Tax and Crime

It is timely to look at the issue of tax and crime as submissions have just closed on a Government discussion document about sharing information to prevent serious crime.

The Government wants to share information to prevent organised crime. It is part of the Government initiative to create a better public service by having the Government sector act in a more collaborative manner.

This initiative may present well to the electorate but has conceptual difficulties. The Government’s objectives are at odds with the statutorily imposed objectives of the Revenue Acts. Revenue officials are charged under the Tax Administration Act 1994 (TAA) with certain overriding objectives – rather like a constitution for tax. Thus in 1994 the country moved to explicitly state what the objectives of the Revenue administration were. They are spelled out in s 6A of the TAA as being:

“…to collect over time the highest net revenue that is practicable within the law having regard to –

(a)     The resources available to the Commissioner; and

(b)     The importance of promoting voluntary compliance; and

(c)     The compliance costs incurred by taxpayers.

Thus officials must focus on maximising the tax collected. The issue is whether sharing tax information in relation to criminal businesses will enhance or erode that objective.

Income tax, illegal activities and secrecy

With respect to income tax there has been a clear international policy preference articulated in the case law for the obligation to pay income tax to extend to income which is derived from unlawfulactivities.  There is a long line of income tax cases from around the world where the Courts have stressed that the proceeds of illegal activities are just as much within the concept of income as those derived legally: see for example the discussion in A Taxpayer v CIR (1997) 18 NZTC 13,350 (CA).

The secrecy policy of the tax department is important in ensuring that the moral hazard associated with returning income on illegal activities is managed. The reasoning is that if returning such income in tax returns simply supplied damning evidence for police prosecutions then criminals would not return that income and hence no tax would be collected from illegal activities. The historical position has thus to encourage and insist on the collection of tax from illegal activities and to facilitate that by ensuring that the information provided to Inland Revenue is not passed on to other agencies. These policy settings enabled tax officials to publicly defend the requirement to pay tax even on illegal earnings and to prosecute those criminals who did not comply with their tax obligations.

The Government might respond by saying that criminals simply do not return any of their income anyway - that they are not the least bit likely to return the income simply because of promises of secrecy. Having derived their income from illegal transactions they have already felt at liberty to operate outside of the laws of society and their objective will largely be profit maximization as opposed to tax compliance. 

There may be some truth in that. For example in the celebrated case involving AL Capone. Police and other law enforcement officials could not obtain enough evidence or witnesses prepared to testify against him, and hence the police and FBI were struggling to secure his conviction and imprisonment.

AL Capone’s conviction and imprisonment was secured through the tax system, by tax officials prosecuting for taxation offences.  The key piece of evidence that they used was a book supplied which recorded a large number of AL Capone’s illegal transactions. Hence Al Capone’s case is an example of illegal earnings not being returned to Inland Revenue. AL Capone’s case illustrates two things. Firstly, that despite the policy intention of encouraging criminals to return their illegal earnings, most do not but interestingly the same policy intention permits prosecution of the criminals for tax related offences. This can occur when law enforcement officers have struggled to prosecute for other crimes.

The Government cannot have it both ways. It cannot both maintain that criminals ought to return and pay tax on their illegal earnings and hence prosecute for failure to do so and at the same time water down the secrecy provisions such that those same returns can be passed on to the police for example.

GST and illegal transactions

While it is clear beyond doubt that income tax applies to criminal earnings the case is not quite so clear with GST. In this regard there is not the same international consensus as there is with income tax. For example the decision by the Court of Justice of the European Communities in Mol v Inspecteur der Invoerrechten en Accijnzen (Case 269/86) [1990] BTC 5014 found that it is not intended that Value Added Taxes (VAT) in the member states apply to the illegal dealing in narcotics. It followed on from the earlier case Einberger v Hauptzollamt Freiburg (Einberger II) [1984] ECR 1177. That case found the VAT in the member states did not apply to the importation of illegal narcotics. The Mol case found that VAT did not apply to drug dealing within the state.

The following aspects of the judgment in Mol are relevant firstly, that model VAT wording for the supply article in the member states is conceptually identical to s 5 and 8 of the GST Act. The model 2(1) provides:

“…the supply of goods and services effected for consideration within the territory of the country by a taxable person…” is subject to VAT.

Article 4(1) of the model wording provides that:

“”taxable person” shall mean any person who independently carries out in any place any economic activity…whatever the purpose or results of that activity.”

The key reasoning of the European Court of Justice was:

• There is an absolute ban in the member states on importing and marketing illegal drugs.
• The importation of illegal drugs cannot give rise to a liability for customs duty or tax.
• Drugs are therefore intended to be outside of the economic channels operating in member states and are not intended to be integrated into the economy of member states.

