Whether an Agreement between Josh and Plumbing Solutions Limited Is Void Against the Commissioner By Virtue Of s BG 1 ITA 2007

Whetheran Agreement between Josh and Plumbing Solutions Limited Is VoidAgainst the Commissioner By Virtue Of s BG 1 ITA 2007

InFebruary 1990, a proclamation on section 99 of the Income Tax Act1976 was issued by the commissioner. The statement issued involved ageneral anti-avoidance provision in the Act and was published as anaddendum to the TaxInformation Bulletin,Vol. 1, No. 8. This report will consider the provisions in this Actand other succeeding Acts exclusively section BG 1 ITA 2007.Basically, the report will review the agreement in reference to theinterpretation of section BG 1 and GA 1 of the Income Tax Act 2007.While considering the explicit provisions of the particular parts ofthe loan agreement between Josh and Plumbing Solutions Limited, thereport will interpret whether the arrangement led to tax avoidance byboth parties involved.

Thereport will provide an in-depth analysis that will be a precedent inhelping determine and define tax avoidance and help curd deficienciesthat destabilize the New Zealand tax system.


First,it is very important to convey the statutory meaning of taxavoidance. This will help in substantiating that some definitelydefined circumstances have not been excluded from the scope of thisreport. Tax avoidance is any arrangement, whether entered by a personwho is influenced by the arrangement or another person, whichstraightforwardly or indirectly changes the incidence of any incometax.1.Advisably, it is also essential to identify what is an “arrangement”.It is an agreement, understanding, contract or plan, whetherenforceable or unenforceable, including every step and transaction bywhich it is accomplished.2

Identifyingwhether the agreement is void as against the commissioner willinvolve mainly considering its economic outcomes and commercialauthenticity. As considered in the anon part of the report, aprecedent set by the Supreme Court in BenNevis intheParliamentaryContemplation Test laid down the approach to be espoused indetermining whether there is tax avoidance. The factors and relevantexamples considered will help confirm whether Josh’s situation fitsthe definition which will indicate that the loan arrangement betweenPlumbing Solutions Limited and Josh is indeed a tax avoidancearrangement.


Notably,according to the Commissioner of Inland Revenue to identify whetherthere has been a tax arrangement, several factors other than thedefinition have to be considered.3First, consider whether there is presence of pretence in theagreement. Josh did not repay any of the “loan” which isinformally agreed on. This proves that Josh was pretending to betaking a loan but did it informally so as not to repay it consideringthe relationship between him and the company as it was in BenNevis.4Secondly, the agreement has financial consequences on the partiesinvolved whereby Josh gains while the state loses since it chargeslower tax for that transaction. This characterizes it as a taxavoidance agreement.

Itis therefore important to note that under s BG 1 ITA 2007 theagreement is void as against the commissioner. This is by high meritof though tax avoidance may not be the purpose of the agreemententered by Josh and Plumbing Holdings Limited the effect broughtabout is seemingly not merely incidental. The loans recorded in thecompany’s account records are not formally documented and do notcontain any specific repayment date. This may be interpreted as foulplay against the law and is not considered as an ordinary businesstransaction and therefore may be voided. This may be proven throughthe objective test.5

Theloan transaction being carried out between Josh and PlumbingSolutions Limited is an economic effect. The company pays money toJosh disguising it as a loan which results to lower tax payments tothe government. The large economic effect caused by the transactionqualifies makes it void as against the commissioner. Moreover, theagreement may be terminated at any time since it is informal and hasno definite repayment date. The artificial nature of the agreementposes a threat6to the direct taxes paid to the Inland Revenue Department (IRD).

Advisably,section BG 1 considers several provisions in determining whether theagreement is void. It not only considers those provisions that doapply but also considers whether certain options provided in thesection do not apply. The facts in the agreement use provisionsrather than circumvention. Notably, several provisions of the IncomeTax Act 2007 apply. For example, an arrangement has to be consideredwhether it is a legal arrangement or just an unofficial,unenforceable understanding. A merely incidental test is conducted toestablish tax avoidance function is simply incidental to anon-incidental purpose.7

However,it may be difficult to outwardly determine whether the agreement wasa tax avoidance arrangement. Section BG 1 ITA 2007 notes that theremay be complicatedness in determining tax avoidance in an agreementcontaining many smaller transactions. Though the transactions wererelated and probably similar, they were transacted separately eachmonth which means they were different. This may act in favor of thecompany with each transaction having to be considered separatelywithin the general anti-avoidance rule (GAAR). Furthermore, it isapparently difficult to distinguish a loan from income since s BG 1ITA 2007 does not clearly provide definite measures of categorizingintended or unintended debtor-creditor liaison as income.8

