IRD backs down from doctor's tax fight

In what is believed to be a rare move, the Inland Revenue Department has backed away from its tax dispute with a Northland-based anaesthetist.

The decision ends nearly a decade of investigation and legal battles for Dr Philippa White, who the IRD claimed was involved in a tax avoidance arrangement.

The dispute was scheduled for a Court of Appeal hearing about now, more than two years after High Court Justice Paul Heath overturned an earlier Taxation Review Authority ruling Dr White was avoiding tax payments.

The case can be traced back to September 2002 when Dr White and her husband formed Wharfedale Ltd. The company was used to employ Dr White as an anaesthetist and to lease two avocado orchards they owned.

Orchards ran at a loss

The orchards ran at a loss in the 2003 and 2004 tax years and the losses were offset by Wharfedale’s income. As a result, Dr White earned no salary and paid no personal tax income for the five months to March 31, 2003, and for the following financial year.

The IRD audited the company and attributed additional income of $34,844 and $95,644, respectively, for the two financial years. The tax in dispute for that period amounted to $50,890.

Dr White was taken to the Taxation Review Authority as a result.

In backing away from the appeal recently, the IRD has effectively conceded the structuring arrangements in place in respect of Dr White’s private anaesthetics practice were not subject to challenge under the general anti-avoidance rule in the Income Tax Act 2007.

IRD has indicated its decision to discontinue the appeal was influenced by the August 2011 Supreme Court landmark decision in Penny & Hooper – which was released after the White appeal was filed – as well as educational and compliance initiatives the IRD has been undertaking since the release of that judgment.

That case involved two Christchurch-based orthopaedic surgeons Ian Penny and Gary Hooper and their moves to minimise their tax.

But in over-ruling the earlier Taxation Review Authority decision against Dr White, Justice Heath said:

• Unlike Penny and Hooper, this was not a case in which a reduced salary was deliberately paid but where the company lacked the funds to pay a salary.
• There was a realistic expectation at the time the structure was implemented there would be sufficient profit to pay a salary to the anaesthetist.
• There is a distinction between purpose and effect, and while the effect of the arrangement was, for unforeseen reasons, to negate the need for the anaesthetist to pay income tax, the purpose was not to obtain an impermissible tax advantage.

Dr White’s lawyer, Minter Ellison partner John Peterson, says Messrs Penny and Hooper had taken their existing medical practices and put them into a company owned by their family trust and then paid themselves a salary, which the court held to be a below-market salary.

They then left the rest of the money in the company, which was taxed at a lower company rate – anywhere between 28 and 33 cents.

The reverse situation

Mr Peterson says Dr White had the reverse situation. "It turned out the orchard made all these losses – their harvest was bad and the exchange rates went the wrong way.

"Quite why the revenue got it into their head this was tax avoidance in the first place, god only knows. But once you get these guys started on a problem, they institutionalise their ideas very, very quickly and it becomes quite hard to convince them otherwise,” he told NBR ONLINE.

Mr Peterson says it is hard to find people prepared to stand up to the IRD. He says he sees a lot of taxpayers backing down because they are on “a hiding to nothing”.

He is not sure why the IRD decided to withdraw the appeal or whether the case will represent the turning of the tide in terms of tax avoidance case law in New Zealand.

“But at least in the area of domestic tax planning arrangements, this case represents a bulwark against the unrestrained exercise of the IRD’s taxing powers … this gives the tax profession a fresh opportunity to engage with crown law over the development of tax policy.”

The IRD has recently told those affected by the Penny and Hooper decision they have until March 31 next year to make voluntary disclosures.

It had previously agreed to accept settlement for those who make voluntary disclosure for a two-year period.

Since the Penny and Hooper Supreme Court decision, IRD has collected $4 million from 170 taxpayers.