We are associated

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Providing tax advice for a living is interesting because of the massive range of issues and industries you encounter.

But inherently the job boils down to one person’s view of the law versus another’s, that other person being the Commissioner of Inland Revenue.

In some cases we agree, in others we disagree. However, we can’t agree to disagree. There needs to be a right and wrong, a winner or loser.

In arriving at a position, we have resources at our disposal. There is obviously the legislation. But there is also third party published commentary, Inland Revenue’s own commentary, Government commentary that accompanied the introduction of a particular piece of legislation and so on.

But an extremely powerful basis for a position, is to align with the decision of the court, the higher the court the better. If a court has decided in favour of a particular argument in the same circumstances and history is simply repeating, that’s ‘gold’. Inland Revenue is careful around what cases they will take to court because of the downside if they lose. From their perspective it might be cheaper (for the Government) to concede with one taxpayer, than have every taxpayer adopt the same approach, whatever that might be.

The flipside is that cases do come along that are untenable from Inland Revenue’s perspective and understandably, they need to take them to court. An easy example is tax avoidance cases. In some cases, the outcome is that offensive to the court it will strike out the tax advantage, but problems will arise when it gets there in an unusual way, and there is collateral damage to the broader tax landscape.

The High Court decisions of Concepts 124 Limited v CIR (2014) and Staithes Drive Development Limited v CIR (2015) are two such decisions. Both cases involved proposed GST claims on the purchase of land from non-registered vendors. The point of contention in both was whether or not the vendor and purchaser were associated. If associated, the purchaser’s GST refunds would have been zero. This type of scenario regularly appears before the courts, as people have tried to ‘game’ the rules to manufacture a GST refund.

The factor that the two cases had in common was that shares in companies were held on trust, for the benefit of another. Trusts have existed for hundreds of years and are heavily ingrained in New Zealand’s legal and commercial landscape. Broadly, trustees are required to act in the best interests of beneficiaries when making decisions in respect of property held on trust. This is colloquially referred to as wearing another hat. The trustee makes decisions wearing their trustee hat and does not act in their own self-interest. Accordingly, the capacity of trustee has become well recognised as a separate and distinct capacity from one self. This has been the status quo for decades and is undisputed.

However, in both of the above cases the High Court focused solely on the legal ownership of the shares in the purchaser and vendor companies when determining whether they were associated. This basically meant that the trustee was treated as the ‘owner’ of the shares and the beneficial interest in the shares was ignored. In reaching this view, the court focused on the control as exercised by the underlying shareholders, ignoring the fact that control cannot be exercised to benefit the shareholders.

You may be asking “why do I care?” The problem is that these decisions are going to give rise to numerous unintended and potentially ludicrous outcomes.

For example, it is common for law firms and accounting firms to act as independent trustee for their clients. This is typically done through a stand-alone trustee company that is appointed as trustee to their clients’ trusts. If a law firm appoints their trustee company to 100 different family trusts, which otherwise have no relationship to each other, there is a risk that all of those trusts and all of the companies whose shares are held by those trusts may be associated.

These cases have, to some extent, flown under the radar. However, we are now seeing Inland Revenue apply the cases and we have had applications for Binding Rulings turned down because of their application.

Inland Revenue is currently assessing whether the legislation needs to be amended to reverse the effect of the decisions and return to the status quo. They produced an Issues Paper in 1997 that discusses the desired scope of the associated persons’ rules and provides a strong sense of who the Government considers should and shouldn’t be associated. By comparison to that document, and from a common sense perspective, application of the above two cases will give rise to overreach.

From our perspective, Inland Revenue needs to act sooner rather than later or we will end up with increasingly unusual and absurd situations arising.

The comments in this article are of a general nature and should not be relied on for specific cases. Taxpayers should seek specific advice.

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Hayden Farrow

Hayden Farrow is a PwC Executive Director based in the Waikato office. Email: hayden.d.farrow@nz.pwc.com

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