Peterson v Inland Revenue Commissioner (New Zealand)
| Jurisdiction | UK Non-devolved |
| Judge | Lord Millett |
| Judgment Date | 28 February 2005 |
| Neutral Citation | [2005] UKPC 5 |
| Docket Number | Appeals Nos. 66 of 2003 and 10 of 2004 |
| Court | Privy Council |
| Date | 28 February 2005 |
[2005] UKPC 5
Present at the hearing:-
Lord Bingham of Cornhill
Lord Millett
Lord Scott of Foscote
Baroness Hale of Richmond
Lord Brown of Eaton-under-Heywood
Privy Council
[Majority Judgment delivered by Lord Millett]
These appeals are brought from a judgment of the Court of Appeal of New Zealand (Gault P, Keith and Anderson JJ) delivered on 19th February 2003 and reported at [2003] 2 NZLR 77. The detailed facts are set out in the judgments below and are sufficiently summarised in the dissenting opinion herein of Lord Bingham of Cornhill and Lord Scott of Foscote to which reference can be made. There is no need for their Lordships to repeat them.
There are two appeals before the Board with the same appellant in each case. They arise out of a tax avoidance scheme of a kind which has been widely used, has excited the attention of the revenue authorities in many countries, and has frequently been challenged by them, sometimes successfully and sometimes not. The success of any challenge depends on the specific features of the scheme, the particular fiscal background, the weaponry available to the tax authorities to counter the effect of the scheme, and the marksmanship with which such weaponry is discharged. In the present case the Commissioner relies on the provisions of section 99 of the Income Tax 1976 of New Zealand to enable him to disallow a tax deduction claimed by the taxpayer.
Section 99.
So far as material section 99 is in the following terms:
"(1) For the purposes of this section - 'Arrangement' means any contract, agreement, plan or understanding (whether enforceable or unenforceable) including all steps and transactions by which it is carried into effect:
'Liability' includes a potential or prospective liability in respect of future income:
'Tax avoidance' includes
(a) Directly or indirectly altering the incidence of any income tax:
(b) Directly or indirectly relieving any person from liability to pay any income tax:
(c) Directly or indirectly avoiding, reducing or postponing any liability to income tax.
(2) Every arrangement made or entered into, whether before or after the commencement of this Act, shall be absolutely void as against the Commissioner for income tax purposes if and to the extent that, directly or indirectly –
(a) Its purpose or effect is tax avoidance; or
(b) Where it has 2 or more purposes or effects, one of its purposes or effects (not being merely an incidental purpose or effect) is tax avoidance, whether or not any other or others of its purposes or effects relate to, or are referable to, ordinary business or family dealings,-
whether or not any person affected by that arrangement is a party thereto.
(3) Where an arrangement is void in accordance with subsection (2) of this section, the assessable income … of any person affected by that arrangement shall be adjusted in such manner as the Commissioner considers appropriate so as to counteract any tax advantage obtained by that person from or under that arrangement …"
Section 99 is a general anti-avoidance provision which entitles the Commissioner to adjust a taxpayer's assessable income in order to counteract a tax advantage which he has obtained by a tax avoidance scheme. Their Lordships observe that reliance by the Commissioner on the section presupposes that he accepts that but for its provisions the scheme would have succeeded in achieving its object; for, if not, the taxpayer has not obtained a tax advantage and there is nothing for the Commissioner to counteract. As Richardson P said in Commissioner of Inland Revenue v BNZ Investments Ltd [2002] 1 NZLR 450 at p 464:
"… it is inherent in the section that, but for its provisions, the impugned arrangements would meet all the specific requirements of the income tax legislation."
For this reason it is usually prudent for the Commissioner to contend in the alternative either that a scheme does not in fact achieve the desired tax advantage or, if it does, that it can be countered by the application of section 99. This is how the Commissioner put his case before the Taxation Review Authority ("the TRA") and the High Court; but before the Court of Appeal and the Board he has relied exclusively on the operation of section 99, thereby tacitly accepting that, but for the provisions of the section, the tax deductions would be allowable.
