Can the word Artifical be defined and is it merely a question of fact?

In this article James looks at a fresh decision from the UK Privy Counsel - Commissioner of Taxpayer Audit and Assessment v Cigarette Company of Jamaica [2012] UK 9. It is a case where the meaning of the word artificial is defined in an avoidance context.

On 16 December 2011, Inland Revenue released its long-awaited draft policy statement on the application of s BG 1 of the Income Tax Act 2007. That document has been commented on in this publication as well as more widely. The draft policy statement was met by a string of critical comment by those frustrated by what is perceived as being a lack of certainty in the application of s BG 1. This malaise is in part a reflection of the prolonged string of thumping losses meted out by New Zealand courts to tax avoidance arrangements in the last six or so years and it is also no doubt a reflection of the fact that it is difficult for officials to provide any more clarity that has been provided in the case law.

A recent United Kingdom case, however, does offer some helpful exegetical insight into a key concept surrounding the modern application of s BG 1. In this regard the word "artificial" has become particularly important in the application of the general anti-avoidance provision in this country by virtue of para [108] of the Supreme Court's landmark decision in Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2009] NZSC 40, [2009] 2 NZLR 358 where the majority said:

"A classic indicator of a use that is outside of Parliamentary contemplation is the structuring of an arrangement so that the taxpayer gains the benefit of the specific provision in an artificial or contrived manner. It is not within Parliament's purpose for specific provisions to be used in that manner."

The reason that this portion of the judgment is so important is that the Supreme Court immediately goes on to say at [109] that the ultimate question is whether the impugned arrangement, viewed in a commercially and economically realistic way, makes use of the specific provision in a manner that is consistent with Parliament's purpose. Clearly given the statements in [108] an arrangement which allows tax benefits to be achieved in an artificial or contrived manner is outside of Parliament's contemplation and hence the arrangement is a tax avoidance arrangement.

The Inland Revenue policy document says at [288] that in most cases, therefore, if the provisions are sought to be applied in a way that provides a tax advantage in an artificial or contrived manner then that use will fall outside Parliament's contemplation. There is some logical ambiguity as to whether it is the arrangement itself that has to be artificial or contrived or whether it is the use of the specific provision in an artificial or contrived manner that is the problem.

It is submitted that it is a logical absurdity to speak of a provision of an act being used in an artificial or contrived way. A provision of an Act is an artificial construct. It is an abstract idea that either applies or not to a situation. The words artificial or contrived can only form the basis of a sensible legal analysis if those concepts are applied to the arrangement in question. Such an approach is consistent with the leading academic writing of Orow, who analysis the meaning of the word "artificial" in General Anti-Avoidance Rules: A Comparative International Analysis (Jordan's Bristol). His analysis of the word in the context of tax avoidance focuses on "transactions". It is transactions that can be stigmatised as being artificial. It is difficult to stigmatise the use of a provision as artificial as a provision of an Act must have some factual circumstance that it engages with and it can only be that factual circumstance that can be manipulated not the provision of the Act.

The New Zealand tax avoidance jurisprudence does not contain any exegesis of the word "artificial". There is rather a series of situations where facts have been classified as artificial. That will not do. If the key pivot around which a finding of tax avoidance rotates is the classification of the arrangement as artificial or contrived then what those words mean need to be spelled out in clear unambiguous terms. If that is not done then the phrase "artificial or contrived" merely becomes a modern replacement for the tax mitigation/tax avoidance distinction, which has been criticised as being merely conclusionary.

The reason that the tax mitigation/tax avoidance distinction was seen as unhelpful was because no guidance was given as to when an arrangement should be classified as being in one camp or the other. The same fate will await the "artificial or contrived" distinction if judicial precision is not forthcoming as to what the phrase means.

In this regard the Privy Council has provided some helpful guidance recently in Commissioner of Taxpayer Audit and Assessment v Cigarette Company of Jamaica [2012] UK 9. This case was an appeal from the Jamaican Court of Appeal. What is helpful about the case is that their Lordships exegete the meaning of the word "artificial" in the context of a provision that is essentially anti-tax avoidance provision.

The relevant section, s 16(1) of the Jamaican Income Tax Act 2007, provides:

"Where the Commissioner is of the opinion that any transaction which reduces or would reduce the amount of tax payable by any person is artificial or fictitious, or that full effect has not in fact been given to any disposition, the Commissioner may disregard any such transaction or disposition, and the persons concerned shall be assessable accordingly."

The Privy Council first referred with approval to the remarks of Lord Diplock in Seramco Ltd Superannuation Fund Trustees v Income Tax Commissioner [1977] AC 287 at 298 where he said, in relation to an earlier version of the abovementioned section:

"Artificial" is an adjective which is in general use in the English Language. It is not a term of legal art; it is capable of bearing a variety of meanings according to the context in wcih it is used. In common with all three members of the Court of Appeal their Lordships reject the trustees' first contention that its use by the draftsman of the subsection is pleonastic, that it, a mere synonym for "fictitious". A fictitious transaction is one which those who are ostensibly the parties to in never intended should be carried out. "Artificial" as descriptive of a transaction is, in their Lordships' view a word of wider import..."

