Approved issuer levy and withholding taxes - High Court dismisses appeal and allows Commissioner's cross-appeal on shortfall penalty
2012 case note - approved issuer levy and withholding taxes - High Court dismisses appeal and allows CIR's cross-appeal on shortfall penalty – residency.
The appeal was dismissed and the cross-appeal allowed. The High Court concluded that Weyand Investments Ltd had its centre of management in New Zealand, was liable to deduct resident withholding tax ("RWT") and that the arrangement was a tax avoidance arrangement. The Court also considered that the appellants were liable for a shortfall penalty for taking an abusive tax position, allowing the cross-appeal by the Commissioner of Inland Revenue ("the Commissioner").
Impact of decision
The High Court confirmed that the centre of management test is factual and the enquiry is to be made by reference to the nature of the company's business and activities. The Court also applied section 138G of the Tax Administration Act 1994 ("TAA") to arguments not raised in the statements of position. The Court also confirmed that the test for applying the abusive tax position shortfall penalty is an objective test.
This was an appeal by the appellants against the decision of the Taxation Review Authority (Case 11/2011 (2011) 25 NZTC 15,177) upholding the Commissioner's assessments. The Commissioner cross-appealed the Authority's decision to disallow the shortfall penalty.
Mr and Mrs Chin lived in New Zealand from 1949 to 1973, in Hong Kong from 1973 to 1989 and in New Zealand from late 1989 onwards. Weyand Investments Limited ("Weyand") is a Hong Kong registered company, incorporated in 1982 by Mr and Mrs Chin, who were the directors and shareholders prior to 1997.
In 1990, Mr and Mrs Chin incorporated a New Zealand company, Vinelight Investments Limited ("VIL"), the shareholders of which were Mr and Mrs Chin's three children. In 1989, Mr and Mrs Chin made advances to Weyand. In 1990, Weyand then made substantial loans to VIL, which were converted to redeemable preference shares in VIL. These were redeemed in 1996 by VIL with the result being VIL was indebted to Weyand for over $3 million.
After receiving tax advice in 1996, a plan was devised to allow income earned in New Zealand by VIL and other Chin family entities to be paid to Weyand subject only to the payment of approved issuer levy ("AIL"). The first step in this plan was the settlement of the Vinelight Trust, with Vinelight Nominees Limited ("Vinelight Nominees") as the sole trustee. Mr and Mrs Chin were the directors of Vinelight Nominees.
In 1997, Mr and Mrs Chin transferred their shares in Weyand to their three children who were appointed additional directors. A deed of acknowledgement of debt was executed in 1997 recording that Weyand had advanced $3 million to Vinelight Nominees by way of a loan with Vinelight Nominees acknowledging the debt to Weyand and was repayable on demand. However, the advance was made to VIL not Vinelight Nominees. An additional deed of assignment of debts and acknowledgement of debts was executed in 1998 recording that in consideration for the assignment to Vinelight Nominees of debts owed by 195 Khyber Pass Road Limited to VIL, Vinelight Nominees agreed to assume liability for VIL's debt to Weyand in the amount of $1.8 million repayable on demand with interest payable pending repayment. Vinelight Nominees also agreed to pay AIL on any interest payments made.
In 1998, Vinelight Trust applied for (and was granted) AIL status and in 1999 applied for (and was granted) registration of the debt owed to Weyand as a registered security.
The Commissioner asserted that from 1999 to October 2003 Weyand was a New Zealand tax resident and accordingly should have deducted RWT as opposed to AIL. The Commissioner accepted that from October 2003, Weyand was not a New Zealand resident. However, the payment of AIL as opposed to non-resident withholding tax ("NRWT") formed part of a tax avoidance arrangement. The Commissioner also imposed shortfall penalties for taking an abusive tax position.
The Court dismissed the appeal and allowed the Commissioner's cross-appeal.
The Court concluded that it was satisfied Weyand had its centre of management in New Zealand, confirming the test is factual and the enquiry is to be made by reference to the nature of the company's business and activities. Among a number of factors, the Court relied on the fact that Mr Chin, in Auckland, instructed Ernst & Young regarding the various Chin family companies (including Weyand) and there was no evidence he consulted anyone outside New Zealand in implementing the advice of Ernst & Young. The Court also confirmed that Mr Chin made the demand for interest on behalf of Weyand and it was significant that the advice to the children, that a reduction in interest rate was desirable and ought to be made, came from Mr Chin in New Zealand.
Was Vinelight Nominees liable to deduct RWT?
The Court considered the appellants' submission that Vinelight Nominees was not liable to deduct RWT because it did not satisfy the criteria in section NF 2(4)(b)(ii) of the Income Tax Act 1994 ("the Act") but held that the effect of section 138G(1) of the TAA meant it was not open to the appellants to make submissions on the issue at first instance or on appeal.
The appellants also submitted that Vinelight Nominees was not liable to pay RWT pursuant to section NF 5 of the Act. The Court was satisfied that Vinelight Nominees must be taken to have concluded that its payment to Weyand constituted non-resident withholding income and that all reasonable inquiries can be taken to have been made. However, the Court considered that the conclusion reached by the appellants could not be reached on reasonable grounds. Accordingly, the Court held that section NF 5(1) of the Act was not satisfied.
In addition, the Court considered that despite submissions to the contrary from the appellants, section 108(1)(a) of the TAA should be read as substituting the phrase "RWT return" for "income tax return" when applied in the context of section 99 of the TAA. Accordingly, the Court was satisfied the Commissioner's assessments were not statute barred.
Tax avoidance arrangement
The Court was satisfied that the appellant's use of section NG 2(1)(b)(i) of the Act could not have been within Parliament's contemplation when it enacted the provision. In particular, the Court concluded that the whole purpose of the arrangement was to ensure Vinelight Nominees would not pay income tax on income that it received and paid to Weyand as interest other than AIL at 2%. The Court also held that if tax avoidance was not the sole purpose, it was the predominant purpose and therefore was not merely incidental. Accordingly, the Court concluded a tax avoidance arrangement existed, which was void as against the Commissioner.
The appellants submitted that even if a tax avoidance arrangement existed, the Commissioner was not able to exercise the reconstruction power in section GB 1 of the Act as the provision is limited to adjusting amounts of gross income, allowable deductions and net losses included in the calculation of taxable income. The Court concluded that section 138G of the TAA precluded the appellants from raising this issue.
The Court accepted that the judgment of the Authority suggests it did not consider the tax position taken by the appellants wholly objectively. The Court concluded that viewed objectively, each tax position was an unacceptable tax position and that the test in section 141D(7)(b) of the TAA was met. Accordingly, the Court allowed the Commissioner's cross-appeal.
Income Tax Act 1994, Tax Administration Act 199