PENNY AND HOOPER – SUPREME COURT DECISION OUT
The Supreme Court has released its decision on the Penny and Hooper appeal heard on 27 to 29 June 2011. The appeal has been dismissed and Penny and Hooper have been ordered to pay costs.
The Supreme Court has found that the arrangement was tantamount to tax avoidance. The Supreme Court did note that the structure the taxpayers had adopted when they transferred their businesses to companies owned by their family trusts was, as a structure, entirely lawful and unremarkable. The Court also noted that there was nothing unusual or artificial in that the taxpayers caused a company under their control to employ them on a salaried basis, and the adoption of a familiar trading structure could not in itself be said to involve tax avoidance.
The Supreme Court accepted that the fixing of salaries at artificially lower levels, whereby the incidence of tax at the highest personal tax rate was avoided, did amount to tax avoidance, and found, in this case, that that was a primary or fundamental purpose of the arrangement. It was noted that tax avoidance can be found in an individual step in a wider arrangement, and that that step, when taken, can make the wider arrangement a tax avoidance arrangement.
The Supreme Court noted at paragraph 35, that the fixing of the low salary enabled most of the profits of the company from the professional practice to be transferred by way of dividends straight through to the trust, avoiding payment of the highest personal tax rate, and then use by the trust for the taxpayer’s family purposes, including benefitting him in the case of Mr Penny by loans, and by funding the family home and holiday home in the case of Mr Hooper.
The Supreme Court noted that other purposes were evident from the arrangements, namely the protection of assets from professional negligence claims, but the actions of the parties demonstrated that this purpose was not the sole or dominant purpose.
The Supreme Court noted also that there was a genuine desire to build up assets for the benefit of the family in both cases, but found that the tax advantage was objectively, at the very least, one of the principal purposes and effects of each arrangement.
How if affects you
A number of comments have been made by the Supreme Court that give comfort that where a business structure has been legitimately and commercially established and implemented, that low salaries will not of themselves give rise to tax avoidance.
GENERAL TAX AVOIDANCE VS SPECIFIC PROVISIONS
As a result of the Supreme Court decision issued in respect of Penny and Hooper, as detailed above, some guidance has been obtained as to how the specific avoidance provisions operate in terms of the general avoidance provision.
The Supreme Court noted that the existence of the personal service attribution rules and cross border services rules are specific anti-avoidance provisions, but they do not mean that the general anti-avoidance provision in s BG 1 cannot operate where the tax avoidance arrangement employed by a taxpayer does not fall within those specific provisions or rules.
The Supreme Court quoted the Select Committee Report on the Taxation (Annual Rates, GST, and Miscellaneous Provisions) Bill, where it was commented that the personal service attribution rules supported the general anti-avoidance provisions of the Income Tax Act . The Supreme Court noted that legislators recognised that the latter would continue to do their residual work, “but no doubt with the hope that the delay and cost involved in using the general avoidance provisions could be obviated in specifically targeted situations”.
The Supreme Court has noted that the specific rules plainly are intended to cover the field in relation to the use of particular provisions by taxpayers or plainly exclude the use of the general anti-avoidance provisions in a certain situation, and in those cases, there will be a limitation on the application of the general avoidance provision.
Where that is not the case, the general avoidance provision in s BG 1 is used to counter avoidance where it has occurred.
In the case of Penny and Hooper, the findings were that the structure itself was lawful in that only one component, which in itself was not unlawful, amounted to tax avoidance because of the specific step taken and the intended consequence or effect of that step, namely the setting of artificially low salaries and reducing the tax paid on the income.
How if affects you
When transactions are entered into, or business structures are established and implemented, it is necessary to take care that no one component puts at risk the balance. Commercially justifiable actions are key, not only at the time of establishing the structure, but also during the implementation and actions that follow. In determining whether or not you are pushing the boundaries, you need to consider not only whether there is any particular tax provision that is met, but whether you fall foul of what the legislator intended.