INV-290
Issued
01 Mar 2004

Promoter Penalties (Mar 04)

INV-290 provides information about applying promoter penalties to promoters of arrangements involving abusive tax positions.

Introduction

  1. This Standard Practice Statement sets out the Commissioner's practice for applying promoter penalties to promoters of arrangements involving abusive tax positions.

Application

  1. This Standard Practice Statement applies from 1 April 2004 to arrangements entered into on and after 26 March 2003.

  2. This Standard Practice Statement must be read in conjunction with the Standard Practice Statements setting out the Commissioner's practice on imposing and reducing shortfall penalties and taking prosecutions.

Background

  1. The discussion document Taxpayer compliance, standards and penalties: a review (August 2001) identified a number of concerns with the application of the shortfall penalties legislation to investors in tax avoidance arrangements. One concern was that in many cases investors in such arrangements are not aware of the tax effects of their investment. Another concern was that the abusive tax position shortfall penalty, which is intended to be applied to taxpayers who are not complying, was, in some cases, being applied to taxpayers who thought that they were complying but were, in fact, misled by the promoters.

  2. Where a taxpayer is a party to an arrangement that results in the taxpayer taking an abusive tax position, a shortfall penalty is imposed on the taxpayer. Although the compliance and penalties legislation penalised promoters in their capacity as taxpayers, the legislation imposed no civil sanctions on promoters in their capacity as promoters of arrangements. The compliance and penalties legislation therefore provided no extra incentive for promoters to ensure that the tax effects they claim for their arrangements were correct. Furthermore, offer documents and securities law in some cases restrict taxpayers from taking legal action against the promoter.

  3. The review considered two principal options, namely increasing the taxpayer's penalty or imposing a new penalty on promoters. The government considered that promoters of such arrangements should be held clearly accountable for their actions. The promoter is usually the party with the greater knowledge of the arrangement's tax effects. Often, the true tax impact of an arrangement may be determined by features that the promoter is aware of but the investor is not. These undisclosed features may place the investor at risk of significant penalties.

  4. The following amendments to the Tax Administration Act 1994 give effect to the recommendations outlined in the discussion document Taxpayer compliance, standards and penalties: a review including that a promoter may be liable to a penalty in their capacity as promoter.

  5. In addition to the following amendments, the legislation provides that in certain circumstances the previous behaviour of a taxpayer may entitle the taxpayer to a reduction of any shortfall penalties.

Legislation

Tax Administration Act 1994

3(1) DEFINITIONS
"Arrangement" -

(a) Means a contract, agreement, plan or understanding, whether enforceable or unenforceable, including all steps and transactions by which it is carried into effect:
(b) For the purpose of Part 5A, includes facts that the Commissioner considers are material or relevant as background or context to a private or a product ruling.

141D ABUSIVE TAX POSITION
141D(3B)

The penalty payable for taking an abusive tax position is reduced to 20% of the resulting tax shortfall if
(a) The taxpayer is a party to an arrangement to which section 141EB applies and becomes liable to a shortfall penalty for an abusive tax position as a result of that arrangement, irrespective of whether a promoter penalty has been imposed in respect of the arrangement; and
(b) The sum of the tax shortfall from the arrangement for the taxpayer and the tax shortfalls from the arrangement for persons with whom the taxpayer is associated under section OD 7 of the Income Tax Act 1994 is less than $50,000; and
(c) The taxpayer has independent advice stating that the taxpayer's tax position is not an abusive tax position.

141EB PROMOTER PENALTIES
141EB(1)
The promoter of an arrangement is liable to a promoter penalty if
(a) A taxpayer becomes a party to the arrangement and a shortfall penalty for an abusive tax position is imposed on the taxpayer as a result of the arrangement; and
(b) The arrangement is offered, sold, issued or promoted to 10 or more persons in an income year.

141EB(2) For the purpose of subsection (1)(b) , an arrangement is treated as being offered, sold, issued or promoted to 10 or more persons if 10 or more persons claim tax-related benefits as a result of the arrangement.

141EB(3) An arrangement is treated as being offered, sold, issued or promoted to all shareholders of a loss attributing qualifying company and partners of a partnership if the arrangement is offered, sold, issued or promoted to the loss attributing qualifying company or partnership respectively.

