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27 Jan 2010
Appeal Status
Not appealed

$5 million of "loans" found to be income after all

2010 case note - property developer who lived on 'loans' and drawings from companies held to have avoided income tax - capital, journal entry, structure.

TRA Decision 3/2010

Income Tax Act 1994


A property developer who lived largely on "loans" and other drawings from his various companies was held to have thereby avoided income tax.

Impact of decision

Tax avoidance jurisprudence has moved very quickly in New Zealand since the Supreme Court decisions in Glenharrow and Ben Nevis. In this case the Authority has applied the relatively new test of "parliamentary contemplation" as well as the more conventional BG1 analyses to a somewhat extreme fact pattern. The Commissioner considers the decision to largely turn on its own facts.


The disputant is a property developer and entrepreneur. During the period 1991 to 2002 he was involved in projects worth, at least, hundreds of millions of dollars. Over that period he paid less than $20,000 net income tax. The disputant did, however, avail himself of loans from entities he controlled. These "loans" amounted to $5,094.442 over the 12-year period. The Commissioner considered the loans and the mechanisms by which the disputant and his entities accounted for profits or gains, to be a tax avoidance arrangement. The disputant was assessed in his personal capacity for income equivalent to the unrepaid loans over the 12-year period.

His Honour Judge Barber described the disputant's business method:

  • [11] I understood that these projects, involving developing land on revenue account, were effected in separate trusts and, at the end of each project, the profit was distributed to the next trust development project, which would be in start-up at that stage and so on and so on. Some projects seem to be the erection (or renovation) of buildings on land for resale but, very often, for retention by the disputant's group as a letting enterprise.
  • [12] Simply put, in order for the disputant and his family to live in the manner he wished, there were constant and very regular drawings by the disputant from his entities. Generally, no salary was paid to him, and the drawings were treated by his accountants, and for the purposes of his tax position, as loans of capital. Mr Lennard's strong submission is that capital was the character of the advances by these group entities to the disputant over the said 12 years.
  • [13] As I understand it, the said technique applied by the accountants and advisers for the disputant, leading to him not appearing to receive earnings, continued unnoticed by the IRD for many years until one of the development projects led to significant losses for the particular group entity ... In examining the fallout from that failure, the regular and systematic drawings taken for living by the disputant, and set out in the relevant book-keeping as loans, showed up, possibly, because creditors saw them as an asset of the lender trust entity to be repaid by the disputant.
  • [14] The disputant's group operated in a tax efficient manner. Virtually no income tax was paid. It is submitted for the defendant that the arrangement was a device whereby the disputant could live off funds obtained from his entities without paying any tax and that there is no other objective rationale for the arrangement.

Some "repayments" were made by book entry into various loan accounts whenever the Group realised a capital gain:

  • [56]... Most repayments were by journal entry. If any trust obtained a capital benefit, this could be distributed to the disputant by journal entry and immediately utilised by him again, by journal entry, in repayment of a loan. In economic terms it means that when an entity obtains a capital amount, the loan can be reduced by that amount with his entities still having the funds available for other projects. That after the repayment the funds may be in a different disputant entity is not significant. The disputant confirmed under cross-examination that there was no difficulty in moving funds within the group and that it is done "all the time".


The Authority embarked upon a comprehensive BG1 analysis in order to determine whether the purported loaned capital receipts were in fact income in the hands of the disputant.

His Honour held that there was a tax avoidance arrangement which consisted of:

  • [a] the disputant borrowing funds from the trust, the said company and other associated entities/trusts;
    [b] a fundamental component of the arrangement was the terms on which such amounts were loaned to the disputant, including no defined date for repayment;
    [c] no (or only slight, depending on the income year) taxable distributions or amounts being paid by the associated entities/trusts to the disputant; the repayments of the loans that were made were sourced from non-taxable distributions received from his associated entities.

The arrangement was held to have avoided tax by virtue of the control the disputant had over all his trading entities:

  • [35] In theory, the disputant must repay the loans but, since he controls the associated entities, he can control when and to what extent demand for payment is made. The repayment can be indefinitely deferred. He could control whether interest was charged; and it did not seem to be. The repayments were merely circular flows of funds that have no economic effect on the disputant's entities other than that the loan balance is reduced or cancelled. The money for the repayment was provided by the disputant's entities and with the repayment being returned to those entities, although not necessarily the same entity.

Judge Barber agreed with the Commissioner's submission that there could be no commercial rationale for such structuring and arrangement and that it could only be explained in terms of tax benefits. For example, when the Group needed funding for another project, it would take on high-interest commercial finance rather than call in the interest-free loan made to the disputant. At [61]:

  • The arrangement is explicable in terms of tax. The arrangement has enabled the disputant to avoid falling within the specific provisions relating to assessability of payment/reward for services, in particular sections CD 5 and CH 3 of the Income Tax Act 1994. The arrangement has also avoided the provisions which assess beneficiary income or, where a company, dividends. Even if I could find that the arrangement had a commercial purpose, the tax benefit is sufficiently significant for it to be a purpose other than a merely incidental purpose.

Regarding the time bar, it was submitted for the disputant that section 108 requires that there be an omission of "income ... of a particular nature ... or derived from a particular source". The disputant claimed that as the Commissioner had reconstructed the loans as income, and that the disputant had returned certain items of income in his tax returns, then the particular nature/source test was satisfied. His Honour held otherwise:

  • [105] The section is directed at the failure to mention income, not a failure to characterise it as income. In Cross v CIR [1987] 9 NZTC 6,101, at 6,111, Somers J considered that the exception does not require a taxpayer to return an amount as income if the taxpayer asserts that it is not income, but it must be mentioned for the exception to not apply:
    "It would be an unreasonable construction of section 24(2) to hold that it requires the taxpayer to return that as income which he asserts is not income. If, however, he omits all mention of the gain which subsequently is found to be assessable income, section 24(2) will apply. The subsection is not directed to a failure to characterise the advantage as income but the failure to mention it at all. It is the latter omission which enables an amended assessment to be made after the four-year period has expired."

The Authority confirmed the Commissioner's assessments and agreed that a 100% shortfall penalty should also apply to the disputant for taking an abusive tax position.