Supreme Court ruling on "Trinity"

Summary

Having regard to the various features of the Trinity investment arrangement, the Court concluded that the taxpayers' use of the specific provisions was not within Parliament's purpose and contemplation when it authorised deductions for the licence premiums and insurance premiums under the depreciation provisions. The taxpayers altered the incidence of income tax by means of a tax avoidance arrangement which the Commissioner correctly treated as void against him. Further, the taxpayers had taken an abusive tax position because their position was an unacceptable interpretation of tax law; and therefore they were liable for the 100 percent penalty imposed by the legislation.

Impact of decision

This decision will have significant and lasting implications for matters engaging section BG 1, and clearly directs that the Commissioner ought to advance a matter on the basis that there is a sham, or avoidance, but not both.

Background

This was an appeal to the Supreme Court by nine investors, or loss attributing qualifying companies (LAQCs) of the investors, in a syndicate that had been involved in the development of a Douglas Fir forest project as part of what is known as the Trinity scheme.

The essence of the case is the long-standing search for clarity over where formal compliance with specific provisions ends and tax avoidance begins. The taxpayers had invested in a genuine forestry investment (a forest was planted) which had been structured to take advantage of specific taxation provisions authorising deductions and depreciation allowances; the Commissioner took the view that strict compliance with those provisions did not immunise the arrangement from being categorised as tax avoidance.

Facts

The appellants were investors in a syndicate that had been involved in the development of a Douglas Fir forest project as part of what is known as the Trinity scheme. The forest was planted in Southland and is due to be harvested by 2048.

The land on which the forest was planted was purchased and held by Trinity Foundation (Services No 3) Limited ("Trinity 3"), which was a subsidiary of Trinity Foundation Ltd, which in turn was owned by the Trinity Foundation Charitable Trust. The investors did not at any stage acquire ownership of the land.

Investors in Trinity 3 became members of a syndicate called Southern Lakes Joint Venture, which then formed a company, Southern Lakes Forestry Limited, to act as the joint venture's agent. That company entered into various contracts on behalf of the joint venture, which constituted the scheme.

Trinity 3 and Southern Lakes Forestry entered into an agreement for an occupation licence, and later a licence agreement. The occupation licence (for carrying on the forestry business) was stipulated to be at $2,050,518 multiplied by the plantable hectares in the land (ultimately 484 ha). The second agreement provided that the licence term commenced on 24 March 1997 and expired on 31 December 2048, and also required the syndicate to establish, manage and protect a Douglas Fir forest on the land. The forest was also required to be arranged for sale on the basis that cutting and extraction should be completed during the period 31 December 2044 to 31 December 2048, and specified the order in which the proceeds from that sale would be applied.

The investors were also required to pay Trinity 3, on 21 March 1997, $1,250 per plantable hectare ("/p ha") for the establishment of the forest, $1,946/p ha for an option to purchase the licensed land in 2048, and $1,000 per investor for a lease option. There was an additional $50 annual licence fee during the licence term.

The result was that the investors effectively met the initial costs of buying the land, planting the forest, and the continuing costs of its future maintenance and management, but did not at any point become the owner of the land or the trees. The net proceeds from the sale of the trees (in 2044-2048) would pay the licence premium. On its face there was a risk that the sale would be insufficient to meet the premium, for which insurance was to be taken out by individual syndicate members through Southern Lakes Forestry and Trinity 3.

To provide that insurance, Dr Muir had CSI Insurance Group (BVI) Limited ("CSI") incorporated in the British Virgin Islands. The insurance would be triggered if an event occurred which prevented the market value at sale from reaching $2,050,518/p ha between the event and 31 December 2048, with the insured being the members of the syndicate and Trinity 3. The insurance premiums were $1,307/p ha in 1997, and $32,791/p ha payable on or before 31 December 2047 for the syndicate, and $410,104/p ha on or before 31 December 2047 for Trinity 3. The premium for Trinity 3 was to scale dollar for dollar up to a maximum of $1,230,311/p ha to the extent that the market value of stumpage at 13 December 2047 would be less than $2,050,518/p ha.

The result was CSI insured Trinity 3 and the investors up to $2,050,518/p ha, but due to the scaling premium Trinity 3 was subject to, and the premiums to be paid, the maximum CSI would have to pay would be $787,416/p ha (if net stumpage was zero), and if fewer than 300 trees matured, CSI would not have to pay anything.

