Peterson v. Inland Revenue (New Zealand) [2005] UKPC 5

Judicial Committee of the Privy Council
Venue FROM THE COURT OF APPEAL OF NEW ZEALAND
Between
PetersonAppellantInland Revenue (New Zealand)Respondent
Before
Lord Bingham of CornhillLord MillettLord Scott of Foscote Baroness Hale of RichmondLord Brown of Eaton-under-HeywoodDate 28 February 2005
[1]:- Lord Bingham of Cornhill Lord Millett Lord Scott of Foscote Baroness Hale of Richmond Lord Brown of Eaton-under-Heywood [Majority Judgment delivered by Lord Millett ] These appeals are brought from a judgment of the Court of Appeal of New Zealand (Gault P, Keith and Anderson JJ) delivered on 19th February 2003 and reported at [2003] 2 NZLR 77. The detailed facts are set out in the judgments below and are sufficiently summarised in the dissenting opinion herein of Lord Bingham of Cornhill and Lord Scott of Foscote to which reference can be made. There is no need for their Lordships to repeat them.[2]There are two appeals before the Board with the same appellant in each case. They arise out of a tax avoidance scheme of a kind which has been widely used, has excited the attention of the revenue authorities in many countries, and has frequently been challenged by them, sometimes successfully and sometimes not. The success of any challenge depends on the specific features of the scheme, the particular fiscal background, the weaponry available to the tax authorities to counter the effect of the scheme, and the marksmanship with which such weaponry is discharged. In the present case the Commissioner relies on the provisions of section 99 of the Income Tax 1976 of New Zealand to enable him to disallow a tax deduction claimed by the taxpayer. Section 99.[3]So far as material section 99 is in the following terms:
"(1) For the purposes of this section - 'Arrangement' means any contract, agreement, plan or understanding (whether enforceable or unenforceable) including all steps and transactions by which it is carried into effect: 'Liability' includes a potential or prospective liability in respect of future income: 'Tax avoidance' includes (a) Directly or indirectly altering the incidence of any income tax: (b) Directly or indirectly relieving any person from liability to pay any income tax: (c) Directly or indirectly avoiding, reducing or postponing any liability to income tax. (2) Every arrangement made or entered into, whether before or after the commencement of this Act, shall be absolutely void as against the Commissioner for income tax purposes if and to the extent that, directly or indirectly – (a) Its purpose or effect is tax avoidance; or (b) Where it has 2 or more purposes or effects, one of its purposes or effects (not being merely an incidental purpose or effect) is tax avoidance, whether or not any other or others of its purposes or effects relate to, or are referable to, ordinary business or family dealings,- whether or not any person affected by that arrangement is a party thereto. (3) Where an arrangement is void in accordance with subsection (2) of this section, the assessable income … of any person affected by that arrangement shall be adjusted in such manner as the Commissioner considers appropriate so as to counteract any tax advantage obtained by that person from or under that arrangement …"
[4]Section 99 is a general anti-avoidance provision which entitles the Commissioner to adjust a taxpayer's assessable income in order to counteract a tax advantage which he has obtained by a tax avoidance scheme. Their Lordships observe that reliance by the Commissioner on the section presupposes that he accepts that but for its provisions the scheme would have succeeded in achieving its object; for, if not, the taxpayer has not obtained a tax advantage and there is nothing for the Commissioner to counteract. As Richardson P said in Commissioner of Inland Revenue v BNZ Investments Ltd [2002] 1 NZLR 450 at p 464:
"... it is inherent in the section that, but for its provisions, the impugned arrangements would meet all the specific requirements of the income tax legislation."
