Tax Treaties and Tax Avoidance: Application of Anti-Avoidance Provisions
University of Auckland; University of Auckland - Faculty of Business & Economics
Victoria University of Wellington; Institut für Österreichisches und Internationales Steuerrecht, Wirtschaftsuniversität Wien; Monash University
October 21, 2009
A Cahiers de Droit Fiscal International, Vol. 95A, pp. 575-595
This article is the New Zealand report for the International Fiscal Association on the important issue of the application of anti-avoidance provisions to tax treaties.
From a New Zealand perspective the key issue arising in this report is the extent to which New Zealand double taxation agreements override section BG 1 of the Income Tax Act, New Zealand’s general anti-avoidance rule. The authors of this report differ in their views. Section BH 1(4) (a) is crucial in this context. It provides that a double tax agreement “has effect in relation to – (a) income tax”. It is the starting point of analysis that leads to the conclusion that New Zealand treaties override not only domestic charging legislation, but also the general anti-avoidance rule. A literal reading of section BH 1(4)(a) suggests that if a taxpayer exploits a treaty in contriving a tax avoidance arrangement, then the treaty ousts section BG 1 and the taxpayer can take advantage of the arrangement. However this literal reading goes too far for the following reasons.
First, the override only arises in circumstances where the treaty prescribes a clear outcome and domestic law differs, and importantly, the treaty is not being used in an abusive manner. This gives effect to possible Parliamentary intention that New Zealand would not wish to enshrine a domestic law treaty override which would be in breach of the public international law obligations it owes to treaty partners.
This will be rare as in most situations by taking a factual approach to reconstruction the treaty and the domestic law will be perfectly aligned. In other words section BG 1 will be effective in the vast majority of cases where the treaty provisions simply adopt the factual reconstruction of the New Zealand Inland Revenue under domestic law.
Secondly, where the treaty and domestic law conflict, the treaty must be interpreted in a way that would not frustrate its object and purpose. The Commentary supports this view. In interpreting the treaty to ensure the object and purpose of the relevant provisions are adhered to, the test is different under the treaty to domestic law. This is because the focus is upon “whether a main purpose” for the transaction was to secure a more favourable tax treatment inconsistent with the object and purpose of the treaty provisions. The domestic test has a lower threshold being a “more than merely incidental purpose” of tax avoidance. This difference could be important in situations where the treaty provisions conflict with domestic law.
Comparing New Zealand law with the law in other Commonwealth countries reinforces this conclusion. The United Kingdom rule is in terms similar to New Zealand’s, whereas Canada and Australia provide that their general anti-avoidance rules override treaties. A possible inference is that having taken no steps comparable to those in Canada and Australia, the New Zealand Parliament is content to allow New Zealand taxpayers to use structures that employ the provisions of tax treaties to avoid New Zealand income tax.
The opposite argument, that section BG 1 avoids tax avoidance arrangements that exploit treaties, has several foundations. The first is that New Zealand courts of construction nowadays consider whether in enacting a particular statutory rule Parliament can have contemplated that it would be legitimate for a taxpayer to use the provision in question to achieve the reduction in tax that the taxpayer argues for. The argument is that Parliament cannot have intended section BH 1(4)(a) to oust the general anti-avoidance rule in any circumstance whatever. The second foundation is the familiar argument that tax treaties are diplomatic, substantive documents never intended to be interpreted in a strict fashion that leads to results contrary to the substantive intentions of their authors.
The third reinforces the second, in that, through the Commentary, we know a great deal of what the intention of the authors was. The most significant of these intentions is spelled out in the Commentary: that taxpayers should not be enabled to use treaties improperly to obtain favourable tax treatment that is contrary to the object and purpose of relevant provisions of the treaty. In view of this expressed purpose, it would be curious if taxpayers could use treaties to override a general anti-avoidance rule, the purpose of which is precisely the same, viz, to prevent taxpayers from exploiting literal rules of tax legislation to obtain unintended benefits.
Fourthly, bearing in mind that New Zealand courts now appear to be disposed to grant considerable scope to the general anti-avoidance rule we reach this result whichever of the factual and interpretative approaches New Zealand follows. The factual approach leads a New Zealand court to recharacterise facts according to their economic substance, by means of sections BG 1 and GB 1, so that when the facts of a case are, as it were, presented to a double tax agreement the agreement applies on the basis of substantive, economic facts, not of legal form. The interpretative approach gives full weight to the terms of the Commentary.
Number of Pages in PDF File: 22
Keywords: tax treaties, international tax, anti-avoidance rules, treaty overrides, specific anti-avoidance rules
JEL Classification: K34Accepted Paper Series
Date posted: June 24, 2010 ; Last revised: July 18, 2011
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