The Week in Tax: Inland Revenue’s sweet taste of victory over Frucor, updated Inland Revenue guidance on cryptoassets, and Labour's tax and small business policy

Late last week Inland Revenue won a tax avoidance case in the Court of Appeal against Frucor Suntory New Zealand Limited.

The background facts are complicated, but basically the case involved an advance of $204 million dollars to Frucor in exchange for a fee and some convertible notes issued by Frucor to Deutsche Bank. There was a related party payment from Frucor’s then Singapore based parent for the purchase of the shares from Deutsche Bank.

Over a five year period Frucor paid Deutsche Bank $66 million dollars on an interest only basis. Inland Revenue argued to this was a tax avoidance arrangement and for the 2006 and 2007 income years disallowed deductions to the extent of $10.8 million and $11.6 million respectively.

Frucor won this case in the High Court in 2018, a decision which actually raised a few eyebrows in the tax advisor industry because it seemed similar to the arrangement, struck down involving the big Australian banks about 10 years ago.

Unsurprisingly, Inland Revenue appealed and have now won in the Court of Appeal. Under the arrangement, Frucor had apparently achieved interest deductions totalling $66 million. But in the court's view, it had not incurred a corresponding economic cost for which Parliament intended deductions would be available. $55 million as a matter of commercial and economic reality of the claimed interest was in fact a repayment of principal borrowed and not an interest cost. The Court concluded that the funding arrangement had tax avoidance as one of its purposes or effects and was this was not merely incidental to some other purpose. The overall purpose of the funding was provision of tax efficient funding to Frucor.

The only bright spot in this decision for Frucor is that the Court of Appeal agreed the High Court was reasonable to find that the shortfall penalties for a tax avoidance arrangement (which can be up to 100% of the tax avoided) should not have been imposed by Inland Revenue.

The key lesson here, and it's going to be of importance looking forward if Labour forms the next government, given its announcement for a higher personal tax rate, is that the courts are still very much onside with striking down tax avoidance cases where they consider the arrangements are not seem to be in line with Parliament's intention. And Inland Revenue has made aggressive use of tax avoidance provisions in section BG 1 of the Income Tax Act, and until Frucor’s High Court victory, it had not lost a case involving a tax avoidance matter for something like 10 years.

So aggressive tax planning is very much still under the gun for Inland Revenue and the courts are supportive of that approach, even though it might look as if the all the necessary legal form has been satisfactorily met. So that’s just a warning for the timed ahead. I think we're going to see Inland Revenue make more use of anti-avoidance provisions in other areas as it returns to normal after its attention was diverted responding to the COVID-19 pandemic in the early part of this year.

Taxing cryptoassets

Moving on, Inland Revenue has issued some updated guidance on the treatment of tax treatment of cryptoassets. There's nothing especially new here. It is confirming that cryptoassets are to be treated as a form of property and that in each case it will look carefully at what is the circumstances behind the acquisition and disposal of the relevant cryptoasset.

The guidance does expand a little bit more on what we've seen previously in this area.

Inland Revenue has said very clearly is that it will look at the purpose for acquiring the cryptoassets. And it is pretty straightforward in saying that if your purpose when acquiring cryptoassets was to sell or exchange them, you will need to pay tax when you do so.

Inland Revenue will look very carefully at your purpose at the time you acquire cryptoassets. The guidance repeats the key point, which is often overlooked, that it is the purpose at the time of acquisition that matters. If that purpose changes later on, that is not relevant. If you plan on selling or exchanging your cryptoassets at some time in point in the future, then you have a purpose of disposal. It doesn't matter how long you plan to hold onto them before doing so. Your main purpose can be to sell or exchange them even if it takes a few years. Then, of course, you've got to have supporting evidence of what your intention was at the time of acquisition.

And one of the things the guidance points out is the nature of the cryptoassets being acquired. And in particular, does it provide an income stream or any other benefits while being held? (By the way, benefits isn't clearly defined). Now, Inland Revenue's view is that if you have cryptoassets that do not provide an income stream or any other benefits, this strongly suggests you acquired them for the purpose of selling or exchanging them. This is because the only benefit you get is when you sell or exchange those cryptoassets. And that, by the way, is similar to Inland Revenue’s position on gold bullion.

