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11 Sep 2012
Appeal Status

Tax avoidance - fraud on a person affected by the arrangement

2012 case note – Tax avoidance and fraud - party to the arrangement, meeting of the minds, person affected by the arrangement.

TRA 011/10

Income Tax Act 1994, Income Tax Act 2004


The Commissioner is not required to satisfy herself that the taxpayer is fully aware of all aspects of an arrangement or that the taxpayer has not been the victim of fraud by a third party in relation to an arrangement to apply the general anti-avoidance rule.


In the income tax years ended 31 March 2004 to 31 March 2006, the disputant participated in an arrangement which purported to constitute an employee indemnity fund ("the EIF") for the benefit of the disputant's employees.

Ultimately, the disputant claimed deductions in the relevant income years for contributions, fees, insurance and interest paid under the EIF. The Commissioner reversed the deductions and assessed the disputant for shortfall penalties.
The parties to this matter agreed to have a preliminary question of law heard by the Taxation Review Authority ("TRA") before proceeding to a hearing on the substantive issues in dispute:

  • Even if there was a fraud on the disputant in relation to any arrangement, either wholly or in part, does that preclude sections OB 1, BG 1 and GB 1 of the Income Tax Act 1994 or the Income Tax Act 2004 from applying to the arrangement?


The disputant asserted that the EIF was fraudulent and as a consequence the contributions paid by the disputant (by way of loan) to the relevant fund never existed. Accordingly, as the transactions were not genuine, the contribution payments could trigger no deductions (albeit the disputant maintained it was still entitled to deductions for payments made relating to insurance, interest and fees on the basis of fraud or misappropriation pursuant to section DJ 8 of the Income Tax Act 2004). The disputant asserted that where there is such a fraud there can be no tax avoidance.


The TRA confirmed that there is no general crime of fraud in the common law albeit it has a clear meaning in criminal law of "dishonesty" (noting that to some extent it overlaps with the meaning of fraud in civil law and equity). For the purposes of this dispute, the TRA confirmed that "fraud" is taken to encompass any conduct as a result of which the disputant has not given informed consent as to the true nature of the scheme in which it participated (which the TRA considered would include being the victim of either civil or equitable fraud).

Further, the disputant had asserted that where there is evidence of fraud, the TRA was required to look behind the arrangements and analyse the substance or the real legal relationship to determine the basis upon which the disputant should be taxed. The disputant relied on the decisions of Calkin v Commissioner of Inland Revenue [1984] 1 NZLR 440 and R v Connolly (2004) 21 NZTC 18,844. The Commissioner rejected these arguments and the TRA agreed with the Commissioner. In particular, the TRA pointed out that Court in Calkin did not consider whether fraud nullifies a transaction for tax purposes and the issue in Connolly was sham (and sham is not an issue in the current dispute).


After setting out the leading case law on the general anti-avoidance rule, the TRA confirmed that it was clear from the Agreed Statement of Facts that there was a plan or understanding between the disputant and the participants/promoters of the EIF.

Further, as a matter of statutory interpretation, the combined effect of section BG 1 and the definitions of "arrangement" and "tax avoidance arrangement" means that even if a taxpayer is the victim of fraud, a tax avoidance arrangement can still exist.

The TRA confirmed that the intention of the parties in entering the arrangement is irrelevant and an arrangement does not require consensus or a meeting of the minds (referring to Russell v Commissioner of Inland Revenue [2012] NZCA 128, (2012) 25 NZTC 20,120, Peterson v Commissioner of Inland Revenue [2005] UKPC 5, [2006] NZLR 433 and the dissenting judgment of Thomas J in Commissioner of Inland Revenue v BNZ Investments Ltd [2002] 1 NZLR 450). Accordingly, the TRA concluded that it was irrelevant that the disputant may not have been aware of the full details of the arrangement or that its knowledge did not extend to all steps and transactions by which the arrangement was carried into effect.

The Commissioner had asserted that the purpose of section BG 1 would be hindered if taxpayers could allege they were unaware of the full particulars of an arrangement and therefore should avoid the application of the general anti-avoidance rule. The Commissioner submitted that the disputant's contentions did not support the purpose of section BG 1 and the TRA agreed.

In addition, the TRA considered that the arrangement had a purpose or effect of tax avoidance. The disputant claimed tax deductions that relieved it of liability to pay income tax (and any subsequent reversal of those deductions by the disputant did not erase that tax advantage) and so there was "tax avoidance" as defined. Further, the TRA was able to infer from the features of the arrangement that it had a clear purpose or effect of such tax avoidance.

The TRA also confirmed that once a tax avoidance arrangement is established, the arrangement is void as against the Commissioner and the Commissioner can adjust the deductions of any person affected by the arrangement so as to counteract the tax advantage. The TRA noted that there was no requirement that the relevant person be a party to the arrangement to be a person affected by the arrangement. The TRA ultimately held that regardless of whether or not the disputant was a party to the arrangement, it was affected by the arrangement in that it claimed deductions in respect of the EIF.

The effect of any fraud

Finally, the TRA also confirmed that, while there are indicators of fraud in this case, any fraud on the disputant by a third party is not relevant to the application of section BG 1. The disputant has legal remedies available to pursue against those third parties and this does not affect the Commissioner's ability to adjust the income of taxpayers who are affected by a tax avoidance arrangement.