Taxpayer wins film investment cases

Summary

The taxpayer was successful before the Privy Council in arguing that the Commissioner could not apply the anti-avoidance provisions to his investment in two film projects (the investments being made in the 1980s).

Facts

These were cases taken by the taxpayer in relation to two film investments made in the 1980s. The films were "Lie of the Land" and "Utu". In both cases the Commissioner concluded that the expenses of the films were inflated by means of non-recourse loans and circular funding. This increased the depreciation deduction apparently available to the taxpayer but for which there was no actual liability as the circular funding at already repaid the loans. The Commissioner disallowed the depreciation deduction to the extent of the inflated expenses.

The taxpayer objected and the cases were heard at the TRA. The taxpayer won one and the Commissioner the other. Both TRA decisions were appealed to the High Court where the taxpayer won one again and the Commissioner the other (see (2002) 20 NZTC 17,583 and 17,761). Both decisions were appealed to the Court of Appeal where the Commissioner won both ((2003) 21 NZTC 18,060 and 18,069).

The taxpayer appealed to the Privy Council.

The main issue was the proper application of section 99 ITA 1976 to the taxpayer. The taxpayer argued that there was no tax avoidance by him and as he was not part of the "meeting of minds" necessary for an arrangement under section 99 (the test from BNZI [2002] 1 NZLR 450) then section 99 could not be applied to him. Further, it was argued that the taxpayer entered a fixed-price contract and this was the cost to him of the investment regardless of what consequently occurred outside his knowledge.

The Commissioner argued that section 99 could be applied to the taxpayer as there was a tax avoidance arrangement which also met the BNZI test even though the taxpayer was not one of those involved in the necessary "meeting of minds" and he was a "person affected by that arrangement" (per section 99(3)). The Commissioner also placed weight upon the phrase "whether or not any person affected by that arrangement is a party thereto" (at section 99(2)).

Decision

In a split decision the taxpayer was successful (split 3-2 in the taxpayer's favour).

Majority decision

The majority accepted the existence of an "arrangement" in this case and considered it was entirely at the CIR's option to identify the whole or any part of a composite scheme as the "arrangement".

The majority did not accept the taxpayer's argument that he needed to be a party or participant to an arrangement to be effected by it:

[34] Their Lordships are satisfied that the "arrangement" which the Commissioner has identified had the purpose or effect of reducing the investors' liability to tax and that, whether or not they were parties to the arrangement or the relevant part or parts of it, they were affected by it. Their Lordships do not consider that the "arrangement" requires a consensus or meeting of minds; the taxpayer need not be a party to "the arrangement" and in their view he need not be privy to its details either. On this point they respectfully prefer the dissenting judgment of Thomas J. in Commissioner of Inland Revenue v BNZ Investments Ltd (supra). Moreover the investors did not merely obtain an economic advantage from the "arrangement" (as in that case); they obtained a tax advantage, viz. a depreciation allowance which reduced their liability to pay tax.

This approach was expressly endorsed by the minority judgment as well (at par [93]).

However, the "critical question" identified by the majority was whether the tax advantage was obtained by tax avoidance and thus within sec 99 (now sec BG1).

The majority considered that the taxpayers are entitled to depreciate the full acquisition costs regardless of how much the film actually cost to make as the CIR did not challenge the apparent acquisition cost of actual cost of the film plus the non-recourse lending. The focus is on the cost to the person acquiring the asset rather than the person disposing of it and what they did with the purchase price (in this case repay the non recourse lending but not discharge the investors' apparent liability under the loan):

[42]....If the Commissioner had shown that the features on which he relied, singly or in combination, had the effect that the investors, while purporting to incur a liability to pay $x+y to acquire the film, had not suffered the economic burden of such expenditure before tax which Parliament intended to qualify them for a depreciation allowance, then he could invoke section 99 to disallow the deduction.

[43] This, however, the Commissioner never succeeded in doing. The inflation of the costs of making the film meant that the production company made a secret profit at the investors' expense; but it did not alter the fact that they incurred a liability to pay $x+y to the production company in accordance with the contract to acquire the film. The costs of making the film were incurred by the production company, and these must not be confused with the costs incurred by the investors, which were the relevant costs in respect of which the deduction was claimed. The fact that the production company made a profit of $y at the expense of the investors did not mean that they did not suffer the economic cost of paying it.

The majority then pointed to a factor that may have enabled the Commissioner to be successful: if there had been a finding of fact at the TRA that the lending was un-commercial [Para 48]. It was also suggested that had the CIR argued that to the extent of the non‑recourse lending was repaid by the production company, the taxpayer did not purchase a film but paid for the acquisition of a loan. This would not have been deductible as part of the cost of acquiring a film [Para 49 to 51].

The minority

The minority considered that this was a tax avoidance arrangement.

While accepting the "meeting of minds" test found in BNZI the minority recognised:

[59]... But, nonetheless, it is clear from sub-section (2) that the tax advantage vulnerable to being nullified under sub-section (3) may be a tax advantage enjoyed by someone who is not part of that consensus, not "... a party thereto".

[89]... sub-section (2) says, in terms, that the arrangement "shall be absolutely void as against the Commissioner ... whether or not any person affected by the arrangement is a party thereto". The fact that the investors were not parties to the arrangement cannot be enough to allow them to escape section 99. Any other conclusion would involve a judicial rewriting of section 99(2).

[92]... To hold that the apparent ignorance of the investors excuses them from vulnerability to the statutory avoidance measures provided by section 99 would be, in our opinion, to emasculate the section.

The minority focused on (and endorsed) the twin pillars of statutory interpretation: statutory scheme and purpose (as found in the Challenge case). Applying the scheme and purpose approach to the facts of the case the minority concluded:

[91]...The statutory right to depreciate an item of cost and to deduct the amount of the depreciation from assessable income is plainly a tax advantage. Whether it is a tax advantage vulnerable to attack under section 99 depends, in our opinion, on whether it is within the purpose of the statutory regime. We cannot believe that if the cost of acquisition of a film is inflated for no commercial reason other than that of qualifying for a higher tax deduction than would otherwise be available the amount of the inflation could be regarded as the sort of cost that the statutory regime was intended to assist or encourage. In any event, in the present case the amount of each non-recourse loan was not presented to the investors as a premium on the cost of production that they had to pay. It was presented to them on the basis that the amount was needed for the cost of production and that it would qualify for depreciation as part of the cost of production. The non-recourse loan was, in fact, nothing of the sort but was no more than a device to produce a higher capital sum to be depreciated and, thereby, a higher tax deduction. Moreover the amounts represented by the non-recourse loans were not received by the respective production companies as premiums that had to be paid as part of the investors' acquisition costs. They were not recorded in their books as having been received at all.