IRD to appeal surgeon tax case

[essence]

09/02/2010

the ird will today appeal a high court decision in favour of two christchurch surgeons it had accused of underpaying themselves in order to save on tax.

Orthopaedic surgeons ian penny and gary hooper both formed companies for their private practices and employed themselves, paying out some company profits as their own salaries.

It meant they paid less tax, as the companies' profits had a tax rate of 33c, compared to the personal top tax rate of 39c.

Ird said the structure was a tax avoidance arrangement, but the surgeons took the department to court, arguing that income tax legislation had no notion of commercially realistic salaries.

Justice alan mackenzie agreed with the surgeons, saying the proprietor of a "one-man" business had the choice to run their business as a sole trader or through a company.

The ird would appeal the high court decision in the court of appeal in wellington today.

The case is seen as an important test case, with implications for how family and small businesses are structured for tax purposes.

[roseneath_rat]

This is indeed a very important test case as it sets the standard for operating through limited liability company and payment of fair market salaries. Probably not so important for property investors unless you are doing your own property management and not paying yourself a market salary.

[PeterEmpowerEd]

This is indeed a very important test case as it sets the standard for operating through limited liability company and payment of fair market salaries.

I thought I recalled a dentist being at the losing end of an argument like this with the IRD a few years back... paying himself a pittance as "salary".

I'm surprised "Justice Alan Mackenzie agreed with the surgeons" ... but I guess he had his reasons.

I'd expect IRD to pursue it hard, as you say RR.

[Winston001]

I thought I recalled a dentist being at the losing end of an argument like this with the IRD a few years back... paying himself a pittance as "salary".

Quite right. I think he paid himself a salary of $80k and the Court held that $120k was the market level.

Goodness knows with surgeons, depending on their speciality the sky is the limit. We'd need to see the decision. Possibly they were close enough to "market salary" the Court decided not to interfere.

Lucky sods. Some of us are prevented by law from such structures.....

[CJ]

I'm surprised "Justice Alan Mackenzie agreed with the surgeons" ... but I guess he had his reasons.

Have you read the case.

This wasn't set up for tax avoidance. There was real evidence they did it for other reasons (personal liability etc). They actually saved very little tax in the scheme of things. One (both?) set it up before the envy tax so the tax savings were even smaller. They also got appraisals for market salary. This was based on the salary they would have got if they were working in the public section (which they did part time) so is a far comparison. I could go on but that will do for now.

Interestingly there is no requirement to pay employees market rates (just ask the DHB they were working for (ie the Govt))!

This will be a very interesting case as it will impact on a lot of people should they lose.

[Perry]

Them 'Our Job To Be Fair' Crowd

The IRD is in the business of collecting as much
tax revenue as possible. By most any means,
fair or foul. I have a bulging folder on the sods.

I hope the surgeons have good lawyers. Further,
I hope the IRD gets slapped with costs and more!

What follows is either a Privy Council or House of
Lords determination. No wonder comrade commissar
Clark, Cullen & co wanted to cut the ties.

Bold emphasis is mine (para 2)

Lord Tomlin held: "...it is said that in [Tax] Revenue cases there is a doctrine that the Court may ignore the legal position and regard what is called the 'substance of the matter', and that here the substance of the matter is that the annuitant was serving the Duke for something equal to his former salary or wages and that, therefore, while he is so serving, the annuity must be treated as a salary or wages. This supposed doctrine ... seems to rest its support upon a misunderstanding of language used in some earlier cases. The sooner this misunderstanding is dispelled and the supposed doctrine given its quietus the better it will be for all concerned, for the doctrine seems to involve substituting 'the uncertain and crooked cord of discretion' for 'the golden and straight mete wand of the law'.

"Every man is entitled if he can to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure this result, then, however unappreciative the Commissioners of Inland Revenue or his fellow taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax. This so-called doctrine of 'the substance' seems to me to be nothing more than an attempt to make a man pay notwithstanding that he has so ordered his affairs that the amount of tax sought from him is not legally claimable."

This approach was subsequently confirmed in New Zealand in a number of cases such as: C of IR v Europa Oil (NZ) Ltd. , Re Securitibank Ltd (No 2), Buckley & Young Ltd v CIR and Mills v Dowdall.

[PeterEmpowerEd]

This wasn't set up for tax avoidance. There was real evidence they did it for other reasons (personal liability etc). They actually saved very little tax in the scheme of things. One (both?) set it up before the envy tax so the tax savings were even smaller. They also got appraisals for market salary. This was based on the salary they would have got if they were working in the public section (which they did part time) so is a far (sic) comparison. I could go on but that will do for now.

This will be a very interesting case as it will impact on a lot of people should they lose.

While I bow to your greater knowledge of this case, CJ, your mention of 'evidence of intention', 'appraisals' etc reminds of the chief lesson that emerged from the Cook Island tax scam/Wine box inquiry:

In NZ, if you have done the paperwork correctly, you are deemed to have obeyed the law.

