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29 May 2014
Appeal Status
Not appealed

Employee entitlement fund and tax avoidance

2014 case note – High Court confirmed decision - employee entitlement fund, tax avoidance, fraud, shortfall penalties.

HC Services Ltd v Commissioner of Inland Revenue [2014] NZHC 1169


The High Court confirmed the decision of the Taxation Review Authority ("TRA") and dismissed the appeal of HC Services Ltd.


This was an appeal against the decision of the TRA, delivered on 6 November 2013 (TRA 11/10 [2013] NZTRA 09); and the earlier Threshold Ruling of the TRA, delivered on 11 September 2012 (TRA11/10 [2012] NZTRA 08).

The appellant made payments to a purported employee entitlement fund ("the EEF") for the benefit of the appellant's employees and claimed income tax deductions for the various payments made in relation to the EEF in the income tax years ended 31 March 2004 to 31 March 2006 (inclusive). The Commissioner assessed the appellant on the basis the appellant was not entitled to deductions under the following black letter provisions: sections DC 5, DA 1, DA 2, DB 6 and/or DB 7 of the Income Tax Act 2004 ("ITA 2004"); and/or alternatively, the EEF it invested in and promoted, was a tax avoidance arrangement. The Commissioner also imposed shortfall penalties for taking an unacceptable tax position pursuant to section 141B of the Tax Administration Act 1994 ("TAA") and for taking an abusive tax position pursuant to section 141D of the TAA (reduced by 50%) in each of the tax years.

In the TRA, the appellant challenged the Commissioner's assessments and asserted it was entitled to deductions under section DB 33 of the ITA 2004 for misappropriation. However, before the substantive issues were considered by the TRA, the parties requested the TRA determine whether fraud on the appellant in relation to any arrangement precludes sections OB 1, BG 1 and GB 1 of the ITA 2004 from applying.

The TRA found that, even if there had been a fraud on the appellant, the fraud did not prevent the general anti-avoidance and reconstruction provisions applying (TRA11/10 [2012] NZTRA 08 at [149]).

At a separate hearing, the TRA considered the substantive issues and confirmed the Commissioner's assessments including shortfall penalties for having taken an abusive tax position (TRA 11/10 [2013] NZTRA 09 at [127]).


Fogarty J agreed with the TRA that the EEF did not meet the requirements of section DC 5 of the ITA 2004 as there was no evidence that there was any intention to "fully secure" employees' rights to receive benefits from the fund.

His Honour agreed with the TRA's findings at [133]-[136] that any fraud on the appellant by a third party is not relevant to the application of the anti-avoidance provisions (HC Services Ltd v Commissioner of Inland Revenue [2014] NZHC 1169 at [25]-[29]).

Further, Fogarty J dismissed the submission that fraud in an arrangement has the same vitiating effect as a sham. At [37] he found:

  • The fact that one of the principals behind this tax arrangement may have intended at some point, either from the outset or during the transactions, to defraud the taxpayer, does not mean that there were no rights and obligations created by the transactions, that they were not real.

His Honour concluded at [62]:

  • An argument that elements of fraud – either in the construction, promotion or operation of the tax avoidance arrangement – vitiated the arrangement so that the tax avoidance provisions could not apply – would render tax avoidance provisions of the Act significantly ineffectual. On such a construction, the best way to sell a tax avoidance package would be to sell an ineffective one! That has to be nonsense.

Finally, in relation to penalties, and having found that the appellant was a party to a tax avoidance arrangement, Fogarty J upheld the Commissioner's abusive tax position shortfall penalty assessments pursuant to section 141D(7)(b)(i) of the TAA, commenting that the High Court has no power to apply subsection (7)(b)(ii) of the TAA.

Tax Administration Act 1994, Income Tax Acts 1994 and 2004