It is possible that this reasoning may be adopted here. There are a handful of TRA cases in New Zealand that assume that the position with GST is the same as that with respect to income tax but the point has neither been the subject of vigorous argument nor particularly well-reasoned decision making in any of the judgments. Rather, application of GST to criminal conduct is simply assumed. 

There are features of the New Zealand GST Act which mean that the European position could well pertain here. This is because applying GST to illegal criminal activities integrates those illegal activities into the economy in undesirable ways.  The first is the input tax aspect of the GST regime and secondly the fact that unlike the Income Tax Act, the GST Act explicitly binds the Crown: see s 7 of the GST Act.

GST compared with income tax provides a system where cash input tax refunds will be paid out by the Crown to the taxpayer. If GST were to be applied to illegal criminal conduct the potential would exist for state funds to be paid in cash to organised criminals for the conduct of their illegal activity. The refunds will be in cash where the inputs for the periods exceed the outputs. The sort of situations where inputs may arise are set out illustratively below:

• Input tax refunds could be claimed by the manufacturer of the narcotics say with respect to the cost of the ingredients. This would enable the costs of the various acids and chemicals needed to make methamphetamine to generate input tax credits: s 20(3) and 24. It could be expected that the dealer would have such tax receipts as these materials are often acquired from legitimate third party businesses. 
• There is no capital/revenue distinction in GST so that the capital infrastructure costs of say a glass house and hydroponic equipment or guns and knives will also generate input tax refunds payable by the state: s 20(3) and 24. It could be expected that the criminal would have such tax receipts as these materials are acquired from legitimate third party businesses. Where large capital items are acquired then large GST cash refunds can be generated. For example a boat used for drug smuggling would generate an input tax credit.
• To the extent that the supplier of the equipment needed for the manufacture of illegal drugs or other criminal activities is not registered for GST, then second-hand goods credits would be available to the registered buyer to permit the claiming of an input tax refund.
• Finally, inclusion of illegal narcotic manufacture within the GST base would permit export of New Zealand made drugs, with no output tax payable (by virtue of the export nature of the business) but with the state providing a 15% subsidy for all input into their production.

One of the policy justifications for taxing illegal income for income tax is that it provides a further disincentive to criminal behaviour. Conversely, under the GST Act the state would be required to provide cash explicitly for the conduct of an illegal criminal activity, which would offend the principle of not allowing a person to profit from their own wrong. The fact that these payments are in cash as opposed to merely generating losses, as arises in the Income Tax context, serves to draw a further distinction between the two taxes. This feature of the GST system means that criminals would be rewarded for illegal actions rather than penalised.

This discussion as to the applicability of GST to illegal endeavours has relevance to the secrecy debate mentioned above. If illegal activity is to be integrated into the economy through the GST system then it is scarcely indefensible to simultaneously take the GST data and hand it to the police. The state cannot both integrate illegal activity into the GST net and at the same time supply the data to police. For the Government to try for both objectives is productive of incoherence because it means that two mutually exclusive objectives are being pursued at the same time.

Does forfeiture under the Criminal Proceeds (Recovery) Act 2009 amount to payment of tax assessed?

The Government has strengthened the law surrounding the proceeds of crime. In this regard it has passed the Criminal Proceeds (Recovery) Act 2009 (CPRA). The CPRA is an enactment which explicitly takes from criminals all their ill-gotten gains, not just 33% of them in the case of income tax and another 15% in the case of GST. This is achieved through profit forfeiture orders. All the benefits, all the profits, and every material advantage flowing from the Crime are handed to the Crown.

It is also the case that Inland Revenue will tax the convicted drug dealer. At this point they are usually in jail. They have no fight left in them and submit to bankruptcy. Thus all remaining assets which by definition are those not procured from crime are then taken by the state. Others settle with Inland Revenue, effectively paying twice.

It would seem that payments of money to the Crown under profit forfeiture orders ought to count as discharging a taxpayer’s tax liability where that tax liability derives from the same criminal activity that lead to the forfeiture orders. The Crown is an indivisible whole and either the payment to the Crown under these orders eliminates the profit or gain or it comprises a straight discharge of the tax liability on the same transactions.

There is nothing in the CPRA which explicitly says that notwithstanding the fact that all benefits flowing from the criminal activity are forfeited the criminal is still liable to pay income tax and GST. There is something Stalinist about the state both taking all the gains from illegal activities and on top of that demanding that tax be paid. If any convicted criminal has the wherewithal to stand up to this it is likely that they would get a sympathetic hearing in our Courts.