The grounds on which the Commissioner has challenged the scheme have varied as the cases have progressed through the courts; many of the grounds advanced at one stage have later been abandoned in favour of others. The only issue before your Lordships is whether, having regard to the facts which have been agreed or found by the TRA, the way in which the Commissioner has put his case, and the allegations and concessions which he has made, he can invoke section 99 to disallow the tax deductions which the appellant taxpayer claims.
The background.
In each of the cases before the Board the appellant was a member of a syndicate formed to finance the production of a feature film in New Zealand. The cases concern different films, one entitled "The Lie of the Land" and the other "Utu". The financing arrangements were similar in all material respects, though they differed in detail and in the monetary amounts involved. There are only two significant differences between the two cases. One is that "The Lie of the Land" was never commercially released and so never generated any receipts, while "Utu" has been one of the most successful films ever made in New Zealand. The film has earned substantial income and was still continuing to earn income 17 years later. The other is that whereas both films were financed in part by a non-recourse loan provided in the course of a circular movement of funds, external funds were inserted into the circle in "The Lie of the Land" but not in "Utu", where the lender was not put in funds to make it. The loan was, however, supported by cheques which were duly honoured, was treated by all concerned as received and applied by the borrowers, and has been fully or partially repaid by them in accordance with its terms.
In order to enable them to deal with both cases together, their Lordships propose to use algebraic symbols to represent the monetary sums involved.
Film financing.
It is generally recognised that investing in the production of feature films is a high risk enterprise. The great majority of such films lose money, that is to say they fail to generate sufficient net receipts after deducting the marketing and distribution costs to recoup the costs of production. The rewards of investing in a successful film, on the other hand, can be enormous. Investors may be persuaded to put their money into several films rather than one in the hope that they will thereby increase their chances of profit by enabling them to recoup their losses from a series of failures by a single success. This, however, only increases their exposure; and it is unlikely that finance for film production would be found were it not for the possibility of obtaining non-recourse financing, which reduces the investor's exposure to loss, and the substantial tax incentives which many countries offer.
In the present cases high rate taxpayers were induced to enter into arrangements to finance the production of a film by the prospect of obtaining significant tax advantages. These arose from a combination of two features which are not uncommon in commercial financing arrangements lacking any overriding tax motivation. One was the prospect of obtaining a depreciation allowance for the cost of the investment; the other was the opportunity to fund it in part with moneys borrowed under a non-recourse loan agreement.
Depreciation.
Income tax is chargeable on the profits of a trade or business, not on gross earnings, and revenue expenditure incurred in earning those profits, if genuinely incurred, normally falls to be deducted from gross receipts in order to arrive at the taxpayer's taxable profits for the year. Capital expenditure incurred in the course of a trade or business, on the other hand, is not normally deductible in arriving at trading profits. Instead a depreciation allowance may be available to permit the capital cost of an asset with a limited life to be written off against the taxpayer's taxable income over the expected life of the asset: see, for example, section EG1 of the Income Tax 1994 of New Zealand. Income tax is charged on an accruals basis not on a receipts and payments basis, and expenditure is deductible when it is incurred not when it is paid.
Film production and distribution have, however, been long accorded special treatment in New Zealand. A ruling (IR 52.3) published by the Commissioner in 1952 and which it is common ground applied to the films in question provided ( inter alia) that all income from the sale or other exploitation of a film was taxable and that the costs of producing films should not be deductible in the year incurred. Instead they should be capitalised and depreciated at the rate of 50% on cost price, that is to say the cost should be written off over a period of two years. In this respect no distinction was to be drawn between investors in films and persons engaged on a full time basis in the business of producing or distributing films. Both were entitled to offset their share of the costs of producing or marketing the film against income from the film and income from other sources.
Counsel seemed to think that the ruling is not happily worded. Although no distinction is to be made between investors and those engaged in producing or marketing films, they were troubled by the fact that the ruling appears to cover only the costs of...
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