Syndicate members provided promissory notes to cover their obligations to pay the licence premium of $2,050,518/p ha in 2048 and to meet their liability to pay the insurance premium in 2047. Trinity 3 provided a promissory note for its 2047 insurance premium liability. Debentures secured the money payable under the promissory notes, the overall effect being to give CSI first rights over the forest until its value exceeded the deferred portion of the insurance premium.

Investors took up proportionate shares in the syndicate by reference to a number of plantable hectares, and in the 1997 claimed deductions from assessable income for:

1. $34,098/p ha for the insurance premiums ($1,307 paid in March 1997 and $32,791 to be paid in cash terms in 2047)
2. A small proportion of the licence premium of $2,050,518/p ha to be paid in 2048 as a depreciation allowance.

In their 1998 returns, the investors claimed the amortised licence premium figure of about $41,000/p ha.

No issue arose over the actual costs of planting and tending trees. Those costs aside, in cash terms investors spent a little under $5,000/p ha in 1997 and $50/p ha in 1998 to qualify for the above deductions.

Decision

Sham
It had not been shown that the parties to the relevant documents were intending to deceive the Commissioner as to the nature of their arrangements in respect of insurance or as to their intention to implement the insurance arrangements according to their tenor [38] (the insurer, the contracts, the forest, and payment of initial premium all having been found by the Courts below, as matters of fact, to exist [36]-[38]).

Deductibility - licence
The licence premium is deductible if it is for a "right to use land", which requires an analysis of the nature of the arrangements actually entered into [46]. The majority held that when considering the application of a specific tax provision, before reaching any question of avoidance, the Court was concerned primarily with the legal structures and obligations the parties had created and not with conducting an analysis in terms of their economic substance and consequences, or of alternative means that were available for achieving the substantive result [47].

In the circumstances in which the transaction had been set up, the licence provided the syndicate with the necessary access to Trinity 3's land to perform its forestry obligations, for which it incurred the licence premium as a cost. The licence gave a 'right to use land' within the meaning of the specific provision and deductible as depreciation on depreciable property, subject to the issue of avoidance [54].

Deductibility - insurance
The present insurance contract is outside the reach of the definition of 'accrual expenditure' and the spreading rules do not apply to it as it was entered into as part of a wider financial arrangement, so the premium did not have to be spread [60]-[64].

Avoidance
Specific tax provisions and the general anti-avoidance provision are meant to work in tandem; each provides a context which assists in determining the meaning and the scope of the other [103]. The purpose of specific provisions must be distinguished from that of the general anti-avoidance provision [103].

Ascertaining when the way a specific provision was deployed crossed the line and turned what might otherwise have been a permissible arrangement into a tax avoidance arrangement should be firmly grounded in the statutory language of the provisions themselves, rather than seizing on past Judicial glosses and elaborations on the statutory language [104].

Where the case involves reliance by the taxpayer on specific provisions, the taxpayer must satisfy the Court that the use made of the specific provision is within its intended scope. If that is shown, then the use of the specific provision by the taxpayer is also to be viewed in the light of the arrangement as a whole. Viewing the transaction as a whole, if the use of the specific provision alters the incidence of income tax in a way which cannot have been within the contemplation and purpose of Parliament when it enacted the provision, the arrangement will be a tax avoidance arrangement [107]. Here the licence premium was within the specific provision as "a right to use land", but viewing the arrangement as a whole, had additional features which caused it to represent and be part of a tax avoidance arrangement [107].

In considering whether a tax avoidance arrangement exists, the general anti-avoidance provision does not confine the Court as to the matters which may be taken into account, and the significance of relevant factors will depend on the particular facts [108].

A classic indicator of a use that is outside Parliamentary contemplation is the structuring of an arrangement so that the taxpayer gains the benefits of the specific provision in an artificial or contrived way [108].

The ultimate question is whether the impugned arrangement, viewed in a commercially and economically realistic way, makes use of the specific provision in a manner that is consistent with Parliament's purpose [109].

Evaluation of avoidance - licence premium
The Court proceeded on the basis that the expenditure on the licence premium was incurred when the promissory notes were executed [119]; however, that was a jurisprudential rather than commercial meaning of "incurred" [118] The Court considered that the giving of the promissory notes before expenditure had been incurred introduced an artificial element into the arrangement [119].

The amounts paid in comparison to the licence premium raised questions over whether the transaction would be profitable in business terms [121].

The clarity of the tax advantage was in marked contrast to the obscurity of the prospect of any ultimate commercial profit. This led to the conclusion that the primary, if not sole purpose of the promissory note, was to generate a tax deduction for the licence premium [122].

The other feature supporting the conclusion of tax avoidance was the timing difference between the incurring and the commercial payment of the licence premium, such that under the arrangement the appellants would receive the benefits of tax deductions but probably never incur the real expenditure [127].

