarised the findings. It was stated that a person who primarily earns the companies income must be appropriately compensated, and if not there must be a valid commercial reason (such as in White v CIR).

2. You work for a local accounting firm and have been asked by your manager to write a brief list of the key facts and findings from the High Court case White v CIR (2010) 24 NZTC 24,600 (HC). This will ultimately form part of a client newsletter.

White v CIR is a case that is distinguishable from Penny v Hooper. In this case, an anaesthetist formed a company called Wharfdale Ltd. This company was formed as a means of reducing personal liability from claims. Wharfdale Ltd also leased an avocado orchard business from the anaesthetists family trust. This orchard was making losses. Wharfdale Ltd did not pay a salary to the anaesthetist, however unlike in Penny and Hooper, this was not held to be tax avoidance. This was because the company could not afford to pay a salary due to the losses from the orchard. It was held that this arrangement had a permissible tax advantage gained from the close company regime. An interesting point is that this is the only case won by the taxpayer since Ben Nevis Forestry Ventures Ltd v CIR.

3. The Commissioner has had the ability to enter into settlement agreements with taxpayers as part of the care and management function set out in s 6A of the Tax Administration Act 1994. With respect to the area of tax avoidance, consider when it may be in the best interests of the Commissioner to settle with a taxpayer when tax avoidance has been alleged. Do you think that the settlement of Alesco New Zealand Limited v Commissioner of Inland Revenue, announced just prior to the Supreme Court hearing in mid-February 2014, was justified?

The case of Alesco New Zealand Limited v CIR was settled out of court. In this case it was held that the use of option convertible notes (OCN) that have debt and equity components was primarily for tax purposes. Alesco was able to claim interest deductions relating to these with reduced their tax liability. An abusive tax position was imposed, however there was a settlement between Alesco and Inland Revenue. The commissioner may choose to settle when it is likely that they benefit outweights the cost e.g. if legal proceedings cost more than than the extra amount they expect to get. There are also timing issues; the Government may want the money straight away if it is a large amount. However, there are issues in regards to equity. Only taxpayers that can afford to pay settlements can settle with Inland Revenue. Smaller taxpayers have to go through the entire process and it could be said it is not fair that larger taxpayers can “buy” their way out. In Alescos case, I believe that the settlement was justified. This is because Alesco is a subsidiary of DuluxGroup, who is a large multi-national company. Because of this they have access to a lot more funds and resources than the average taxpayer, which means that legal proceedings could continue for a long time.

4. The Commissioner’s Policy Statement on s BG 1 received a mixed reception when it was released in mid-2014. Assume that Inland Revenue is interested in receiving feedback on this Policy Statement with the view of determining whether it may revise the statement. Outline the issues that you have with it and/or areas where you believe improvement or clarification is needed.

The Commissioner’s Policy Statement on s BG 1 has a few issues. One of these is that it states the "[t]he test to identify whether an arrangement involves tax avoidance is to ask if the arrangement, viewed in a commercially and economically realistic way, makes use of the Act in a manner that is consistent with Parliament's purpose." It can be difficult to ascertain what Parliaments purpose is, especially because Parliament changes periodically. One Parliament may have a certain intention, while another Parliament may have another intention. Because of this, I believe clarification is required on this point. Another point that I believe requires clarification is the statutory definition of “tax avoidance” is not an exhaustive one. This may mean that the Courts could theoretically find any arrangement they want to be tax avoidance. While there are tests that are to be applied, with out an exhaustive definition of tax avoidance it is hard to minimise tax obligations legally.