Anexample to demonstrate the above points is CIRv penny &amp hooper.The judgment is one of the latest in the long line of decisions undergeneral anti-avoidance provision (GAAP) which involved an appealagainst the High Court judgment of Mackenzie J.9The case’s significance is outlined in its success in examining an“organic” tax avoidance hereby the CIR termed it as thealteration of a pre-existing business as or into a tax avoidanceagreement. More significantly the case was the first tax avoidancecase in the Court Of Appeal involving comparatively minor tax forevery agreement as it is in Josh’s arrangement.

Thefacts of the case were that the taxpayers were practicing orthopedicsurgeons. Originally, they practiced differently in their accountsbut later started companies which were substantially owned by theirrespective family trusts. The CIR considered the income received asartificially low while the remaining income was taxed at companyrates and paid as accredited dividends to family trusts. CIRpostulated that each practice for the tax payers was unswervinglyprofitable where Mr. Hooper invested in bank and cash deposits whileMr. Penny received the trust as an unsecured and interest-freepayment with no specific payment date.

Thiscase is similar to Josh’s agreement in that the agreement bringsinflated expenditure to Plumbing Solutions Limited and Reduces thelevels of income by Josh which shows establishes that it affects thelevels of income tax coming from both parties. The tax is charged incompany rates but still goes directly into the account of Josh thusavoiding direct taxes. Outstandingly, the agreement is also a pre-taxnegative which reduces the amount considered by the government fortax from Plumbing Holdings Limited. In keeping with s BG 1 ITA 2007,this qualifies the agreement as a tax evasion arrangement whichcauses tax advantages to both Josh and Plumbing Solutions Limited.

Ina judgment by Randerson J, the arrangements were found to be taxavoidance arrangements and were therefore stated as void against theCommissioner of Inland Revenue. This is because the taxpayers reducedtheir salary to a conspicuous extent which coincided with theincrement in personal tax rate in year 2000. Moreover, the goodwillpayments made to the taxpayers by their family trusts wereuncommercial while surplus profits were transferred to family trustswhich were beneficial to the tax payers in the long run. The salariespaid were small and did not fit a commercial reality and still theycontinued putting their efforts to attain income with the same amountof devotion.

Notably,the amount Josh draws from the company as a loan is $ 6000 per monthwhile his salary is approximately $ 5420 per month. Therefore, thetransactions are neither commercial nor realistic. CIR may considerthe arrangement as using unreal and maybe hypothetical alternativeswhich go well with Josh’s litigation ends. Using a nominal incomeof $ 100, the tax payment can be conceptualized as follows:

Anotherdefining example to illustrate the arrangement between Josh andPlumbing Solutions Limited is CIRv Marcus Seymour Dymock and Charlotte Jane Dymock whichwas an application in opposition to freezing order approved andindemnity costs awarded against the commissioner.10The commissioner aimed at obtaining freezing orders over accounts ofthe defendants and get indemnity costs. This example will critiquethe penalties and decisions that may be made against Josh andPlumbing Solutions Limited if any attempt to transfer funds orliquidate the company is detected.

Thefacts of the case were that the defendants aimed at setting aside anex parte freezing order over $ 462000 that was held in an account bythe second defendant, Mrs. Dymock. The first defendant, Mr. Dymock,decided to voluntarily liquidate three related companies which he wasthe sole shareholder. A provisional distribution amounting to $ 1.3million was made to Mr. Dymock by virtue of that he was the soleshareholder. However, the commissioner contended this decision andsought for the amount to be returned to the liquidator. Theliquidator only sought $ 462000 and therefore the amount was agreedto be transferred. Due to complications the process was delayed butthe amount eventually transferred. The commissioner required that themoney be conserved so as to pay her debt but those undertakingsweren’t provided. Therefore, the commissioner sought ex parteapplication to freeze $ 462000 in accounts of the first and seconddefendants. The order was approved but complications in itsimplementation made the bam to freeze the whole amount in theaccounts of Mr. and Mrs. Dymock. Due to challenges faced in payingfor expenditure, Mrs. Dymock sought limiting of the freezing order toone account, specifically that owned by Mrs. Dymock.