For this reason it is usually prudent for the Commissioner to contend in the alternative either that a scheme does not in fact achieve the desired tax advantage or, if it does, that it can be countered by the application of section 99. This is how the Commissioner put his case before the Taxation Review Authority ("the TRA") and the High Court; but before the Court of Appeal and the Board he has relied exclusively on the operation of section 99, thereby tacitly accepting that, but for the provisions of the section, the tax deductions would be allowable.[5]The grounds on which the Commissioner has challenged the scheme have varied as the cases have progressed through the courts; many of the grounds advanced at one stage have later been abandoned in favour of others. The only issue before your Lordships is whether, having regard to the facts which have been agreed or found by the TRA, the way in which the Commissioner has put his case, and the allegations and concessions which he has made, he can invoke section 99 to disallow the tax deductions which the appellant taxpayer claims. The background.[6]In each of the cases before the Board the appellant was a member of a syndicate formed to finance the production of a feature film in New Zealand. The cases concern different films, one entitled "The Lie of the Land" and the other "Utu". The financing arrangements were similar in all material respects, though they differed in detail and in the monetary amounts involved. There are only two significant differences between the two cases. One is that "The Lie of the Land" was never commercially released and so never generated any receipts, while "Utu" has been one of the most successful films ever made in New Zealand. The film has earned substantial income and was still continuing to earn income 17 years later. The other is that whereas both films were financed in part by a non-recourse loan provided in the course of a circular movement of funds, external funds were inserted into the circle in "The Lie of the Land" but not in "Utu", where the lender was not put in funds to make it. The loan was, however, supported by cheques which were duly honoured, was treated by all concerned as received and applied by the borrowers, and has been fully or partially repaid by them in accordance with its terms.[7]In order to enable them to deal with both cases together, their Lordships propose to use algebraic symbols to represent the monetary sums involved. Film financing .[8]It is generally recognised that investing in the production of feature films is a high risk enterprise. The great majority of such films lose money, that is to say they fail to generate sufficient net receipts after deducting the marketing and distribution costs to recoup the costs of production. The rewards of investing in a successful film, on the other hand, can be enormous. Investors may be persuaded to put their money into several films rather than one in the hope that they will thereby increase their chances of profit by enabling them to recoup their losses from a series of failures by a single success. This, however, only increases their exposure; and it is unlikely that finance for film production would be found were it not for the possibility of obtaining non-recourse financing, which reduces the investor's exposure to loss, and the substantial tax incentives which many countries offer.[9]In the present cases high rate taxpayers were induced to enter into arrangements to finance the production of a film by the prospect of obtaining significant tax advantages. These arose from a combination of two features which are not uncommon in commercial financing arrangements lacking any overriding tax motivation. One was the prospect of obtaining a depreciation allowance for the cost of the investment; the other was the opportunity to fund it in part with moneys borrowed under a non-recourse loan agreement. Depreciation.[10]Income tax is chargeable on the profits of a trade or business, not on gross earnings, and revenue expenditure incurred in earning those profits, if genuinely incurred, normally falls to be deducted from gross receipts in order to arrive at the taxpayer's taxable profits for the year. Capital expenditure incurred in the course of a trade or business, on the other hand, is not normally deductible in arriving at trading profits. Instead a depreciation allowance may be available to permit the capital cost of an asset with a limited life to be written off against the taxpayer's taxable income over the expected life of the asset: see, for example, section EG1 of the Income Tax 1994 of New Zealand. Income tax is charged on an accruals basis not on a receipts and payments basis, and expenditure is deductible when it is incurred not when it is paid.[11]Film production and distribution have, however, been long accorded special treatment in New Zealand. A ruling (IR 52.3) published by the Commissioner in 1952 and which it is common ground applied to the films in question provided ( inter alia) that all income from the sale or other exploitation of a film was taxable and that the costs of producing films should not be deductible in the year incurred. Instead they should be capitalised and depreciated at the rate of 50% on cost price, that is to say the cost should be written off over a period of two years. In this respect no distinction was to be drawn between investors in films and persons engaged on a full time basis in the business of producing or distributing films. Both were entitled to offset their share of the costs of producing or marketing the film against income from the film and income from other sources.