... can't remember who said it, but it stuck with me. - P

[roseneath_rat]

In the dentist case I believe he was paying himself $60-80K, however the courts looked at the practical way that dentists are generally renumerated... most dentists who do not own their own practice operate as 'associates' and get paid 40% of the fees that they charge. Given that the dental surgeon in question was billing some $800K in revenue (can't remember the specific numbers) he was deliberately underpaying himself from market wage for tax purposes.

The general rule of thumb in dentistry-
40% to practitioner
40% in overhead costs
10% in materials
10% profit

[foss]

These situations arise from time to time. Hopefully IRD sticks it to him.

Is very important test case. Whilst got media attention doesn't have the same profile of the property tax rorts unfortunately.

[CJ]

From what I heard, the IRD may win at the court of the appeal. One judge was clearly on their side.

[VincyV]

Difference between an employee and a business person.

Why don't we put envy aside (foss, Winston001) and look at this dispassionately.

From memory, the earlier judgement that is being contested by IRD, held that the IRD had no right to interefere with the running of a business and dictate earnings for owners of a business.

If I was a creating a new business, conventional wisdom suggests that I put in as much of revenue I can back into the business to fund growth . So It should be OK to take a minimum, or even zero, remuneration ploughing all available revenues into the business. Owners can receive income as drawings through shareholder current accounts (and pay provisional tax) or as a salary (and use PAYE). IRD has no problem with this. And a most businesses including Prop Inv LAQC owners know and do this .

How would above mentioned business owners or an LAQC shareholders respond it if they were told that they must treat themselves as employees and must pay themselves market "salaries" ? How are the surgeons different ? Is it just that they earn a lot of money ?

Perry's earlier post Them 'Our Job To Be Fair' Crowd, I think adds to that and says that the law cannot require that something different must be done to pay more tax as long as it is following the rules (including that of 'intent') -- in other words the "paperwork is sound"

[Winston001]

Why don't we put envy aside (foss, Winston001) and look at this dispassionately.

It should be OK to take a minimum, or even zero, remuneration ploughing all available revenues into the business. Owners can receive income as drawings through shareholder current accounts (and pay provisional tax) or as a salary (and use PAYE). IRD has no problem with this.

How would above mentioned business owners or an LAQC shareholders respond it if they were told that they must treat themselves as employees and must pay themselves market "salaries" ? How are the surgeons different ? Is it just that they earn a lot of money ?

Ah, I'm not envious or jealous of the surgeons incomes, it's their ability to use a company structure to reduce personal liability. Most people can do this except for lawyers and opticians who are prevented by law from limiting their liability.

As for market salary, so far as I know IRD can audit any company return and disallow an unrealistic salary to a shareholder/employee. Not just dentists and doctors.

Usually the risk is paying too much to a shareholder who does no work at all. This occurs often as a way of family income splitting.

[Viking]

Not good for the IRD to win because it allows them to challenge everything that happens in any employment relationship between shareholders/owners.
The IRD is becoming very aggressive with these cases and each win creates another precedent that can and will be use3d somewhere else.

The bigger case for IRD IMHO is the use of trusts and the apportioning of incomes to others and to lower taxed entities.
This is where the tax base is seriously eroded.
Best way to fix, change the Trust tax rate tp 39% and bring down the personal to 30 along with company tax. Removes the use of trusts to minimize income to an individual who can them make use of that minimal income to qualify for WFF , Gold Cards, Free medical and rest homes etc etc.

That's the mistake Clark and Cullen made, they attacked the individual taxpayer rather than the vehicle which allowed some many to minimize there assessable incomes. Financial geniuses.

[Perry]

. . . I think adds to that and says that the law cannot require that something different must be done to pay more tax as long as it is following the rules (including that of 'intent') -- in other words the "paperwork is sound"

The way I read Lord Tomlin's finding is a little
different, but only on semantical grounds. As
I read it, he was saying that if the law was
being complied with, then intent, circumstance,
'substance,' consequence, et al are of no cogent
relevance or effect. I.e. he was agreeing with
the axiom that [if] 'the paperwork was sound'
the constituent had no need to fear the law or
its enforcers because the law had been corr-
ectly and properly relied upon!

There are all sorts of flow-on consequences
to that perspective. Not the least being that
if the law-makers had intended something
different to the words they had enacted in
statute, it was not the prerogative of gov-
ernment functionaries to interpret or inter-
polate the words of the law. That was the
duty of the Courts.

And if the law and law makers fell foul of
the "law of unintended consequences" then
it was up to them to fix their error; it was
not a duty that became the 'problem' of
some bureaucrat or the Courts.

Further, most Courts/judges have held that
it is not their role to guess at the intention of
parliamentarians or their statutes, when there
was room for doubt. Rather, it was their role
to interpret what was written, because - in
the final analysis - that was all the ordinary
citizen had to go on!
.

[Viking]

Problem Perry is that in NZ lately we have activist judges who have moved from that principle to endeavoring to establish the laws intention and that's where the danger lies especially with IRD cases. BY twisting Parliaments intent to another interpretation all sorts of issues can be compromised. That's why we should never have removed the Privy Council in favour of leftist kiwi lawyers and judges.
English Law Lords have a clear understanding of the principles involved while ours fudge the line.