Judge slams Law Lords' role

By BRIAN FALLOW economics editor

The Privy Council's approach to tax cases has cost this country "inestimable millions of dollars" in tax revenue, says Justice Edmund Thomas of the Court of Appeal.

As the highest court in New Zealand's judicial hierarchy, the Privy Council must bear ultimate responsibility for the formalism prevalent in tax law here, Justice Thomas says.

"There is in respect of almost any issue relating to tax a baggage of judicial rules that impedes an orderly and logical decision-making process."

The over-zealous application of the doctrine of form over substance has spawned a culture in certain sections of the community and the specialist tax advice industry dedicated to extreme legalism, he says.

Abandoning the present right of appeal to the Privy Council would not rectify the situation.

"The Privy Council's approach has become embedded in the law and judicial methodology of this country and would, I fear, survive the Privy Council's demise. Indeed, nothing short of further legislation will be needed to reverse the English approach and create a climate in which tax avoidance in this country is significantly reduced."

Including its effects on economic efficiency, tax avoidance has cost the country billions of dollars, he says.

Justice Thomas unburdens himself of these criticisms of the Law Lords in a dissenting judgment in a winebox case, between the commissioner of Inland Revenue and BNZ Investments.

The Court of Appeal, in a four-to-one decision, upheld the High Court's ruling that transactions between BNZ Investments and Capital Markets in the late 1980s did not breach section 99, the general anti-avoidance provision of the Income Tax Act.

The IRD's litigation director, Mike Lennard, said the department was seeking advice from the Solicitor-General, Terence Arnold, QC, about the prospects of an appeal to the Privy Council.

Money raised by the issuance of redeemable preference shares (RPS) to BNZ Investments, a subsidiary of the Bank of NZ, was used by Capital Markets in complex structures, including Cook Islands entities.

The dividend paid on the preference shares included a cut of the tax saved, and the bank had an indemnity against the possibility that tax would be assessed.

Justice Thomas apart, the Appeal Court accepts the distinction between "upstream" transactions involving the bank and the "downstream" transactions which, it is accepted, constituted tax avoidance but the details of which the bank did not inquire into (apart from a junior bank executive who was told it was none of the bank's business).

The court held that for upstream and downstream transactions to form part of the same "arrangement" there would have had to be a consensus or meeting of minds about what activities Capital Markets would undertake downstream.

Justice Thomas, however, interprets the language of the statute as not requiring conscious involvement or awareness of the tax avoidance.

It is the effect of the arrangement which matters, he says.

"I fully accept that RPS are a conventional means of funding companies ... However, the fact that it was agreed or understood that the dividend yield would reflect a tax saving obtained as the result of the use of a tax shelter from which BNZI would obtain a direct benefit cannot be ignored," Justice Thomas says.

"Taxpayers who set out to obtain a tax advantage by means of transaction, the exact details of which they deliberately leave to the other party, are to be regarded as having entered into an arrangement to accept whatever tax shelter or mechanism is in fact utilised. Metaphorically speaking they have agreed to fly blind and must be taken to have agreed to accept the consequences ... "