 Their Lordships in the Cigarette Company of Jamaica case went on to say that:

 "[22] In relation to a natural, tangible object (such as silk, or leather, or even a human limb) it is not a matter of degree: either an object is artificial or it is not. But a transaction is an abstract construct. Every transaction is in a sense artificial in that it is put together by two or more parties in order to create or alter legal rights and obligations as between them....The board consider that in this context a transaction is "artificial" if it has, as compared with normal transactions of an ostensibly similar type, features that are abnormal and appear to be part of a plan. They are the sort of features of which a well-informed bystander might say, "This simply would not happen in the real world....".

"[23] A transaction is not artificial merely because it is not commercial, or not fully commercial. Income tax affects transactions by way of bounty as well as commercial transactions. But if a transaction effected in a commercial context is attached as uncommerical that may be a reason for looking at it closely. is necessary to examine the particular transaction and the circumstances in which it was made and carried out....".

"[28] ...the Board does not agree.. that an artificial transaction would invariably (or even usually) involve dishonesty".

The failure in New Zealand to provide exegetical precision to the meaning of the words "artificial or contrived" cannot be excused by claiming that the inquiry is simply a matter of fact. In this regard the judgment of the Privy Council is helpful. The Privy Council held that the question of whether a transaction was artificial is not a pure question of fact. It considered that recognising whether a transaction was artificial was an evaluative exercise calling for legal experience and judgment. They said "t was certainly not an ordinary question of primary fact...".

A further issue is whether the word "contrived" has any sphere of meaning broader than that covered by the word "artificial". It is suggested that the word "contrived" is pleonastic - a mere synonym for the word "artificial". In this regard, the dictionary meaning of "contrived" carries connotations of planned action towards a preconceived goal. But the word arrangement in s BG 1 explicitly carries that meaning so there is no useful additional purpose being served by that shade of meaning being imported into the inquiry through the use of the word "contrived".

The Privy Council had to apply the word "artificial" to a situation where very large loans had been made within a large multinational group to avoid the impost of tax on dividends. Loans totalling $6.4 billion were made by the Cigarette Co of Jamaica Ltd (CCJ) to Carreras Group Limited. Carreras Group did not ever own 100 per cent of CCJ but by the end of the period in question had 99.7 per cent of the shares. The question was whether the loans were "artificial". The Jamaican High Court found that the loans were artificial for the following five reasons:

First, there was an absence of documentary evidence of management policy, decisions, and implementation of decisions;

Second, no interest was paid on the loans, and there was no reliable evidence that the loans were a quid pro quid for the use of Carreras's trademarks, or that any such reciprocal agreement was quantified;

Third, no repayment of the loans occurred until 2003, when there was a decision that there should be a major reorganisation within the group;

Fourth, there was no evidence that external group borrowing being reduced as a result of the loans being made.

Fifth, Carreras, which owned 99.7 per cent of CCJ had virtually unlimited power as a matter of fact and law, to determine what was to be done with surplus cash held by CCJ. There was no evidence that any explanation was ever given to CCJ as to how Carreras proposed to use the funds in question.

The taxpayer appealed to the Jamaican Court of appeal which reversed the decision of the High Court Judge. The Commissioner of Taxation of Jamaica then appealed to the Privy Council. The issue was still whether the loans were "artificial". The Privy Council said that the answer was no the loans were not artificial and that s 16 had no application at all. Their reasoning was as follows:

Firstly, that the absence of board minutes evidencing management policy and decision making was entirely understandable. Company law cases show that board minutes often reflect immediate preoccupations rather than long term policy;

Secondly, the trademark point was an ill-advised argument. The only justification for the loans was the group structure;

Thirdly, it was accepted that the loans were real loans; and

Fourthly, the existence of a group structure was not a reason for treating the loans as artificial. In the commercial context there was nothing abnormal or artificial in the loans being unsecured, interest-free, and documented only by normal accounting and audit procedures.

Given the new emphasis on the concept of artificiality in the New Zealand tax-avoidance jurisprudence this case may be important. Its importance may lie in (a) the comparative exegetical clarity provided to the word "artificial" and (b) the demonstration of rigorous commercial logic to the legal question of whether a particular arrangement is artificial. After all, with respect to this second point, our Supreme Court has already said that the inquiry is to be conducted without distraction by intuitive subjective impressions of the tax morality of what has occurred (Ben Nevis at [102]).

Content of the James Coleman website is the property of James Coleman and may not be copied or published, and content may not be saved to, emailed to or linked to from other sites or servers without the copyright holder's written permission. However, users may print, download or email content for individual use.