Beacham v The Commissioner of Inland Revenue

• Jurisdiction: New Zealand
• Judge: Goddard J
• Judgment Date: 14 November 2014
• Neutral Citation: [2014] NZHC 2839
• Docket Number: CIV-2014-485-7319
• Court: High Court
• Date: 14 November 2014

BETWEEN

UNDER the Income Tax Act 2004 and the Tax Administration Act 1994

Gregory Marc Beacham And Vilma Amelia Beacham

Appellants

and

The Commissioner of Inland Revenue

Respondent

[2014] NZHC 2839

CIV-2014-485-7319

IN THE HIGH COURT OF NEW ZEALAND WELLINGTON REGISTRY

Appeal from a decision of the Taxation Review Authority that the Commissioner of Inland Revenue had been entitled to reconstruct the appellants' income for the 2007 tax year and impose shortfall penalties — appellants had entered into a tax avoidance arrangement to whichs BG 1 Income Tax Act 2004 (ITA04) (Avoidance arrangement void) applied — Commissioner reconstructed the appellants income and also imposed shortfall penalties for taking an abusive tax position — whether there was an outstanding tax advantage notwithstanding the tax avoidance arrangement was void as against the Commissioner for income tax purposes — whether the reconstruction carried out was within the scope of GB 1(3) ITA04 — whether shortfall penalties should not have been applied as the arrangement was not entered into with a dominant purpose of avoiding tax.

Counsel:

R J Cullen for Appellants

H Ebersohn for Respondent

JUDGMENT OF Goddard J

Introduction

1 This is an appeal from the decision of Judge Sinclair sitting as Taxation Review Authority (the Authority). The appeal is brought by Dr and Mrs Beacham 1 pursuant to s 26A of the Taxation Review Authorities Act 2004 and Part 20 of the High Court Rules.

2 The grounds of appeal are that the Authority has failed to apply the tax avoidance sections BG 1(1) and (2) and GB 1 (1) and GB 1(3) of the Income Tax Act 2004 (the ITA 2004) correctly to the facts of the appellants' case, by creating a liability for income tax for the appellants where it is contended no such liability properly existed. Broadly, the issues are first, whether the Commissioner's reconstruction of the appellants' 2007 income tax assessments was outside the scope of her powers; and second, whether the imposition of shortfall penalties was incorrect.

The agreed statement of facts and issues

3 An agreed statement of facts was submitted to the Court, together with a bundle of documents. The salient features of the background to this proceeding can be summarised under three headings: the facts before the restructuring of the appellants' companies; the restructuring itself; and the effect of the restructuring.

The facts before the restructuring

4 Beacham Holdings Ltd (Beacham Holdings) was incorporated in 1991 as Beacham Cars Ltd. Dr Beacham was the sole director and held 296,000 shares. Andrew Rafferty held the remaining 4000 shares. On 30 October 2000 Mrs Beacham purchased Mr Rafferty's shares.

5 Beacham Jaguar Ltd (Beacham Jaguar) was incorporated in 1994 as Major Trauma Research (New Zealand) Ltd. Dr Beacham and Mrs Beacham each held 50 per cent of the shares in the company.

6 Dr Beacham was, and is, a medical practitioner and owner of a medical practice. In 1996, he transferred ownership in his medical practice to Beacham Cars Ltd and changed its name to Beacham Holdings. Beacham Holdings' medical practice was profitable but its car restoration business was not. Beacham Holdings was able to utilise the losses of the car restoration business to reduce or eliminate the assessable income of the profitable medical practice. In 2000, Major Trauma Research (New Zealand) Ltd changed its name to Beacham Jaguar; and later that year Beacham Holdings transferred its car restoration business to Beacham Jaguar.

7 Dr Beacham and Mrs Beacham operated a current account with Beacham Holdings which funded their living expenses. By November 2006 Dr Beacham's current account with Beacham Holdings was overdrawn by approximately $1,079,657.60.

Facts in respect of the restructuring

8 Beacham Holdings returned a taxable profit of $558,047.15 in the 2007 year and the company retained profits of $1,856,277.19. These profits were available to be paid as a dividend to the appellants if the directors declared the dividend should be paid. The dividend would be taxable as income.

9 In August 2006 Dr Beacham and Mrs Beacham sought tax advice from their accountant. A tax consultant was commissioned and he proposed a restructure, comprising the following elements.

