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Case Z24 – Troubling trends in tax avoidance jurisprudence

In Case Z24 the taxpayer had transferred an avocado orchard and her private practice as an anaesthetist to a family company.  In the 2003 and 2004 years she provided her services to the family company for a nil or low salary.   The Commissioner had argued that the rent paid by the family company to the family trust for the lease of the orchard was inflated and the salary paid to the taxpayer for her services was too low.  Judge Barber was unimpressed by the Commisioner’s arguments as to the inflated rent but held that the payment of an artificially low salary was tax avoidance. 

Two elements of this case are troubling:  there was no reference to Penny & Hooper anywhere in the case, notwithstanding the High Court decision was delivered over a year ago; and there is no explanation of how the tax consequences of combining a loss-making business (the orchard) with a profitable business (the private practice) achieved a result that was manifestly outside the contemplation of Parliament.  If it is accepted, which it appears to have been, that in aggregate there was little in the way of distributable profit from both businesses, then what principle of tax law would compel the owner to pay themselves a salary?

2 Responses

Vicki Ammundsen on March 20, 2010 at 12:39 pm

You make some good points. In the event a salary was paid, or if as Judge Barber suggested the company borrowed money to pay salaries (if that were even possible), another question to consider is the obligations owed by the director(s) to the company and whether in the event salaries were paid, the director(s) would be meeting the obligations owed by them to the company.

Some guidance regarding what is and is not within the contemplation of parliament (and how that is determined) would be much appreciated – particularly given the observations made regarding how a similar outcome could have been achieved through the use of an LAQC. However, it appears that the outcome in this case had a lot to do with the commerciality inherent (or not) in the arrangment. Irrespective of the fact that the locum was paid at a market rate while the disputant was not, perhaps the outcome would have been different if there had been an employment contract determining how the disputant would be paid (rather than the strategy that salaries would be paid to the disputant and her husband from any profits). The substantial payments to the children, relative to the payments to the disputant were also unhelpful.

Where does Z24 leave matters regarding the payment of a below market salary? You would have to be brave to consider it. But if you do, make sure there is an employment contract.

John Peterson on March 22, 2010 at 4:44 pm

At last weekend’s IFA conference – Rob McLeod suggested that the time had come to lobby for reform of the General Anti-Avoidance Rule (GAAR). He suggested that the uncertain and ever expanding scope of the rule is undermining confidence in the rule of law. It appears that we can no longer expect the Courts to provide us with any useful guidance in this area – increasingly these cases are decided on their facts and we have no ability to derive usable points of principle from them.

There is plenty of scope for reform in this area. The Valabh committee recommended adopting a GAAR that had a “dominant” purpose test and that set out a list of tax avoidance factors similar to Australia’s part IVA – perhaps we could also have a provision similar to the Canadian statute that puts the burden of proof on the Commissioner when it comes to establishing that an arrangement is contrary to the scheme and purpose of the Act.

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