Trinity investors lose appeal
2007 case note - Court of Appeal dismissed the taxpayer's appeal and upheld the finding that the Trinity Forestry arrangement is a tax avoidance scheme.
The Court of Appeal has dismissed the taxpayers appeal and upheld the finding that the Trinity Forestry arrangement is a tax avoidance scheme.
This was an appeal against the judgment of Venning J Accent Management Ltd & Ors v The Commissioner of Inland Revenue (2000) 22 NZTC 19,027 in which he upheld tax avoidance assessments and 100% shortfall penalties against the taxpayers who were investors in the Trinity forestry scheme.
The Court of Appeal has dismissed the appeal and ordered the appellants to pay costs to the Commissioner.
Investors in the Trinity scheme acquired licences to use land for forestry purposes. The purpose of the licences was cultivation of Douglas fir trees, and the duration was 50 years, which approximates one Douglas fir growing cycle.
The licence agreement purported to give no title to the land or the trees but gave rights to proceeds of sale of the trees after deduction of various charges. The investors agreed by promissory note to pay a fixed price for the licence in 50 years time. The up-front licence fees paid to the landowner exceeded the cost of the land.
Investors in the scheme in the 1997 year (Tranche1) also took out a loss of surplus insurance policy under which the insurer assumes risk for a stipulated value of the forest in the final year of the scheme. The value is the amount the investors must pay for the licence in 2047. Payment of the insurance premiums was also largely on a deferred basis with a small cash payment in 1997 and a further amount by promissory note for payment in 2047. Over 99% of the total expenditure claimed over the life of the investment, and 87% of the expenditure claimed for the first (1997) year was deferred until the year 2047.
The investors contended that the insurance premium and forestry agency fees were deductible in full in the first year, being the year in which they are incurred and that the licence fee was deductible as depreciable intangible property under Schedule 17 of the Income Tax Act 1994. The licence fee cost was the combination of the initial payment and the amount due in year 50, which is amortised over the 50 year duration of the licence.
The Court of Appeal dealt with the issues in the following way (and order):
Sham - Because the insurance policy creates separate insurance arrangements, it would be possible to treat the insurance arrangements as a sham in relation to the investors associated with Dr Muir and Mr Bradbury only, but while there was artificiality, pretence, and concealment [on their part], it could not be said that Muir and Bradbury intended the provisions regarding the wash-up of the scheme to be a dead letter, although the Court saw this aspect of the case as closely balanced. The Court held that the state of mind of Muir and Bradbury could best be categorised as involving indifference as to whether the wash-up transactions occurred.
Spreading of insurance deductions under the accruals regime - The Court held for the Commissioner on his cross-appeal that the deductions for insurance premiums are accruals expenditure and are required to be spread over the life of the policy. The Court held that the High Court has misappliedEH 2 in its decision. However, because of the Court's findings on tax avoidance, this point was of no ultimate importance.
Licence premium deductibility under section EG 1 - The Court held for the taxpayers on this issue and said that the issue was one of statutory and not contractual interpretation, and that it must ignore elements of the scheme which are primarily relevant to tax avoidance arguments. Accordingly, the Court thought that if the whole of the licence premium had been paid at the outset, the Commissioner would have treated it as the cost of a right to use land, thus able to be depreciated over the term of the venture. It therefore held that the licence payment was the cost of the right to use land.
Tax avoidance - The Court upheld the High Court's finding of tax avoidance and said that the real purpose of the arrangement is not the conduct of a forestry business for profit, but rather generation of spectacular tax benefits. This was the major issue for the Court of Appeal and most of the discussion was on this issue, which involved consideration of the Challenge, BNZI, and Petersen cases. The Court found:
Manifestations of the absence of a genuine business purpose cannot be brushed aside as irrelevant because of taxpayer autonomy principles.
The scheme was well and truly across the "line" referred to by Richardson P in BNZI.
If the scheme is void as against the Commissioner, there is no need for the Commissioner or the Court to conjure up an alternative and more effective scheme into which the taxpayer might have entered.
Penalties - This was an entirely tax-driven scheme. The penalties were not imposed prematurely; on any sensible approach the interpretation of section BG 1 taken by the taxpayers was unacceptable.
Income Tax Act 1994