10 A shell company, Beacham Group Ltd (Beacham Group) would be incorporated, in which the appellants would be directors and 50/50 shareholders. They would then sell their shares in Beacham Holdings to Beacham Group for $1.84 million. Beacham Group would record the cost of its purchase of the shares as an on demand interest free loan by the appellants to Beacham Group. The key element of the arrangement was for relevant journal entries to be made to effect the crediting of the appellants' current accounts with Beacham Holdings and Beacham Group, thereby partly repaying the loan granted by the appellants to Beacham Group. In effect, instead of Beacham Group repaying the appellants directly, Beacham Group would take over the liability of Dr Beacham to Beacham Holdings. Instead of Beacham Group having to repay the appellants, it would repay Beacham Holdings; and Dr Beacham's liability to Beacham Holdings would be extinguished.

11 The appellants would then treat the amounts received from the sale of their shares in Beacham Holdings to Beacham Group as capital in nature and as repayment of their shareholder current account liabilities in Holdings and Beacham Group.

12 In a letter dated 31 August 2006, the tax consultant recorded the following objective for the restructuring:

The aim is to offset Mr and Mrs Meacham's (G&V) value of the shares against the overdrawn current account in Beacham Holdings Ltd …

13 The appellants followed this advice and formed Beacham Group. On 1 February 2007 they each sold their shares in Beacham Holdings to Beacham Group for a combined total of $1,840,000. 2 Beacham Group recorded the cost of its purchase of the appellants' shares in Holdings as an on demand loan by the appellants to Beacham Group. Payment for the sale of shares was made by means of various journal entries that operated to credit the appellants' current accounts in Beacham Holdings in the amount of $1,213,900; and the share transfers were effected. The balance of the purchase price for the appellants' shares in Beacham Holdings was recorded in Beacham Group's financial statements as a loan repayable to the appellants by Beacham Group upon demand. This amount could be accessed in future as a repayment of loan capital (that is, it would not be income under the Income Tax Act 2007 (the ITA 2007)).

The effect of the restructuring

14 Dr Beacham returned taxable income of $49,023.98 in the 2007 tax year. The Commissioner's assessment was that he should have returned taxable income of $916,523.00 for that year, comprising $49,023.98 and $867,000 (half of the $1,735,000 purchase price for the shares). The assessed tax shortfall is $337,666.38.

Mrs Beacham returned taxable income of $40,061.75 in the 2007 tax year. The Commissioner's assessment was that she should have returned taxable income of $907,561.00, comprising $40,061.75 and $867,000. The assessed tax shortfall is $337,128.66

15 The parties agree that the arrangement outlined above was a tax avoidance arrangement to which s BG 1 of the Act applies. In 2012 the appellants commenced a proceeding in the High Court against Markhams and Tax Assist Ltd regarding the advice provided in relation the restructure of their companies.

16 Their income in the 2007 tax year was assessed by the Commissioner on the basis that: the amount of $1,735,000 received by them from Beacham Group was deemed to be a dividend under s GB 1(3) of the ITA 2004; or alternatively, the amount received would be reconstructed as the appellants' income under s GB 1(1) of the ITA 2004. The Commissioner also imposed shortfall penalties for taking an abusive tax position under s 141D of the Tax Administration Act 1994.

17 Judge Sinclair upheld the Commissioner's reconstruction and the shortfall penalties imposed.

The position of the parties

18 The appellants' position is that there was no need for any reconstruction of their income for the 2007 tax year. They say that s BG 1 has voided the arrangement and thereby eliminated any tax benefit. The Commissioner's position is that the reconstruction was within the scope of her powers.

The primary ground of appeal

19 The appellants' primary ground of appeal is that the Commissioner exceeded the scope of her powers by exercising her powers of reconstruction. The power to reconstruct under s GB 1(1) is constrained by BG 1(2). In other words, the Commissioner can only reconstruct so as to counteract a tax advantage “that a person has obtained from or under a tax avoidance arrangement”. That is the first issue to be determined. Provided that such a tax advantage existed, the Commissioner had the option of basing her assessment on s GB 1(3) or s GB 1(1). Accordingly, for the appellants to succeed on appeal, they must establish that the Commissioner could not reasonably reconstruct under either s GB 1(1) or GB 1(3).

Was there an outstanding tax advantage notwithstanding the effect of BG 1(1)?

20 Section BG 1 is the general anti-avoidance provision that was contained in the ITA 2004. It provided:

• BG 1 Tax avoidance

• Avoidance arrangement void

• (1) A tax avoidance arrangement is void as against the Commissioner for income tax purposes.

• Reconstruction

• (2) Under Part G (Avoidance and non-market transactions), the Commissioner may counteract a tax advantage that a person has obtained from or under a tax avoidance arrangement.

21 Section BG 1 entitles the Commissioner to completely disregard the arrangement and any ensuing transactions, so...