Watson finding of no real surprise
Arguably the highlight of the week for some people I spoke to, was the release of the High Court’s finding for the Commissioner, against Eric Watson’s Cullen Group challenge to IR’s assessment of NRWT.
When Mr Watson decided to relocate to the UK in 2002, I expect his esteemed advisors at the time, recommended a restructure of his affairs, which included the establishment of two Cayman Island conduit companies, who eventually lent funding to Cullen Group, an existing NZ company. Or did they? What did in fact happen, was that the shares Mr Watson owned in Cullen Investments Limited, were eventually (as a consequence of other transactions) replaced by loans owed by Cullen Group to the two Cayman Island companies. No new funds therefore actually came into NZ under the restructure.
For whatever reason was decided justifiable at the time, rather than just accepting that NRWT was probably the correct answer in terms of what was actually required to be deducted from any interest payments made on the debt, Cullen Group instead registered the loan documents with IR (as required), and obtained approval to use the AIL payment regime.
Under the AIL regime, the requirement to deduct NRWT (at a 15% rate in this instance), is negated by the borrower paying a 2% AIL levy calculated on the gross interest paid to the lender. However the use of the AIL regime is not permitted where the borrower and the lender are associated. The difference in this instance, between the AIL that was paid, and the NRWT that should have been deducted instead, was $51.5m, and that is before any use of money interest or penalty charges.
The prime issue for the Revenue to overcome in this case, was that while the average person on the street would think there could be little doubt that Cullen Group and the two Cayman Island entities were associated, legally they were not, and this was so, even though Mr Watson was on both sides of the loan and retained a high degree of control over all relevant entities.
How did the Revenue manage to leap this hurdle then? They argued instead that the use of the AIL regime by Cullen Group in this way, was not in a manner that was within Parliament’s contemplation or purpose, that the altering of the incidence of tax was more than merely incidental, and that the quantum of tax avoided and the integral nature of payment of AIL as a term of the relevant loans, were all factors signalling that this was an arrangement used by the taxpayer to avoid tax as a means to an end in its own right.
While this is a High Court decision, it is Mr Watson we are dealing with, so an appeal is likely I expect.
Regardless however, the decision is still a timely reminder to us all, that even if you are smart enough (or at least have the money to pay someone else who is smarter than you) to develop an arrangement or transaction that ticks all the black letter boxes within the law, if the Revenue do not like it and consider you have not used the taxing provisions in a way that Parliament would have intended for you to use them, then do not be surprised to see the anti-avoidance finger pointed your way.
Modernising Tax Administration Bill receives third reading
The Bill which has at its core focus, making tax simpler and easier for individuals, has passed its third and final reading and is now awaiting Royal assent.
As a result of the passing of the Bill, from April 1st, expect to see a more pro-active Inland Revenue, as it pursues its goal of attempting to ensure an individual receives the right amount of income at the right time. It will do this by monitoring the tax codes used by individuals, and where it is considered the individual could be better off by using a different tax code, that individual will then be contacted and have suggested to them, not forced, that they consider amending their code.
We will also see a change to the way individuals file their end of year tax returns, with an eventual phasing out completely of the existing personal tax summaries (PTS) and IR3 tax returns. With respect to the income year ended 31 March 2019, IR will issue pre-populated accounts to all individuals, which will include all reportable income details that IR already holds. For taxpayers who only derive reportable income, they will then have a final account issued and not have to do anything further unless they think their assessment is wrong, in which case they will have up until their terminal tax due date to advise IR of any changes required.
For those taxpayers who have income from non-reportable sources, they will need to provide that income information to IR, before their final account assessment will be made.
There will also be a new, low cost binding ruling system available to SME’s and there will be an expansion to the existing scope of the binding ruling regime, which previously only permitted a taxpayer to seek a ruling with respect to a particular arrangement they were entering into. The expanded rulings scope will now allow you to seek rulings on such things as confirming your purchase intention with respect to an acquisition of land, or having IR rule on your tax residency status.
Finally there are a number of changes to KiwiSaver, including the addition of 6% and 10% employee contribution rates, reduction of the contribution holiday (now renamed “savings suspension”) from a maximum period of 5 years to 1 year, and allowing for over 65 year-olds to now elect into KiwiSaver, as a potential low-cost managed funds saving option for them.