[12]Counsel seemed to think that the ruling is not happily worded. Although no distinction is to be made between investors and those engaged in producing or marketing films, they were troubled by the fact that the ruling appears to cover only the costs of producing or marketing a film and not the costs of financing or acquiring it. Nevertheless they were agreed that, in relation to investors, the ruling does cover the capital costs of financing or acquiring the film, and that such costs, if genuinely incurred, can be set off against the investor's income either from the film or from other sources over a period of two years. Their Lordships agree, but they think that the effect of the ruling may have been misunderstood. It is concerned with the tax treatment of persons engaged in the business of producing or distributing films and assimilates it to the treatment accorded under the general law to persons who invest capital in film production. Films are assets with a relatively short life (evidently taken to be two years) and investors can write off the capital costs of acquiring or investing in such assets over their expected life under the general depreciation provisions of the taxing Acts. The effect of the ruling is to deny persons engaged in the business of film production or distribution the right which they would otherwise have to deduct their revenue costs immediately they are incurred and requires them instead to capitalise such costs and write them off over a period as if they constituted capital expenditure.[13]In the present cases high rate taxpayers were induced to invest in the films in part by the prospect of obtaining a depreciation allowance which would allow them, over a period of two years, to set off against their taxable income from other sources the whole of their investment in the film, even if the film was never commercially released and so never generated any income at all. This was an attractive proposition, for it significantly reduced, though it did not extinguish, their exposure to loss. Non-recourse financing.[14]A further inducement to invest in the films was the prospect of funding the investment in part with money borrowed under a non-recourse loan agreement. A non-recourse loan is a loan made on terms that the borrower has no personal liability to repay it. Such loans are normally made to enable the borrower to acquire a capital asset; in such cases the lender may be content to look for repayment to the income stream which the asset is expected to generate. Non-recourse loans are common in the mining and extraction industries. Arrangements of this kind may be entirely commercial; but they are also undeniably attractive to those devising tax avoidance schemes.[15]Borrowed money belongs to the borrower not to the lender, and this is so whether the borrower incurs a personal liability to make repayment or not. Depreciation allowances depend on the taxpayer having incurred the cost of acquiring an asset, not on his liability to repay the lender. It does not matter how he came by the money to acquire the asset; he may have been given it by a friend or relative. Accordingly the fact that the cost of acquisition is funded wholly or in part by a non-recourse loan ought ordinarily to be irrelevant; and in his ruling IR 52. 3 the Commissioner confirmed that this was his approach.[16]The ability to borrow funds on a non-recourse loan is particularly attractive to a prospective investor in films. It allows him to increase the amount of his investment, and therefore of the amount available for deduction from his taxable income, without increasing his exposure to loss. If the proportion of his total investment which is funded by the loan is sufficiently high, he may be able to make a profit after taking the tax deduction into account even if the film generates no income at all. Of course he will have to pay a price for these advantages. The price usually takes the form of a deferment of his right to participate in the profits of the film if it is successful, for a lender will normally require to be repaid in full before the borrower has recourse to the source of repayment to recoup his investment. But this is a matter for negotiation; the lender may instead insist on payment of an exceptionally high rate of interest or a procuration fee, neither of which would, in the ordinary course of things, be deductible expenditure in the hands of the borrower; or the lender may insist on taking (or be in a position to take) a share of the profits made by the production or distribution company. The facts.[17]The facts, which are common to both cases, can be summarised as follows:(1) The appellant was a member of a syndicate of investors which acquired the screenplay and the film and other rights and acquired the film (by commissioning a production company to produce it) for a fixed price.(2) The film was expected to cost $x to make but the investors were falsely led to believe that it would cost $x+y.(3) Accordingly they were induced to sign a production contract by which they incurred a liability to pay $x+y to the production company to make the film.(4) This sum was payable in cash at the outset and was to be funded as to $x by the investors out of their own resources and as to $y by the proceeds of a non-recourse loan from a third party lender connected with the production company.(5) The investment was highly geared; $y represented more than half (56.6%) of the investors' total investment of $x+y.(6) The investors received (or were treated as receiving) $y by way of loan and paid it (or were treated as paying it) together with $x out of their own resources to the production company in the discharge of their contractual liability under the production contract.(7) The production company applied $x in making the film. Unknown to the investors, however, it did not use the $y to make the film (for which it was not needed), but recycled the money to the lender immediately it was received.(8) "Utu" has proved to be extremely successful and is still generating income. In the absence of evidence to the contrary, it may be assumed that the lender has wholly or nearly recouped the loan of $y and interest out of the receipts of the film and that the investors have suffered a corresponding reduction in their (taxable) share of the film receipts. "The Lie of the Land" has never been commercially released, the investors have lost the whole of the investment of $x which they made out of their own resources (though if their claim is successful they will recover more than this in tax relief), and although not out of pocket the lender has failed to recover any part of its loan of $y. The rival contentions.