IRD stalks tax dodge plans

By JIM EAGLES

Inland Revenue is moving to block off mass-marketed tax avoidance schemes that are costing the Government hundreds of million of dollars.

The schemes, designed to allow participants to claim greater tax deductions than the amount of money invested, were popular in the early 1980s but then disappeared.

Their re-emergence in recent years has this week prompted IRD and the Treasury to publish an issues paper proposing law changes.

The paper says such schemes have been extensively marketed in past six years, mainly to high-income individuals, but also to trusts and companies.

By the end of the 2000 income year, the IRD was aware of about $436 million in tax credits being claimed by such schemes.

IRD audits have so far recovered $100 million of the tax credits claimed, and the department is auditing 22 schemes involving a further $376 million of income tax.

Typically, the paper says, such schemes involve relatively small investments in high-risk activities - often films, forestry projects or the commercialisation of "concepts" - with "apparently optimistic or unrealistic future sales projections".

They often include the transfer of property at an excessive price so as to magnify tax deductions.

The financial structure is arranged so that an investor is at no risk of ever having to repay loans but still has access to interest deductions.

They often use non-residents, tax-exempt organisations such as charities, or entities not registered for GST.

While most of the schemes involve income tax some also have GST implications - for example, GST refunds being claimed on the purchase of second-hand goods "at prices IRD considers are well in excess of apparent market values".

The IRD say it knows of about $60 million in GST input credits being claimed under structured tax schemes between 1996 and 2000 alone.

The issues paper identifies four reasons for new legislation:

pf* The potentially serious loss of tax revenue

pf* The undermining of the system's credibility, which could make other taxpayers less willing to comply

pf* The huge drain on IRD resources. Last August, 22 auditors plus litigation management and adjudication staff were working fulltime on the 22 schemes being audited.

pf* The impact on investors in the schemes, many of whom, the paper says, appear to be unaware of the financial risk if the supposed tax benefits do not arise.

To deal with those issues IRD and Treasury have proposed a two-part solution.

First, they want schemes that meet any of a number of criteria to have to be registered with the IRD and to have to disclose that fact on their prospectuses. Schemes failing to register might be unable to claim tax deductions.

Second, the deductibility of any net tax losses beyond the money at risk would be deferred until the schemes generate income or the financial structure changes.

The paper acknowledges that care would need to be taken to ensure legitimate investment proposals - especially in the forestry industry - are not caught in the net.

Julia Hoare, a tax partner with PricewaterhouseCoopers, said IRD's proposals would need to be viewed with caution.

"There are ... some fine lines between what is genuine and what is a rort. We already have some pretty stringent tax-avoidance legislation in place and it has rather sharp teeth."

"But in an environment of self-assessment it is quite difficult for IRD to identify, out of the thousands of assessments, which ones may involve a rort."

She says the key is the registration process, "which will make it much easier for IRD to keep track of what schemes are out there so it can monitor how genuine they are".

The paper is on line at the Inland Revenue website. Submissions on it close on February 22.

Inland Revenue Tax policy