Thecourt found that the goal of the proceeding had been fulfilled andsuggested the commissioner be ranked as a creditor. For that reason,the freezing order was subsequently discharged since the court foundno purpose for its continuation. The relevance of this case is thatthe court searches to find the “intention” of the taxpayer withregard to identifying the business goal and recognized principlesunderlying the notion of intention.11

Asper the general anti-avoidance provisions (GAAR) in the Income TaxAct 2007, BG 1 Tax Avoidance stipulates that a tax avoidancearrangement is void as against the Commissioner of Income taxpurposes. It is here forth important to note Josh is liable topenalties as outlined that Under Part G, which includes non-markettransactions and avoidance, the commissioner has authority tocounteract the tax advantage that Josh and Plumbing Solutions Limitedobtain from their loan agreement.

Itis therefore important to note that since the arrangement isconsidered void under s BG 1 then s GA 1 becomes operational andallows several measures to be taken by the Inland Revenue Department(IRD). The commissioner has authority to adjust the taxable income ofJosh and those of Plumbing Solutions Limited so as to respond to thetask advantage that they gained over the tax avoidance arrangement.CPRA notes that the law can take away a percentage of property ofcriminals who have attained ill-gotten gains, i.e. 33% in case ofincome tax and another 15% in case of GST.12

InAlescoNew Zealand Ltd and Others v CIR,the commissioner was tasked to confirm whether OCN arrangement was atax avoidance arrangement. Optional Convertible Notes (OCN) has anarrangement with Alesco Group in which they sought for deductions forinterest by virtue of Deduction G22 and the financial arrangementrules.13The case identifies how tax avoidance is confirmed using such factorssuch as reducing income tax.

Thefacts for this case were that the case was an appeal by Alesco NewZealand Limited (Alesco NZ) against the high court decision in whichthe court upheld assessments by the commissioner which thearrangement as void as against the commissioner by virtue of s BG 1ITA 2007.14Alesco NZ, an entirely owned auxiliary of Alesco Corporation, had anarrangement to use OCNs in an intra-group circumstance to financeacquirement of two businesses in New Zealand. For a ten-year term,Alesco NZ issued OCNs to Alesco Corporation in exchange with proceedsworth $ 78 million. At maturity, Alesco Corporation would bereimbursed $ 78 million or change the OCNs to shares in Alesco NZ.Notably, there was no interest to be paid on the OCNs. At pertinentsituation, G22 assessment by the commissioner was applicable but itsapplication to the conditions and provisions of the OCNs broughtabout considerable interest deductions for Alesco NZ between 2003 and2008.

Thecourt found that Alesco NZ obtained a reduction in tax liabilitywhile as it did not pay tax. In addition, Alesco NZ failed to showthat its G22 determination method and financial arrangement rulesfell outside parliament’s contemplation. As a result, it hadengaged in tax avoidance. The court also held that in reconstruction,the commissioner had the right to counteract the advantage byprohibiting the impermissible deductions or search for anyunconventional arrangement that she is obliged to. The appeal wasunanimously rejected by the Court Of Appeal.

Thearrangement between Josh and Plumbing Solutions Limited also fallswithin parliament’s contemplation. This proves beyond reasonabledoubt that such a measure may also be implemented if a court rulesthe situation as tax avoidance. Both Josh and the company may suffershortfall penalties in which the court may instruct a fundingarrangement to settle the debt suffered by the commissioner. Thiswill be so as to secure the tax advantage that prevalent in thearrangement. The court may also have the right to follow up anddetermine the tax position of Plumbing Solutions Limited to ensurethat it does not continue following “an abusive tax position”

Amilestone decision in the history of income tax law occurred inGregoryv Helveringin the United States. The case discusses tax avoidance with respectto business purpose or intention. The business purpose doctrine iswhere a transaction has no significant business purpose rather thanreducing or avoiding tax. The case has become an important precedentin determining tax avoidance such is in our situation.

Thiscase involved Mrs. Evelyn Gregory, owner of all shares in UnitedMortgage Company, and Guy T. Helvering, Commissioner of internalrevenue. United Mortgage Company owned 1000 shares of MonitorSecurities Corporation. Mrs. Evelyn created a new company AverillCrop and after three days, she transferred all the shares frommonitor to Averill. After another three days, she transferred theshares to herself and sold then the same day for $ 133,333.33. She“planted” expenses of $ 57,325.45 and therefore only $ 76, 007.88worth of capital gains were taxed. She termed the transaction as atax-free company reformation. CIR, Guy Helvering, argued that theredid not exist any economic substance in the reorganization and termedit as foul play where she sold out Monitor shares without payingample tax.

