The appeal in Penny and Hooper has been decided in favour of the Commissioner in a 2:1 majority decision of the Court of Appeal released on 4 June 2010.
In the first instance the decision could be considered to have been rendered largely nugatory for the time being given the recent reduction of the top marginal rate to that of the trustee rate. However, with the new company rate now significantly below these rates, the matter of below market salaries will likely be a live issue for some time.
Although the decision has to some extent confirmed the structure adopted by both Penny and Hooper as commercially acceptable, comment was made regarding the taxpayers’ respective ability to control salaries and cash flow in their capacity as directors and through the control exerted over family trusts (para. 119). As a practical response to this decision taxpayers in similar situations may wish to revise certain elements of control, so far as is commercially realistic.
The Court of Appeal has not signalled that any below market salary will necessarily amount to tax avoidance, and in fact in this regard Randerson J stated at para. 125 that “this decision should not be regarded as establishing a principle that salary levels in family companies which are below the levels which could be expected in an arms-length situation, are necessarily to be regarded, without more, as evidence of a tax avoidance arrangement.” That said an unavoidable outcome of this decision is uncertainty for both the commissioner and taxpayers regarding whether any below market salary could be construed as tax avoidance. It is expected that the decision will be appealed.
Practitioner’s thoughts on the decision and its ramifications are invited.
The full text of the decision is available at cch.co.nz.
Interesting reading. Hammond J’s judgement is as strong a renunciation of the principles of the Duke of Westminster case as I’ve read by a NZ judge. His judgement has a very strong emphasis on the “scheme and purpose” approach. Both he and Randerson J also emphasize the level of salaries as lacking commerciality. Ellen France J’s judgement not as forthright although she (para 183) gives prominence to the potential uncertainty arising from the Commissioner’s use of hindsight to determine tax avoidance.
Para 121 of Randerson J’s judgement also gives pause for thought “I do not attach any weight to the suggestion that the company structure was
necessary to protect the respondents from negligence claims given the existence of the ACC legislation and the fact that a company structure would not avoid personal responsibility in respect of any such claims in any event.”
Plenty of food for thought here.