141EB(4) The amount of the promoter penalty is the greater of nil and the sum of tax shortfalls resulting from taking an abusive tax position on the arrangement, for which the promoter would have been liable if the promoter had -
(a) Been a party to the arrangement in the place of each party to the arrangement to whom the arrangement was offered, sold, issued or promoted; and
(b) Taken the tax position that the arrangement produced for the promoter the taxation-related benefits that were intended by the parties to the arrangement; and
(c) Had the taxation-related characteristics that would, under the tax position referred to in paragraph (b), produce for the promoter the maximum taxation-related benefits from the arrangement.

141EB(5) A promoter who satisfies paragraph (a) of the definition of promoter in section 141EC is liable for the promoter penalty associated with the arrangement -
(a) Jointly and severally with the other such promoters of the arrangement, for the whole promoter penalty:
(b) Jointly and severally with each promoter of the arrangement who is liable for part of the promoter penalty under subsection (6), for the part of the promoter penalty for which the other promoter is liable.

141EB(6) A promoter who does not satisfy paragraph (a) of the definition of promoter in section 141EC is jointly and severally liable, with the other promoters of the arrangement, for the portion of the promoter penalty that is associated with the arrangement entered into by taxpayers to whom the promoter offered, sold, issued or promoted the arrangement.

141EC DEFINITION OF PROMOTER
141EC(1)
In section 141EB, promoter of an arrangement means (a) A person who is a party to, or is significantly involved in formulating, a plan or programme from which an arrangement is offered; or (b) A person who is aware of material and relevant aspects of the arrangement and who sells, issues or promotes the selling or issuing of, the arrangement, whether or not for remuneration.

141EC(2) For the purpose of subsection (1), promoter does not include a person whose involvement with the arrangement is limited to providing legal, accounting, clerical or secretarial services to a promoter.

In this Standard Practice Statement, all legislative references are to the Tax Administration Act 1994 unless otherwise stated.

Discussion

The promoter

  1. New sections 141EB and 141EC have been inserted to provide for the imposition of a civil penalty on promoters, in cases where investment in an arrangement leads to any investor having a shortfall penalty for an abusive tax position imposed.

  2. If an arrangement is offered, sold, issued or promoted to ten or more people in an income year and it involves an abusive tax position, the promoter will be liable for a promoter penalty. The penalty will be the sum of the tax shortfalls resulting from the arrangement. The penalty is aimed at reducing the number of such investments by holding the people responsible for the design and sale of tax arrangements directly accountable for their actions.

  3. Under section 141EB(4)(c) the penalty is based on the maximum taxation-related benefits that the arrangement would produce. This means, for example, that if the arrangement was based around income tax, the tax rate used to calculate the promoter penalty would be 39 cents in the dollar as that rate produces the maximum tax-related benefit, or if the arrangement involves a GST transaction the rate used to determine the promoter penalty would be 12.5%.

Independent advice - reduction of investor's shortfall penalty

  1. Although not intended to impose a significant burden on an investor, there is an obligation on investors (and their advisors) to consider the tax issues involved with an arrangement before an investor can qualify for a reduction of the abusive tax position penalty from 100% to 20%.

  2. The Tax Administration Act 1994 requires investors to have had the advantage of independent advice that the tax position resulting from the investment is not an abusive tax position.

Definitions

  1. "Arrangement" - for the purposes of the promoter penalty, "arrangement" means a contract, agreement, plan or understanding, whether enforceable or unenforceable, including all steps and transactions by which it is carried into effect.

  2. "Promoter" - the definition of "promoter" in section 141EC includes:

    • a person who is a party to, or is significantly involved in formulating, a plan or programme from which an arrangement is offered; or

    • a person who is aware of material and relevant aspects of the arrangement and who sells, issues, or promotes the selling or issuing of, the arrangement, whether or not for remuneration.


  3. "Promoted" - is not defined, however, from the definitions of "promoter" contained in the Tax Administration Act 1994 and the Securities Act 1978, promoted would generally include the selling or issuing, or arranging the selling or issuing, of the arrangement.

  4. "Offered" - is not defined in the Inland Revenue Acts, however, the definition of "offer" in the Securities Act 1978 includes an invitation, and any proposal or invitation to make an offer (for example advertisements). Case law [1] has given this a broader definition than "offer" as used in contract law.

  5. "Issued" - is not defined in the Tax Administration Act 1994. Generally it will take on the same meaning as under Securities law.

  6. "Tax-related benefits as a result of the arrangement" - is not defined, however such benefits could include tax deductions, tax losses, input tax credits, and deferred output tax. Benefits may arise from timing advantages or claiming deductions of a private or capital nature.