But just because you've got cryptoassets that do provide an income stream or other benefits, for example, staking, that doesn't mean that you didn't acquire them for the main purpose or sending of sale or exchange. Somewhat helpfully, there are a number of examples of how the Inland Revenue sees these rules working.  

So the position to be mindful of if you’re involved in holding cryptoasset, is that the default position is almost that any funds realised on a sale or exchange are going to be taxable. To counter that, you're going to need to show good records at the time of acquisition of what your intention was and what type of assets you acquired.

This is a perennial problem that we face in our tax system because the taxation of capital gains or gains is very much driven around a rather nebulous definition of purpose or intent. It comes back to a point I've said beforehand that one of the advantages of a capital gains tax is it does clear away all the uncertainty.

But this is the current position and we have to work with it. And so my advice is be very clear in recording what your intention is when you acquire cryptoassets. And if you haven't done that, it's too late. Inland Revenue's default position with cryptoassets is that any sort of exchange is going to be taxable.

Election 2020 tax policies

And finally, Labour has now come out and announced its tax policy, the centrepiece of which is a new top income tax rate of 39% applying to income above $180,000. It's also said that there will be a freeze on fuel tax increases, no new taxes and no further income tax increases for the entire next term of government.

The other point it's raised is is it going to continue to work with the OECD to find solution on the to the taxation of multinationals? It’s prepared to go ahead with the implementation of a digital services tax, which present projections estimate would raise between $30 and $80 million yearly.

As can be seen there’s not a lot of tax involved with multinational taxation, but it'll be a popular measure because it's something that keeps coming up in conversations I have with people on the issue of taxation. People are always saying multinationals should pay more. But they’re not a bottomless well, and opportunities to tax them are limited.

The digital tax space is where there could be some movement. But that's very much dependent on how the OECD goes. And as I've mentioned in the past, the Americans have pretty much bought that particular pathway to stop earlier this year by basically saying they weren't going to cooperate or be involved

With the proposed income tax rate increase to 39%, we've been there before. I thought if Labour was going to raise the top tax rate, it would be to 39% percent. Crossing the 40% threshold would be a psychological barrier too far. We haven't had an individual tax rate of more than 39% for over 30 years. 1988 was the last time the tax rate was above 40% when it was 48% as I recall. It's expected to raise 550 million dollars.

There's already a lot of talk going around about making use of trusts and companies to get around the increase. My understanding is they're going to look at trusts and the trust tax rate. Conceptually, the trust tax rate should really rise to be equal to the top personal tax rate. And that's the story in Australia, the UK and the US as well. But my understanding is trusts will be looked at to find out exactly how many trusts really would be caught by that, because there are trusts settled for minors and orphans and other charitable or semi charitable purposes.

But even if nothing happens in that space, I’ll just remind you about the first item this week, the Frucor case and the Inland Revenue's approach to tax avoidance. Last time we had tax rates at 39% we ended up with the Penny-Hooper decision. That's the case involving dentists who used a company to trap income at the company tax rate, which was then 33% and then then lowered to 30% instead of the personal 39% rate was struck down as tax avoidance. You can see that happening again.

So, yes, Labour seems to have opened an opportunity for tax planning. But my answer to that would be ‘Proceed with great caution’, because Inland Revenue has a big stick in the form of an anti-avoidance provision.

The other thing of note from Labour is that it's campaigning on extending applications to the Small Business Cashflow Scheme to 31st December 2023 for ‘viable’ businesses. h   And it's also promising to extend the interest free period of loans under the scheme from one year to two years, which would be very welcome for small businesses. Labour will also look at a permanent iteration of the scheme, which is something I would support.

That's it for this week. Thank you for listening. I'm Terry Baucher and this has been The Week in Tax. Please send me your feedback and tell your friends and clients until next week. Ka kite āno.

This article is a transcript of the September 11, 2020 edition of The Week In Tax, a podcast by Terry Baucher. This transcript is here with permission and has been lightly edited for clarity.

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