[18]In each case the investors contend that they have borrowed $y, incurred and discharged a liability to pay $x+y to acquire the film, incurred a liability to repay the loan of $y out of any film receipts, and (in the case of "Utu") done so. They claim to set off $x+y, being the cost to them of acquiring the film, against their taxable income. The Commissioner has accepted their claim to deduct $x, but has disallowed the balance of their claim on the ground that it does not represent expenditure incurred by the partnership at all.[19]It is not surprising that the Commissioner challenged the scheme. In opposing the investors' claim he cited the deceitful inflation of the costs of production (of which the investors were found to be unaware), the use of a non-recourse loan to fund part of the investment, the high gearing of the investment, and the circular movement of funds. The use of a non-recourse loan to leverage the amount of the investors' direct investment had the effect that they were not exposed to any risk of loss after tax relief was taken into account, so that it could be argued that the films were being financed by the general body of taxpayers. The recycling of the loan demonstrated that it was not needed for and was not applied in film production. While there clearly was an underlying commercial activity with a potential for profit, the actual amount which was applied in that activity was only a small part of the investment for which tax relief was claimed. The underlying activity could not sustain the total amount of the investment which the investors claimed they had made.[20]While the Commissioner was able to point to features of the scheme which he considered to be unacceptable, however, he never gave a satisfactory answer to the investors' case that they had paid $x+y to acquire a capital asset and were in consequence entitled to a depreciation allowance of a corresponding amount. The course of the proceedings below. "The Lie of the Land".[21]In the TRA the Commissioner contended that the non-recourse loan was a sham because there was no evidence that the money was advanced to the investors or spent by the production company on the making of the film. In fact there was clear evidence that the money was advanced to and received by the investors and was applied by them in payment to the production company to acquire the film. In the alternative the Commissioner relied on section 99. He identified the non-recourse loan as constituting the relevant arrangement and contended that its effect should be counteracted under section 99. The TRA rejected the Commissioner's allegation that the loan was a sham and his claim under section 99 also failed.[22]In the High Court the Commissioner abandoned his claim that the loan was a sham and relied almost entirely on section 99. He identified the recycling of the loan to the lender as the relevant arrangement and sought to counteract the effect of the whole loan agreement, which the Court declined to do. Alternatively he argued that the payment of $y should be disallowed because "there ought not to be a deduction on inflated costs" for "if the marketing costs were never expended and drawn down from the available loan the [investors] had no liability to repay what they had not received". The High Court had little difficulty in rejecting this confused submission and upholding the investors' claim to tax relief.[23]In his Notice of Appeal to the Court of Appeal the Commissioner relied exclusively on section 99. He contended that the entire investment scheme was an arrangement by which (or by the relevant parts of which, and in particular the recycling of the loan) the investors were affected whether they were parties to it or not. The Court of Appeal would have found in favour of the Commissioner without recourse to section 99 on the ground that, despite the investors' obligation to repay it out of the receipts of the film, the loan did not form part of the cost of making the film because it was repaid to the lender. While plainly correct, this resurrected the confusion between the costs of making the film which were incurred by the production company and which were only $x, and the costs incurred by the investors, who had not made the film but acquired it from the production company, which were the relevant costs and which were $x+y.[24]The Court of Appeal could not and did not decide the case on this ground, however, because of the limited grounds of appeal. Instead it held that the arrangement which could be counteracted under section 99 included the immediate recycling of the loan to the lender so that "the deduction for depreciation was overstated" and the liability to pay $y was not "truly incurred". Their Lordships find this difficult to follow. The recycling of the loan shows that the production company did not apply it to make the film; but it does not show that the investors did not pay it to the production company in accordance with the production contract in order to acquire the film or incur a genuine liability to repay it out of the receipts of the film. The Commissioner did not contend that the investors paid the money to the production company for any other purpose, so that the choice was between holding that the money was not paid at all (ie. that the payment was a sham, a finding which the TRA had rejected) or that it was paid to acquire the film. "Utu".[25]In this case the TRA found that the lender never obtained the finance necessary to enable it to make the loan to the investors. It made clear findings that neither the investors not their accountant knew of this or of the inflation of the cost of making the film. It did not, however, base its conclusion on its finding that no external funds were injected into the circular movement of money. It held that the question for determination was whether the investors could claim a deduction for what they understood to be the contract price for the film irrespective of whether or not the total contract price was actually spent in making the film. The TRA answered this question in the negative, finding that the production company had made the film as agent for the investors, so that the expenditure of $y had never been incurred. This made it unnecessary for the TRA to consider the application of section 99.