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04 Feb 2010
Appeal Status
Not appealed

Allocated salary important when considering "objective test" in tax avoidance cases

2010 case note – disputant transferred practice to company in which she was shareholder - income splitting, tax avoidance, arrangement and objective test.

TRA Decision 4/2010


The disputant is an anaesthetist who transferred her private practice to a company in which she was a shareholder. A minimum salary was paid by the company for her services. It was held that an arrangement was in place, which when looked at objectively had a purpose of tax avoidance.

Impact of decision

The decision appears to follow other Taxation Review Authorities ("TRA") decisions on section BG1 and emphasises the importance of the allocated salary as a significant part of the "objective test" in income splitting cases. The Court of Appeal is due to hear the Penny and Hooper Appeal in February 2010, which decision will become the leading authority on "income splitting" arrangements.


The disputant is an anaesthetist in public and private practice. Her husband provided quality assurance services as an employee and privately. On 1 November 2002, the couple restructured their business affairs. One stated reason for the restructuring was to protect their family after concerns were expressed about exposure to claims which could be made by clients against private professional services being provided.

The restructuring involved an arrangement whereby a family trust owned assets including horticultural land, an avocado orchard and business assets relating to the private services provided by the disputant and her husband. A company "W" Limited was established and the disputant and her husband each held a 35% share in the company.

On 1 November 2002, the disputant stopped being self-employed in what Judge Barber saw as "her very profitable private anaesthetist practice" and took up employment in the newly incorporated W Limited, which had taken over the running of her private practice. Her services were then provided to the clients of W Limited, those services being exactly the same as she had been providing when in private practice. However, instead of receiving a substantial income commensurate with her skills and exertions she received no salary from W Limited for 5 months work in 2003 and only $4,875 in the year ended 31 March 2004 for 12 months work.

The reason given for the lack of salary was that W Limited was not making sufficient income to enable her to be remunerated at the same rate as she had been when in private practice. The avocado orchard business which was owned by W Limited was operating at a loss. One of the larger overheads for the avocado orchard business was the rental paid for the orchard which was owned by the family trust. The disputant claimed that the orchard returns were less than expected due to poor cropping results and lower than expected prices.

As part of his defence the Commissioner drew the attention of the Authority to the fact that W Limited appeared to be paying above normal market rates to lease the orchard. The disputant claimed that rent was not an issue raised by the Commissioner in his Statement of Position and he was therefore excluded from presenting evidence regarding a market rent.


BG1 and GB1 ITA

The case is fact specific, with Judge Barber finding that the structures implemented by the disputant left her "unremunerated in a manner which is artificial and contrived and has no sensible reality" (paragraph [23]). The structure was in effect seen as an assignment of her income to the company. It was acknowledged that there are ways in which income from one business activity could be offset against another, but this was not one such situation (paragraph [25]).

Judge Barber acknowledged at paragraph [47] that the leading authority on what constitutes tax avoidance is Ben Nevis Forestry Ventures Limited v CIR; Accent Management Ltd v CIR, 24 NZTC 23,188 (SC). He followed the two-step process set out in paragraph [107] of Ben Nevis, the first step of which is to determine whether or not the taxpayer has used specific tax provisions within their intended scope.

Having established that step one applies, he notes that a second step considers the use of the specific provisions as a whole and that at this point section BG 1 applies in tandem with the specific provision. At paragraph [48] he quotes from Ben Nevis (paragraph [107]) which states:

  • ... a further question arises based on the taxpayer's use of the specific provision viewed in light of the arrangement as a whole. If, when viewed in that light it is apparent that the taxpayer has used the specific provision, and thereby altered the incidence of tax, in a way which cannot have been within the purpose or contemplation of Parliament when it enacted the provision, the arrangement will be a tax avoidance arrangement.

At paragraph [49] he set out the indicia of when specific provisions under an arrangement will not be within the purpose or contemplation of Parliament. As set out in paragraph [108] of Ben Nevis, the indicia include:

  1. the manner in which the arrangement is carried out
  2. the role of all relevant parties and the relationship they have with the taxpayer
  3. the economic and commercial effect of the documents and transactions
  4. the duration of the arrangement
  5. the nature and extent of the financial consequences of the arrangement
  6. the structuring of the arrangement in a contrived and artificial way.