Inthe resulting litigation, the judgment was offered in favor of thetaxpayer. However, in an appeal in the court of appeal, the courtruled in favor of the commissioner. The Supreme Court also ruled infavor of the commissioner emphasizing that in reality the statuteintended to avoid taxation.15The subsequent appeals to the initial ruling conducted an in-depthanalysis on the dominant purpose of the transaction and concluded itwas tax avoidance.

TheInland Revenue Department (IRD) has also made some huge wins in taxavoidance such as in the Supreme Court16and in the Trinity case in the court of appeal.17This advisory report, having considered relevant examples and stepscited in s BG 1 ITA 2007, wishes to assert that the arrangement is anunacceptable tax position in which tax avoidance seems to be thedominant purpose. As cited in the report several shortfall penaltiessuch as payment arrangements for a certain percentage and prohibitionof continuation of the transactions.



Diewert,W. Erwin, and Denis Anthony Lawrence Themarginal costs of taxation in New Zealand.(online ed, The Roundtable, Wellington, 1994.)


BenNevis Forestry Ventures Ltd v CIR Accent Management Ltd v CIR(2009) 24 NZTC

&quotATaxpayer&quot v CIR(1997) 18 NZTC 13,350 (CA) and Pattison(Inspector of Taxes) v Marine Midland Ltd[1984] A.C. 362 (HL)

Pennyv CIR Hooper v CIR(2009) 24 NZTC 23,406.

Commissionerof Inland Revenue v Marcus Seymour Dymock and Charlotte Jane Dymock[2013] NZHC 3346

Gv CIR (1961) NZLR 994

AlescoNew Zealand Ltd and Others v Commissioner of Inland Revenue (2013)

AlescoNew Zealand Ltd v Commissioner of Inland Revenue [2012]2 NZLR 252 (HC)

Gregoryv. Helvering,293 U.S. 465 (1935)

BenNevis Forestry Ventures Ltd v CIR Accent Management Ltd v CIR(2009) 24 NZTC 23,188, “Ben Nevis”

AccentManagement Ltd v CIR(2007) 23 NZTC 21,323



IncomeTax Act 2007

CriminalProceeds (Recovery) Act 2009 (CPRA)


InlandRevenue Department How We Develop Tax Policy www.ird.govt.nz


CCHNewZealand Tax Library(Online, CCH) -“The case could well be different, for example, ifthe interests of financiers or joint venturers required that abusiness structure be quarantined.”

1Inland Revenue Department How We Develop Tax Policy &ltwww.ird.govt.nz&gt

2 s YA 1 Income Tax Act 2007

3Previously section 108 of the Land and Income Tax Act 1954, then section 99 of the Income Tax Act 1976, then section BB 9 and later section BG 1 of the Income Tax Act 1994, and penultimately section BG 1 of the Income Tax Act 2007

4 Ben Nevis Forestry Ventures Ltd v CIR Accent Management Ltd v CIR (2009) 24 NZTC 23,188 at para [108]

5 s BG 1 1TA 2007 at para [175]

6 The case could well be different, for example, if the interests of financiers or joint venturers required that a business structure be quarantined

7Diewert, W. Erwin, and Denis Anthony Lawrence. The marginal costs of taxation in New Zealand. The Roundtable, 1994.

8 See e.g. &quotA Taxpayer&quot v CIR (1997) 18 NZTC 13,350 (CA) and Pattison (Inspector of Taxes) v Marine Midland Ltd [1984] A.C. 362 (HL)

9 Penny v CIR Hooper v CIR (2009) 24 NZTC 23,406.

10 Commissioner of Inland Revenue v Marcus Seymour Dymock and Charlotte Jane Dymock [2013] NZHC 3346

11 G v CIR (1961) NZLR 994, at 1,000 per McCarthy J

12 Criminal Proceeds (Recovery) Act 2009 (CPRA)

13 Alesco New Zealand Ltd and Others v Commissioner of Inland Revenue (2013)

14 Alesco New Zealand Ltd v Commissioner of Inland Revenue [2012] 2 NZLR 252 (HC)

15 Gregory v. Helvering, 293 U.S. 465 (1935)

16 Ben Nevis Forestry Ventures Ltd v CIR Accent Management Ltd v CIR (2009) 24 NZTC 23,188, “Ben Nevis”

17 Accent Management Ltd v CIR (2007) 23 NZTC 21,323