[26]In the High Court the judge (Hammond J) accepted the investors' argument that on a proper construction of the production contract the relationship between the investors and the production company was not that of principal and agent but of purchaser and vendor under a fixed price contract. He therefore disagreed with the TRA that the cost to the investors was limited to the expenditure of $x on the film. On his view, it was the full $x+y. But he agreed with the Commissioner that the inflation of the costs of making the film was the "arrangement" for the purposes of section 99 and that the Commissioner was entitled to adjust the investors' income under section 99 as persons who were affected by the arrangement even though they did not know of it. The investors contended that they had not obtained a tax advantage from the arrangement, observing that they were not claiming a fictitious amount but the amount that they were obliged to pay pursuant to the production contract. The judge found that the investors had obtained a tax advantage, albeit indirectly, through what he described as "a share in the inflated price of the film".[27]In the Court of Appeal the Commissioner was content to have the matter determined under section 99. As their Lordships have already observed, this is inconsistent with a contention that the loan was a sham; the section is not needed and has no application to deny effect to a sham transaction. The Court of Appeal would have decided the case on the ground that the obligation to repay $y out of the proceeds of the film was not incurred or, if incurred briefly, was extinguished. This was because the money had passed back in a circle to the lender, thereby repaying the loan. It did not need to be repaid again from the proceeds of the film. The difficulty with this reasoning, which the Commissioner did not attempt to support before their Lordships, is that he did not obtain a ruling from the TRA, and there was no evidence, that the production company paid the money to the lender in repayment of the loan. Moreover it is impossible to reconcile it with the finding of the TRA that the investors knew nothing about the movement of the money (and therefore did not authorise the production company to repay the loan on their behalf) and the evidence that the investors have actually repaid all or part of the loan.[28]The Court of Appeal could not and did not decide the case on this ground, however, because of the limited way in which the Commissioner put his case. It held that section 99 applied to the case in the same way that it applied in "The Lie of the Land". It said that the "assumption of liability for [the] loan moneys constituted part of the cost which the [investors] agreed to pay. No such liability endured, if it was ever assumed. The depreciation [allowance was] to be calculated not on what was agreed to be paid but on the cost actually incurred. The arrangement to falsely inflate that cost was for the purpose of increasing the loss for tax purposes. The [investors were] directly affected by that arrangement and obtained a tax advantage under it".[29]Their Lordships do not find this easy to follow. The investors' obligation to repay the loan was not, with respect, "part of the costs which the investors agreed to pay" on which their claim to depreciation was based, but the means by which they funded their liability to pay them. As they understand it, the Court of Appeal adopted the same analysis as they had adopted in "The Lie of the Land". This does not depend on a finding that the loan was never actually received by the investors or paid by them to the production company, but on the proposition, which the Commissioner did not support before the Board, that the investors' liability to repay the loan was discharged by its recycling to the lender. Summary of the Commissioner's contentions below.[30]It will be seen that the Commissioner advanced a variety of arguments, based on the fact that it cost the production company only $x to make the film coupled with the fact that the loan of $y was either not made at all or if made was immediately recycled to the lender, to contend that the investors did not pay or incur a liability to pay the full amount of $x+y to the production company. At no stage did the Commissioner contend that, if they did pay the whole of that sum, they did not pay $y as consideration for the acquisition of the film but paid it for some other purpose. The Commissioner's contentions before the Board.[31]Before the Board counsel argued the case of "The Lie of the Land" at length and referred only briefly to "Utu", it being tacitly assumed that the outcome of the two cases should be the same. The Commissioner made the following concessions:(i) the investors incurred a contractual obligation to pay $x+y to the production company as the consideration for the making of the film;(ii) as to $y they discharged (or in the case of "Utu" were treated as having discharged) this obligation by applying the proceeds of the non-recourse loan in payment to the production company;(iii) the recycling of $y by the production company to the lender did not discharge the investors' liability to repay the loan out of the receipts of the film, so that the Court of Appeal's conclusions (that the liability to repay $y was not "truly incurred" or that the investors obligation to repay the loan, if ever incurred, was extinguished) could not be supported;(iv) (tacitly) that absent section 99 the taxpayers were entitled to succeed.[32]For the purpose of section 99 the Commissioner took the scheme as a whole to constitute the relevant arrangement, comprising as it did the non-recourse loan, the inflation of the costs of the film and the circular movement of the $y. He contended that the arrangement had the purpose or effect of generating a claim to tax relief which was achieved by the contrivance or pretence that the film cost $x+y to make when in reality it cost only $x. The investors thereby reduced their liability to tax without suffering the economic consequences which Parliament intended should be suffered by a taxpayer qualifying for the tax relief in question. Discussion.