He also acknowledged that the purpose or effect of an arrangement is objectively determined "by looking at the overt acts done in pursuance of the whole arrangement": Elmiger and Anor v CIR [1966] NZLR 683 at paragraph 694; CIR v Challenge Corporation Ltd (1986) 8 NZTC 5,001 at 5,006; V20 (2002) 20 NZTC 10,233 at pp 37 and 39; Ashton & Anor v CIR (1975) 2 NZTC 61,030; Tayles v CIR (1982) 5 NZTC 61,311.

At paragraphs [53] and [54] he confirmed that the "effect of an arrangement" will establish its "purpose". Tayles, Ashton; Newton v C of T [1958] AC 45; V20 and Westpac Banking Corporation v CIR, CIV 2005-404-2843, 7 October 2009, HC, Harrison J at paragraph 199.

The Commissioner submitted that the arrangement consisted of several parts including:

  1. the incorporation of W Ltd
  2. the disputant's self employment anaesthetist business being transferred to W Ltd
  3. the family trust's anaesthetist business and orchard business being transferred to W Ltd
  4. the family trust's leasing the anaesthetist equipment to W Ltd
  5. The family trust's leasing the orchards, plant and vehicles to W Ltd
  6. W Ltd offsetting losses from the orchard business against profits from the anaesthetist business
  7. the disputant carrying out the anaesthetist services for W Ltd for no consideration in 2003 and much less consideration than she had previously been receiving in 2004
  8. W Ltd failing to adequately remunerate the disputant for anaesthetic services as under the previous contract between the family trust and the disputant due to insufficient company funds.

Judge Barber saw some steps as neutral while steps 2, 6, 7 and 8 were considered significant (paragraph [81]).

At paragraph [82] he agreed with the Commissioner that the tax provisions the disputant was avoiding related to making payment or reward for services income and the payment of tax for personal exertions at a graduated rate. He also acknowledged that income which would ordinarily be the disputants was being "diverted" and taxed at a lower rate than would otherwise be the case.

At paragraph [83] Judge Barber agreed that it is not the formation of the company which is tax avoidance. But rather it is the artificial use of these structures to reduce tax paid in respect of income generated through the disputant's personal exertions, while retaining full control over and benefit from that income which amounts to tax avoidance.

While agreeing that tax avoidance can be found in individual steps or in a combination of steps at paragraph [84] he states: "but I consider that the disputant's transfer of personal exertion income to "W" Ltd for no benefit to her, other than tax savings, is in itself tax avoidance" [emphasis added].

At paragraph [87] he further states: "... From a commercial perspective, it made no sense for her to agree to receive an artificially low income. The only reason she would agree to such a low income is because an associated entity and trust still controlled the practice income and such income was still available to her and her family by paying debts of "W" Ltd."

At paragraph [88] Judge Barber looked at Parliamentary Contemplation and stated: "Parliament would not have contemplated the artificial use of structures to reduce the tax paid in respect of the income generated through the disputant's personal exertions while, through those structures, she retained full control and benefit from that income" [emphasis added].

The test of whether or not the tax advantage was "more than merely incidental" is discussed in paragraphs [93] to [99] of the decision. In particular, Judge Barber emphasises paragraph [114] of Ben Nevis which states:

  • [114] ... It will rarely be the case that the use of a specific provision in a manner which is outside Parliamentary contemplation could result in the tax avoidance purpose or effect of the arrangement being merely incidental. [emphasis added]

In relation to the ability of the Commissioner to reconstruct the tax affairs of the disputant under section GB 1, Judge Barber noted that the Commissioner has a wide discretion to reconstruct the arrangement to impose tax on the taxpayer. He remained unconvinced as to the proper arithmetical outcome for reconstruction purposes but gave reserve leave for the parties to apply to the TRA for direction should they fail to agree on the correct method for reconstruction.

138 G TAA

Judge Barber agreed that the issue of commerciality of the rental charged was not a new issue and referred to a number of paragraphs in the Commissioner's Statement of Position which sets out various parts of the "arrangement" including leasing from the Family Trust. It was also noted that the disputant raised the issue in evidence about how the accountant set the rental.

Sections 15 and 17 of the Taxation Review Authorities Act 1994 gives the Authority wide powers to accept evidence in a proceeding. The evidence of an expert (in this case a valuer) was held to be admissible under section 25(1) of the Evidence Act 2006.

Income Tax Act 1994, Tax Administration Act 1994