Tax avoidance: It's just the vibe, says Court of Appeal
Tax lies at the heart of the constitutional arrangements New Zealand inherited from what was then called Britain.
New Zealanders are inclined to forget this: it is significant the terms of reference of the current Constitutional Review Panel says a lot about Treaty of Waitangi issues and electoral systems but nothing about tax.
Yet the origins of parliamentary democracy lie in principles about how we are taxed. The British cut off one king’s head because he wanted to impose a tax arbitrarily, without going through parliament.
From the blood-stained 17th century onwards, the principle of Westminster democracies like New Zealand has been that the state can only take a person’s property if duly elected representatives have specifically provided laws to this effect.
Yet the New Zealand judiciary is, step by step, evolving a doctrine which in effect allows officials to do just what Charles I so messily failed to do away with. The Alesco case, decided by the Court of Appeal this week, is the latest effort.
Vague principle of their own
The problem arises because the courts have, since 2007, combined one vague-but-necessary principle in the Income Tax Act, with another vague principle of their own.
The first vague principle is the “general anti-avoidance rule”, or GAAR, which states in essence that even if a citizen meets all the specific provisions of the tax law, Inland Revenue has the power to accuse the citizen of tax avoidance if an arrangement appears to have tax avoidance as its main purpose or effect – that is, it is not an incidental purpose or effect.
Once the Inland Revenue invokes that rule against a citizen, the onus is then on the citizen to demonstrate the IRD is wrong.
One important ancillary point needs to be made here: in most of the literature on these issues, including the court judgments and the commentaries from tax practitioners, the citizen is constantly referred to as “the taxpayer”.
This seems to me to be a major, if mostly unwitting, selling of the pass. Citizens should not be defined in such a way which reduces them as simply as sources of income for the state.
The constant use of the term “taxpayer” betrays an implicitly statist, socialistic assumption about the role of the individual and is something which should be firmly discouraged.
But to return to the sweeping and undefined nature of the anti-avoidance provisions in the Income Tax and Goods and Services Tax statutes: these are a pragmatic answer to the fact that citizens will often find ways to comply with the letter of the law but still avoid tax.
How far to invoke it
The question has always been how far to invoke this rule. Its broad scope, its arbitrary and retrospective nature, and its reversal of the burden of proof have meant that historically the IRD has invoked it only in the most egregious cases, and whenever matters have reached the courts judges have, in the main, treated the civil liberty implications of the rule with great care.
That began to change in the middle of the last decade, partly, it has to be said, because tax avoidance became so rife. The combination of a top personal tax rate of 39% and the arbitrage opened up by a 33% company and trust rate, the generous deduction allowed for by the loss attributing qualifying company regime for property and forestry investment, and then the Working For Families package, saw a golden age for tax planners – something parliament largely winked at, at the time.
The bulk of these arbitrage opportunities have since been closed (even though the closure of some of these has brought its own problems).
The turning point appears to have been the Ben Nevis forestry case in 2007. Out of this evolved the courts’ doctrine of parliamentary contemplation, which states that part of the burden of proof on the citizen accused of tax avoidance is a requirement to show that “the specific provisions they relied on had been used in a manner which was within parliament’s purpose and contemplation when it enacted them”.
This sets the bar rather high on the citizen, for several reasons. One is parliament is often maddeningly unclear about such matters – especially relating to financial arrangements and tax, when at any given time there are only, at best, one or two MPs who fully comprehend the highly technical nature of the laws they are passing.
Restated this week
The doctrine states – and was restated this week by Justice Rhys Harrison in the Alesco case – that a citizen accused of tax avoidance “must satisfy the court that the use made of the specific provision is within its intended scope”.
That is, that the citizen has to prove he/she has used the relevant tax provision in a way Parliament intended when it made that particular law.
Now, the lay person might think that if parliament did not know the implications of the laws it was passing it can hardly be said to have contemplated, or not contemplated, their use in any particular way the citizen might come up with.
Yet the courts have taken quite the opposite view. The run of judgments since Ben Nevis which have used the parliamentary contemplation doctrine, stripped of their legalese, effectively say “parliament would not have approved of this particular practice if it had contemplated it: even though it is clear parliament did not contemplate it, we are just going to assume that if parliament had contemplated this arrangement, it would not have approved, so we’re going to find it is tax avoidance.”
To put it another way: “It's just the vibe, citizen taxpayer – so pay up.”
What this boils down to is a major extension of the arbitrary power of unelected officials – and a major dereliction of duty by our elected representatives. And it is all being aided and abetted by the judiciary.
The country’s legislators have not only a constitutional but a moral responsibility to be clear when they make laws, especially those which take away citizens’ property.
Judges, at the same time, have a duty to point out to parliament when its law-making abilities have been neglected, and to not simply evolve handy legal fictions to cover parliament's negligence.
Put it very well
PWC tax partner Eugen Trombitas, in an essay in the New Zealand Law Journal a few years ago, put this very well: although parliament cannot conceive of every type of transaction, he noted, it still has the power to counter aggressive tax avoidance schemes by making specific and clear rules, which should then be backed up in extreme cases by the general anti-avoidance rule.
“The primary power of the GAAR is that it acts as a powerful deterrent. Once invoked, however, the GAAR is an extraordinary power and must necessarily be used prudently, but, vitally, not in a way that rewrites tax law.”
The question he posed is this: is the general anti avoidance rule “being used as a tax charging provision in cases where parliament should have done a better job in expressing its intention?”
Increasingly, the answer to that question is yes.
That has major negative implications for New Zealand’s reputation as a place to invest, but moving beyond that sort of functionalism, also for the status of New Zealand citizens and their status vis a vis the state.
As your columnist has noted before, our ancestors did not overthrow the doctrine of the divine right of kings, only to see it replaced by the divine right of the IRD. But that is what is happening.