[33]Their Lordships consider that the Commissioner is entitled at his option to identify the whole or any part or parts of a single composite scheme as the "contract, agreement, plan or understanding" which constitutes the "arrangement" for the purpose of section 99. Whether there was a single "arrangement" or two or more connected but distinct "arrangements" (as there were in Commissioner of Inland Revenue v BNZ Investments Ltd [2002] 1 NZLR 450) is a question of fact for the TRA. The Commissioner must then show(i) that the "arrangement" which he has identified has the purpose or effect of avoiding tax, an expression which includes reducing any liability to pay income tax;(ii) that whether or not the taxpayer was a party to the "arrangement" he was affected by it; and(iii) that he obtained a tax advantage from it. If he can satisfy these conditions, he can adjust the assessable income of any person affected by the "arrangement" in order to deny him the tax advantage which he has derived from it.[34]Their Lordships are satisfied that the "arrangement" which the Commissioner has identified had the purpose or effect of reducing the investors' liability to tax and that, whether or not they were parties to the arrangement or the relevant part or parts of it, they were affected by it. Their Lordships do not consider that the "arrangement" requires a consensus or meeting of minds; the taxpayer need not be a party to "the arrangement" and in their view he need not be privy to its details either. On this point they respectfully prefer the dissenting judgment of Thomas J. in Commissioner of Inland Revenue v BNZ Investments Ltd ( supra ). Moreover the investors did not merely obtain an economic advantage from the "arrangement" (as in that case); they obtained a tax advantage, viz. a depreciation allowance which reduced their liability to pay tax.[35]The critical question is whether the tax advantage which they obtained amounted to "tax avoidance" capable of being counteracted by section 99, for the courts of New Zealand have long recognised that not every tax advantage comes within the scope of the section; only those which constitute tax avoidance as properly understood do so.[36]In Challenge Corporation Ltd. v Commissioner of Inland Revenue [1986] 2 NZLR 513 at p 549 Richardson J pointed out that it was obviously never intended that transactions should be struck down merely because they were influenced by the prospect of obtaining a tax advantage. In many cases, but for the anticipated availability of a tax benefit, the taxpayer would never have entered into the transaction at all. Basic features of the tax system such as depreciation and trading stock valuations, he said, clearly allow for the deliberate pursuit of tax advantage.[37]When that case reached the Board Lord Templeman explained the distinction between an acceptable tax advantage (which he described as tax mitigation) which was not caught by section 99 and an unacceptable one (which he described as tax avoidance) which was: ib [1986] 2 NZLR 513 at p 561, where he said:
"The material distinction in the present case is between tax mitigation and tax avoidance. A taxpayer has always been free to mitigate his liability to tax … Income tax is mitigated by a taxpayer who reduces his income or incurs expenditure in circumstances which reduce his assessable income or entitle him to reduction in his tax liability… Section 99 does not apply to tax mitigation where the taxpayer obtains a tax advantage by reducing his income or by incurring expenditure in circumstances in which the taxing statute affords a reduction in tax liability. Section 99 does apply to tax avoidance. Income tax is avoided and the tax advantage is derived from an arrangement when the taxpayer reduces his liability to tax without involving him in the loss or expenditure which entitles him to that reduction. The taxpayer engaged in tax avoidance does not reduce his income or suffer a loss or incur expenditure but nevertheless obtains a reduction in his liability to tax as if he had"
(emphasis added).[38]Lord Nolan said much the same in the English case of Commissioners of Inland Revenue v Willoughby (1997) 70 TC 57 at p 116:
"The hallmark of tax avoidance is that the taxpayer reduces his liability to tax without incurring the economic consequences that Parliament intended to be suffered by any taxpayer qualifying for such reduction in his tax liability … But it would be absurd in the context of [the provision there affording relief from tax] to describe as tax avoidance the acceptance of an offer of freedom from tax which Parliament has deliberately made."
[39]Investors in films are entitled to depreciate their full acquisition costs. This is so however much the film actually costs the production company to make and by whatever means the investors have obtained the funds to finance the acquisition. Given the fact, never challenged and now conceded by the Commissioner, that the investors paid $x+y to acquire the film, they incurred the expenditure which Parliament contemplated should entitle them to the depreciation allowance which they claim. If viewed alone this amounted to a tax advantage but not to tax avoidance within the scope of the section.[40]It is, however, necessary to look a little further and consider the acquisition of the film in its wider setting. Their Lordships endorse the observations of Richardson P in Challenge Corporation Ltd v Commissioner of Inland Revenue [1986] 2 NZLR 513 at p 549:
"… section 99 would be a dead letter if it were subordinate to all the specific provisions of the legislation. It, too, is specific in the sense of being directed against tax avoidance ... while the use [of trusts and companies] is regarded as perfectly legitimate and not on its own affected by section 99, it may be only one element in a wider arrangement which is caught by the section."