Standard Practice

  1. This Standard Practice details the following:
    • the criteria
    • promoter
    • offered, sold, issued or promoted
    • calculating the penalty
    • multiple promoters
    • imposition of a promoter penalty
    • disputable decision
    • independent advice - reduction of investor's penalty
    • previous behaviour - reduction of penalties.

The criteria

  1. A promoter is liable for a promoter penalty when the following criteria are met:
    • there is a promoter as defined
    • there is an arrangement as defined
    • a taxpayer becomes a party to the arrangement
    • a shortfall penalty for an abusive tax position is imposed on a participant as a result of the arrangement the arrangement is offered, sold, issued or promoted to 10 or more persons in an income year.

Promoter

  1. A promoter of an arrangement includes a person (individual or non-individual) who is a party to or who is significantly involved in formulating a plan or programme. Whether or not a person is a party or significantly involved is largely a matter of fact. It is necessary to consider a number of factors including:
    • the flow of money/profits
    • input into the design of the arrangement
    • level of knowledge
    • documents
    • advertising/promotional material.


  2. Generally this will require knowledge of the key features of the arrangement, or contractual or similar involvement. However it may also apply to directors of companies, or key professional advisors (whose roles are not limited to providing legal, accounting, clerical or secretarial services to promoters), involved in formulating a plan or programme from which an arrangement is offered.

Example 1 [2]
An accountant in private practice works closely with an entrepreneur to design a scheme and prepare offer documents. The entrepreneur offers an arrangement to at least 10 people who claim tax-related benefits. The knowledge and role of the accountant would indicate that they were significantly involved in formulating a plan. Accordingly they would be considered to be a promoter for the purposes of the promoter penalty provisions. Other factors to consider may be whether the financial advisor is paid for their services or receive a share of the proceeds.

  1. The person's involvement needs to be other than in a professional or administrative capacity on behalf of another person who is a promoter.

  2. A promoter also includes a person who is aware of material and relevant aspects of the arrangement and who sells, issues, or promotes the selling or issuing of, the arrangement, whether or not for remuneration. This is also a question of fact and would involve looking at the relevant factors set out above. This would for instance, include persons aware of material and relevant aspects of a scheme who actively market the scheme to their clients, for example financial advisors.

Example 2
Following on from Example 1, a financial advisor, who was not involved in formulating the plan, offers an arrangement to their clients. The financial advisor, who is aware of material and relevant aspects of the arrangement, is considered to be a promoter for the purposes of the promoter penalty provisions. Whether or not the financial advisor received remuneration is not relevant.

Offered, sold, issued or promoted

  1. One of the criteria for liability for the promoter penalty is that the arrangement has been offered, sold, issued or promoted to 10 or more persons in an income year.

  2. This criterion is deemed to be met when 10 or more persons claim tax-related benefits as a result of the arrangement. Such benefits could include tax deductions, tax losses, input tax credits, and deferred output tax.

Example 3
If an investigation identifies 10 taxpayers who each claimed, as a result of a particular tax avoidance arrangement, a deduction for a share of partnership losses, then the arrangement is deemed to be offered, sold, issued or promoted to 10 or more persons in an income year.

  1. When determining whether an arrangement has been offered, sold, issued or promoted to 10 or more persons, each shareholder of a loss attributing qualifying company (LAQC) and each partner of a partnership is counted, if the arrangement is offered, sold, issued or promoted to the loss attributing qualifying company or the partnership.

Example 4
An arrangement is offered to a LAQC with 3 shareholders, and another company with 6 shareholders. That will count as an offer to 4 persons - 3 through the LAQC and 1 for the other company.

  1. It is the Commissioner's view that whether in fact an arrangement has been offered to 10 or more persons is measured by reference to such things as attendance at promotional events, records of correspondence held by the promoter and other objective means. Imposition of the promoter penalty is not limited to circumstances in which 10 or more persons claim tax-related benefits.

  2. Arrangements advertised in the general media will be considered to be offered to 10 or more persons - regardless of how many invest in the arrangement.

  3. In general, the Commissioner will apply principles derived from the Securities Act 1978 when considering whether an arrangement has been offered or promoted.

Calculating the promoter penalty

  1. The penalty on the promoter is determined by reference to the total tax shortfalls resulting from the arrangement. This ensures that the promoter faces a penalty that reflects the total tax impact of the arrangement and is calculated from the maximum taxation-related benefits (shortfalls) that each investor in the arrangement would have obtained. Add those taxation-related benefits together to calculate the penalty on the promoter.