Look out for full details of all of the above changes arising from the passing of the Modernising Tax Administration Bill, and more, in a forthcoming issue of IR’s taxpayer information bulletin (TIB).
Director not in breach of duties
I wanted to make a mention of this particular decision of the Court of Appeal, because while not completely tax flavoured (although the liquidation was brought about by IR chasing unpaid GST), I think the decision is a very useful guide commercially to us all, and the tough decisions that our clients are sometimes forced to make when their businesses are in trouble.
I have certainly been around long enough now, to have had a client approach me when in financial difficulty, requesting advice as to what they should do next, and most importantly, what personal exposures could the decisions they make, create for themselves. While it is so simple to say to someone that it is no use continuing to flog a dead horse (as the saying goes), and that the business should just be wound up, it can be extremely hard for the recipient of that advice to put aside the emotions and realise that for all parties concerned, including themselves, it is just the right thing to do.
This case concerned the director of a building company, who had four building projects on the go, when he appreciated that the company was clearly in financial difficulties. Realising the need to take a breath and seek professional advice, he arranged a meeting with his accountant. The decision was in essence, close the door now, or attempt to find some temporary funding to at least complete the four projects, which based on the numbers had the potential to significantly improve the existing position for all creditors of the business, including the IRD.
The outcome of the meeting was to limit the company’s trading to the four uncompleted projects, and obtain funding from an existing second tier lender, as well as the directors family trust, for which a GSA was taken. The four projects were then fully completed and sold, the net outcome being three creditor groups (trade, IRD & the shareholders/trust) all being owed roughly similar amounts.
IR then applied to liquidate the company, subsequent to which the director was personally pursued by the liquidators, to which the High Court ruled he had breached his duties under the Companies Act – duty to act in good faith, reckless trading and duty to not agree to the company incurring an obligation it cannot ultimately satisfy.
However the Court of Appeal quashed the High Court decision, on the basis of adopting a business judgement approach to its analysis of the director’s duties. In this respect the Court commented:
- The purpose of the Companies Act is to provide that directors are allowed a “wide discretion in matters of business judgment” while protecting shareholders and creditors from the abuse of management power;
- While the director’s belief (when acting in good faith) cannot be based on a wholly inappropriate appreciation of the interests of the company, these words do not require perfect business judgment. The duty must be assessed recognising the wide discretion given to directors in matters of business judgment. Commercial good practice is relevant in assessing good faith;
- If directors are to have a wide discretion in matters of business judgment to encourage efficient and responsible management of companies as the long title envisages, the bar in terms of risk to the company’s creditors must not be set too high. A court is not to assess the risk of a particular transaction ignoring up-side to the business. It is a risk and loss to the company as a whole that is referred to and not just in relation to a particular transaction;
- With respect to the reckless trading issue, caution must be exercised to avoid bringing hindsight judgment to bear in circumstances which do not fully and realistically comprehend the difficult commercial choices facing the directors.
Bearing these comments in mind, the Court therefore found:
- The director did not act in bad faith and was not reckless. When things got rough, the director took stock of the company’s position, put the brakes on further projects, and focused on completion of the developments to best serve the interests of creditors. He incurred further debt in order to complete, but he considered whether those creditors could ultimately be paid, and did his costings with that in mind, and by and large they were paid with the exception of the IR and the Trust. In relation to that IR debt, the GST situation was complex and the IR was not necessarily going to be worse off, and could be better off, after completion and sales. The option which the liquidators say should have been taken of some sort of walk away by the director in November 2012 leaving the houses unfinished was in the Court’s assessment the less sensible commercial option.
- It was not strictly necessary to consider the application of the defence for a director relying on a professional advisor. The Court of Appeal agreed with the High Court that s138 was not available as a defence. However, the accountant’s general support expressed to the director in favour of completing the buildings and selling them, was a significant factor in the reasonableness of the director’s actions, and whether there was any element of recklessness.
A good commercial practical decision in my view, and certainly at a level of authority where as an adviser I can have some confidence in using the Court’s commentary as potential guidance for future scenarios of client’s faced with the same predicament – do I close the door now or push on, with a realistic supported view, that in doing so, there is a chance to improve my creditors ultimate outcome, although naturally coupled with the risk that such a result does not subsequently materialise.