The wider setting on which the Commissioner relies includes the false inflation of the costs of production, the leverage obtained by use of a non-recourse loan, and the recycling of the loan to the lender.[41]Before considering the effect of these features, their Lordships must say something about the purpose for which depreciation allowances are granted by Parliament. They are not specific to film financing but are of general application and have nothing to do with encouraging people to invest in films or indeed anything else. The statutory object in granting a depreciation allowance is to provide a tax equivalent to the normal accounting practice of writing off against profits the capital costs of acquiring an asset to be used for the purposes of a trade: see Barclays Mercantile Business Finance Ltd v Mawson (Inspector of Taxes) [2004] 3 WLR 1383 per Lord Nicholls of Birkenhead at p 1394, para 39.[42]Consistently with the statutory purpose, it is not only necessary but also sufficient that the taxpayer should have incurred capital expenditure in acquiring an asset for the purposes of trade. The focus is on the party who acquires the asset. It does not matter what the party who disposes of the asset does with the money: see ib at p 1395, para 39 per Lord Nicholls. It is therefore quite wrong to suggest that the purpose of the statutory depreciation regime, when invoked by persons who have incurred a liability to pay a capital sum to acquire a film, is not satisfied unless the disponor applies the proceeds in making the film. If the Commissioner had shown that the features on which he relied, singly or in combination, had the effect that the investors, while purporting to incur a liability to pay $x+y to acquire the film, had not suffered the economic burden of such expenditure before tax which Parliament intended to qualify them for a depreciation allowance, then he could invoke section 99 to disallow the deduction.[43]This, however, the Commissioner never succeeded in doing. The inflation of the costs of making the film meant that the production company made a secret profit at the investors' expense; but it did not alter the fact that they incurred a liability to pay $x+y to the production company in accordance with the contract to acquire the film. The costs of making the film were incurred by the production company, and these must not be confused with the costs incurred by the investors, which were the relevant costs in respect of which the deduction was claimed. The fact that the production company made a profit of $y at the expense of the investors did not mean that they did not suffer the economic cost of paying it. As Lord Diplock speaking for the Board said in Europa Oil (NZ) Ltd v Commissioner of Inland Revenue [1976] 1 NZLR 546 at p 556: "Their Lordships' finding that the monies paid by the taxpayer company ... is deductible under section 111 as the actual price paid by the taxpayer company for its stock-in-trade under contracts for the sale of goods entered into with Europa Refining … is incompatible with those contracts being liable to avoidance under [the predecessor of section 99]. In respect of those contracts the case is on all fours with Cecil Bros Pty. Ltd. v Federal Commissioner of Taxation (1964) 111 CLR in which it was said by the High Court of Australia "it is not for the Court or the commissioner to say how much a taxpayer ought to spend in obtaining his income." ( ibid p 434)[44]The leverage obtained by use of a non-recourse loan meant that the investors did not sustain an economic loss after the tax deduction is taken into account. Their Lordships suspect that it is this feature of the scheme which has most exercised the Commissioner. But a moment's reflection shows that what Lord Templeman had in mind was expenditure or loss before any tax advantage is taken into account. Tax relief often makes the difference between profit and loss after tax is taken into account; and a transaction does not become tax avoidance merely because it does so. The fact that the investment was funded by a non-recourse loan did not alter the fact that the investors had suffered the economic burden of paying the full amount of $x+y. It was not and could not be suggested that either loan was on terms which meant that it was unlikely ever to be repaid. The investors have repaid one of the loans in whole or in part, albeit out of the film receipts; and they incurred a liability to repay the other if the film generated sufficient receipts, as it was hoped it would.[45]The circular movement of money sometimes conceals the fact there is no underlying activity at all. But each of the payments in the circle must be examined in turn to see whether it discharged a genuine liability of the party making the payment. It does not matter whether external funds were introduced into the circle or whether cheques were handed over and duly honoured. If the money movements did not discharge a genuine liability the introduction of external funds will not save it; if they did, their absence will not affect it. In either case the payments are interdependent, in the sense that each of the payments is dependent on the receipt which funds it and each receipt on the payment by which it is funded. On the way in which the Commissioner put his case the relevant payments were those by which the investors received the non-recourse loan and paid it out to the production company. Subsequent payments through the circle of which the investors were unaware and which they could not control or prevent did not alter the fact that they had borrowed $y and used it towards the discharge of their liability to pay $x+y to the production company, thereby suffering the loss or incurring the relevant expenditure for which the depreciation allowance is granted.[46]The $x+y was ostensibly paid as consideration for the acquisition of the film, and while the Commissioner was at pains to argue that was never "truly" paid it was no part of his case at any stage that it was paid for any other purpose. Before the Board he conceded that it was paid as consideration for the making of the film. Their Lordships consider that this concession, which was inevitable from the way in which the Commissioner has conducted the case throughout, is fatal to his case. Could the Commissioner have challenged the nature of the consideration for the payment?