Landmark tax avoidance decision has wide impact

Today’s Supreme Court decision in favour of the Commissioner of Inland Revenue in a case involving two surgeons who were alleged to have paid themselves artificially low salaries to reduce their tax bill is a landmark decision, says PwC Chairman and Tax Partner John Shewan.

Mr Shewan, who acted as an expert witness for the taxpayers in the case, says the decision has wide application. “There are thousands of small businesses that operate through companies and which pay salaries or wages to their owner operators. Today’s judgment confirms the Commissioner’s view that where the amount paid is artificially low that may well constitute tax avoidance.”

“SMEs do not need to panic over the decision, but they will want to review their circumstances to ensure they are on the right side of the line,” adds Mr Shewan.

The decision is helpful in pointing to some cases where avoidance would not be involved, such as the need to retain funds to make capital expenditure or where the company is experiencing financial difficulties or it would be imprudent to pay a market salary.

“As a practical matter it will be necessary for Inland Revenue to issue further guidance along these lines because it is in everyone’s interests for there to be reasonable certainty as to where the boundaries lie” says Mr Shewan.

The decision also reinforces the importance of documenting the reasons businesses are taking particular decisions.

“Taxpayers need to be able to demonstrate why they did what they did. The second step is that if what they did reduces their tax they need to be able to satisfy themselves and Inland Revenue that it is an advantage that Parliament would have contemplated.

“We have some concerns over how the Parliamentary contemplation test will be applied in practice. What Parliament intends is sometimes hard to fathom” says Mr Shewan.

It is clear there is a new playing field with regard to the application of tax avoidance rules in New Zealand. The key is for people to understand this and to respect the fact that the Courts have made it very clear that the avoidance provisions will be applied more literally than previously. So in any situation where there is a reduction in tax relative to an alternative or a prior position people need to be able to justify that this is a result of genuine commercial decisions, not as a result of a tax objective in itself unless, such as in the case of the PIE regime, that tax objective is clearly contemplated by Parliament.