  2. If the arrangement was based around income tax, the tax rate used to calculate the promoter penalty is 39 cents in the dollar, as that rate produces the maximum tax-related benefit.

  3. If the arrangement involves a GST transaction, the rate used to determine the promoter penalty would be 12.5%.

Example 5
A promoter sells an arrangement to 11 investors designed to give them a deduction of $30,000 each. Using the maximum income tax rate of 39%, the sum of these maximum taxation-benefits is 11 x $11,700 which totals $128,700. Accordingly, the amount of the promoter penalty is $128,700.

Multiple promoters

  1. There may be more than one promoter associated with an arrangement, and the promoters may have differing levels of involvement with the arrangement. In order to determine the extent of the liability of each promoter it is necessary to determine whether each promoter of an arrangement is:
    1. a party to or significantly involved in formulating a plan or programme from which an arrangement is offered; or
    2. aware of material and relevant aspects of the arrangement and who sells, issues, or promotes the selling or issuing of, the arrangement, whether or not for remuneration.
    The extent of the promoter's liability will depend on which of these two categories applies to the promoter.

  2. Each promoter that is a party to or significantly involved in formulating a plan or programme from which an arrangement is offered is jointly and severally liable with the other promoters for the whole promoter penalty.

  3. Where there is more than one promoter, each promoter who is not a party to or significantly involved in formulating a plan or programme from which an arrangement is offered, but is:
    1. aware of material and relevant aspects of the arrangement; and
    2. sells, issues or promotes the selling or issuing of the arrangement,
    is jointly and severally liable, with the other promoters, for the portion of the promoter penalty associated with the arrangement entered into by taxpayers to whom the promoter offered, sold, issued or promoted the arrangement.

Imposition of a promoter penalty

  1. Promoter penalties are imposed in addition to shortfall penalties. The promoter penalty is imposed in tandem with the shortfall penalty where the promoter is subject to a shortfall (as an investor in the arrangement) - but if further shortfalls are detected, further penalties will be imposed.

  2. Investors remain liable for shortfall penalties when a promoter penalty is imposed on a promoter.

  3. Other than where an exclusion applies under section 89C of the Tax Administration Act 1994, the Commissioner will first propose any promoter penalty in a NOPA (Notice of Proposed Adjustment).

Disputable decision

  1. The imposition of a promoter penalty is a disputable decision and, as such, can be disputed in accordance with the disputes procedures provisions in Part IVA of the Tax Administration Act 1994.

Independent advice - reduction of investor's shortfall penalty

  1. The abusive tax shortfall penalty on the investor will be imposed at 20% rather than 100% where:
    • the tax shortfalls of the investor and any associated person are less than $50,000; and
    • the investor has independent advice stating that the investor's tax position is not an abusive tax position.


  2. The advice must state more than just facts - it must express an opinion and must state that the investor's tax position is not an abusive tax position. Statements by the promoter will not be sufficient.

  3. Generally, advice will be independent when:
    • an investor receives the advice, for example in promotional material or a legal opinion
    • an investor, or a promoter on behalf of investors, paid for professional advice that the arrangement is not an abusive tax position
    • the advice expressly states that it was prepared on the basis that it would be given to the investors
    • the advisor is independent of the promoter; and
    • the advisor is not a promoter.


  4. The advice must be genuinely identifiable as coming from someone independent of both the taxpayer and the promoter. When determining whether advice is independent, the Commissioner will consider:
    • any relationship between an investor and an advisor
    • any relationship between a promoter and an advisor; and/or
    • the information available to an investor regarding any relationship between a promoter and an advisor.

Previous behaviour - reduction of penalties

  1. A taxpayer (i.e. an investor including a promoter who is also an investor) may be eligible to have their abusive tax position shortfall penalty reduced for previous behaviour in certain circumstances. If it is, then such a reduction will be available in addition to any other applicable reduction.

  2. Note that the promoter penalty cannot be reduced under section 141FB which reduces shortfall penalties on the grounds of previous behaviour.

This Standard Practice Statement was signed by me on 15 March 2004

Margaret Cotton
National Manager
Technical Standards

[1] Robert Jones Investments Limited v Gardner & Anor (1993) 6 NZCLC 68,514; Orr v Martin (1991) 5 NZCLC 67,383; Dingwall & Paulger (in Rec) Steel & Ors v New Zealand Guardian Trust Company Limited (1990) 5 NZCLC 66,780

[2] Please note, the examples in this Standard Practice Statement are intended to illustrate how the Commissioner may apply the practice set out in this Standard Practice Statement – they do not set practice in themselves.