TAX NEWS - June 2010

New Zealand Tax: Tax avoidance test

Inland Revenue has moved to calm tax litigation fears following a contentious court decision against two Christchurch surgeons.

But one tax expert says legislative change is needed.

In a "revenue alert" issued yesterday, the IRD said anyone generating money largely from their own efforts should be personally taxed for the full amount and could not offload tax responsibility through trusts or companies.

But the IRD also said many small businesses used companies and trusts for "reasonable" commercial purposes and legal action would "generally focus on the most serious and artificial cases".

The alert follows a Court of Appeal decision published on June 4, which overturned a High Court ruling in favour of Christchurch orthopaedic surgeons Ian Penny and Gary Hooper, both accused of tax avoidance.

IRD claimed the men avoided paying about $168,000 in personal tax during three years by channelling their income through a "contrived" structure of family trusts and companies.

Both men set up companies, owned indirectly through trusts, to buy their own surgical practices and then paid themselves a reduced salary.

After 2000, Hooper's personal income dropped dramatically from $650,000 to $120,000 and Penny's dropped from $302,000 to $125,000 and then to $100,000, while the income of their companies grew.

The court decision drew widespread criticism from tax experts who claimed it left tens of thousands of small business owners who properly used companies and trusts vulnerable to tax avoidance prosecution.

In the alert yesterday, IRD said it accepted there were good non-tax related reasons for business owners to pay themselves a smaller amount of a businesses' profits.

A business owner could legitimately be paid less if their company was in startup mode or was experiencing financial difficulty, it said.

The tax-avoidance test would partly rest on whether business owners were paying themselves less than they would have been paid by an "arm's length" business.

Other features likely to draw IRD's attention include, "artificially low" salaries, and profits diverted into a company which ultimately benefited the business owner or their family.

PricewaterhouseCoopers partner John Shewan, a member of the Government's Tax Working Group, said the alert was "cold comfort" for small business owners and effectively said the law would be applied at IRD's discretion.

"The law says one thing but `wink wink nod nod if you're a good boy we won't apply it'," he said. "Well that's just not good enough in my view."

The Court of Appeal decision has confused tax payers' responsibilities and legislative change was now needed, he said.

Ernst & Young tax partner Ben Willems said the alert did little to clear up confusion around tax avoidance laws but did not think the uncertainty could be solved through laws.

"They are various shades of grey with these things," he said.

Earlier this month, Revenue Minister Peter Dunne said a law change would be considered only once the case had run its course, with the surgeons still able to apply to appeal to the Supreme Court.

He has rejected suggestions the decision had created uncertainty, describing it as clear.

Hooper has previously said the decision was unlikely to be appealed but neither he nor Penny could be reached for comment yesterday.

All tax experts who spoke to The Press expected the decision to be appealed.