Evaluation of avoidance - insurance
The formation of a special, single purpose company to undertake the insurance risk in a tax haven, gives rise to immediate issues about the true purpose of what is being done [132]. The evidence suggested that CSI was not intended to be anything more than a pro forma vehicle for obtaining the anticipated tax benefits [138].

Dr Muir was also at pains to try to avoid disclosing the true substance of what CSI did [145].

The letter of comfort given to CSI by the Trinity Foundation Charitable Trust (the ultimate beneficial owner of the Trinity Foundation), led to a substantial element of circularity in the whole insurance arrangement, which fact alone led to a strong inference that the insurance was simply a method whereby substantial tax benefits could be obtained by deducting one lump sum in 1997, a premium not payable in commercial terms until 2047 [146].

The plaintiffs' argument that the execution of the promissory note was done to give CSI a readier means of enforcing payment than if it had simply been left to sue in contract was not accepted as being the principal purpose of the promissory note, there being no transfer of real value to the creditor by substituting one form of obligation for another. The promissory note did not pay the second premium in any real sense. CSI undertook no real risk and was simply a vehicle to achieve the deductibility of a premium which was not truly paid [147].

The Court viewed the insurance dimension of the Trinity scheme as both artificial and contrived, and the insurance arrangements, as constructed, could not have been within the contemplation of Parliament when it enacted section DL 1(3). The insurance dimension was a material contributor to making the whole Trinity scheme a tax avoidance arrangement.

Avoidance - conclusion
The appellants' use of the specific provisions was not within Parliament's purpose and contemplation when it authorised deductions of the kinds in question. The appellants altered the incidence of income tax by means of a tax avoidance arrangement which the Commissioner correctly treated as void against him [156].

Novel point
The Court declined to allow the new point raised by Accent Management Limited to be taken, giving as reasons that leave had not been granted to raise that point, nor would it have been appropriate to grant leave at the hearing in the face of opposition by the Commissioner [151].

Participation
All appellants entered into a tax avoidance arrangement simply by becoming members of the syndicate and parties to the agreements with Trinity 3 [159]. On the ordinary meaning of the "any person affected by that arrangement" and "that person" in section GB 1, once the existence of a tax avoidance arrangement has been established, all those taxpayers who have benefited from it may be subject to corrective adjustments by the Commissioner; the taxpayer need not even be aware of the tax avoidance aspect [164] or directly involved [168]. A taxpayer who claims a deduction in terms of a tax avoidance arrangement can hardly claim not to be affected by the arrangement [168].

Reconstruction
The appellants had not established that the Commissioner adopted a reconstruction which was outside the scope of his powers [170]. It is settled law that the onus is on the taxpayers to demonstrate not only that the reconstruction is wrong, but also by how much it is wrong, and in this case the appellants had done neither. In particular, the appellants had not submitted any particular reconstruction of their own which the Court could then have evaluated [171].

Penalties
While the expenditure for the licence premium and insurance premium satisfied the ordinary meaning of the specific provisions relied on for claiming the deductions this was not enough on its own. Features of the arrangement led the Court to conclude that the arrangement was clearly a tax avoidance arrangement, with the effect under section 141D(6) that the appellants in their returns took an incorrect tax position under a general anti-avoidance tax law [182]. The appellants' tax position failed to meet the required standard of "about as likely as not to be correct" [203].

Due to the wording of the statute (the qualification in section 141D(7)(b) reinforced by section 141D(7)(b)(ii)), the dominant purpose to be considered was the dominant purpose of the arrangement itself, not the dominant purpose in the mind of each taxpayer.

It followed that the appellants each took an abusive tax position, and subject to particular further arguments from three appellants, were liable for the 100 percent penalty imposed by the legislation.

Double penalties
The argument advanced by Ben Nevis and Greenmass was not accepted, with the Court sharing the view of the Court of Appeal that the language of the definition of "tax shortfall" covered the position of each LAQC, and nothing in the Act enabled the Court to read down the words of the definition [214]. The Court observed that the double penalty issue had been subsequently addressed by the enactment of section 141FC of the TAA [215].

The argument advanced by Redcliffe Forestry Venture Limited that its own ultimate position was not to claim a loss was not in point, and viewed as a whole Redcliffe's return involved taking a tax position in relation to the Trinity scheme which resulted in too little tax being paid by Redcliffe's shareholders. This was a tax shortfall and Redcliffe was correctly held liable to a shortfall penalty [218].

Appeals dismissed and costs to the respondent.