[47]Their Lordships wish to make it plain that they have reached their conclusion on the facts agreed or found by the TRA, the way in which the Commissioner has put his case from time to time, and the allegations and concessions which he has made. They should not be understood as deciding that, had the necessary allegations been made and the necessary facts found, he might not have successfully challenged the investors' case that the obligation to make a payment of $x+y which they incurred was exclusively incurred as the consideration for the acquisition of the film.[48]The starting point would be for the Commissioner to obtain a finding of the TRA that the loans were made on uncommercial terms such that no commercial lender would advance money unless it received some additional consideration for doing so. But this was never alleged by the Commissioner, established by evidence, or found by the TRA.[49]The next step would be to consider the disbursement of the $y by the production company. The production company paid the money away immediately it was received. The payment is not recorded in the production company's books, has never been explained and appears to have been made without consideration. Such a payment would normally be improper. It is more likely that it was properly made but for a consideration which it was considered impolitic to disclose. The Commissioner could plausibly invite the TRA to infer that the production company agreed to recycle the money to the lender in order to procure it to make the loan to the taxpayers. But he never did so and the TRA made no such finding in either case.[50]On these facts the Commissioner could contend that the investors paid the production company $x+y not merely as consideration for the acquisition of the film but also for its services in procuring the lender to make the loan to them. The argument would be particularly cogent in the case of "Utu" where it could be said that the investors did not merely indirectly procure the lender to make the loan by paying $y to the production company but the lender's ability to lend $y to the investors depended on the indirect receipt of $y from them.[51]The production company attributed the whole of the consideration of $x+y which it received from the investors as consideration for making the film and nothing as consideration for procuring the loan. Where, however, a single consideration is given for the supply of two or more goods or services the Commissioner is probably entitled even without section 99 to go behind the allocation agreed between the parties and allocate the consideration among the several goods or services for which it was paid on a proper basis. The Commissioner could argue that $x should be treated as paid to the production company as consideration for making the film and $y for procuring the loan. On this basis $y would not form part of the cost of acquiring a depreciating asset and would not qualify for the deduction claimed.[52]If such an argument were countered by the investors' the ignorance of the scope of the arrangements which had been made on their behalf (as to which their Lordships say nothing) the Commissioner could contend in the alternative that the arrangement by which the production company allocated the payment of $y as part of the consideration for acquiring the film instead of as consideration for the procurement of the loan (which affected the investors whether or not they were parties to it) could be counteracted under section 99.[53]The Commissioner, however, has never put any such case forward, it is not supported by the necessary evidence or findings, and it is contrary to a concession made before the Board. It cannot be said to be unanswerable; and it is not open to their Lordships to adopt it. Conclusion.[54]Their Lordships will humbly advise Her Majesty that both appeals should be allowed and the orders of the Court of Appeal set aside, and that the order of the High Court in "The Lie of the Land" should be restored and a similar order ( mutatis mutandis) made in "Utu". The Commissioner must pay the costs of the appellant of both appeals before the Court of Appeal and the Board. Dissenting judgment by Lord Bingham of Cornhill and Lord Scott of Foscote[55]We regret that we are unable to concur in the opinion of the majority on these appeals. The appeals[56]There are two appeals before the Board. In both the appellant is Mr Peterson and the respondent is the Commissioner of Inland Revenue. In both the issue arises out of a claim by Mr Peterson to make a deduction from his taxable income on account of his investment in a film. In the courts below various reasons were put forward on behalf of the Commissioner to justify the disallowance of Mr Peterson's tax deduction claims. But before the Board the only issue is whether section 99 of the Income Tax Act 1976 applies and whether, if it does, it entitles the Commissioner to disallow the claimed tax deductions. Section 99[57]Section 99 is a provision the statutory purpose of which is to provide the Commissioner with the means to counter tax avoidance. It is not necessary to refer to more than the first three sub-sections. They provide as follows:- "(1) For the purposes of this section – 'Arrangement' means any contract, agreement, plan or understanding (whether enforceable or unenforceable) including all steps and transactions by which it is carried into effect:
'Liability' includes a potential or prospective liability in respect of future income: '
Tax avoidance' includes – (a) Directly or indirectly altering the incidence of any income tax: (b) Directly or indirectly relieving any person from liability to pay any income tax: (c) Directly or indirectly avoiding, reducing or postponing any liability to income tax. (2) Every arrangement made or entered into, whether before or after the commencement of this Act, shall be absolutely void as against the Commissioner for income tax purposes if and to the extent that, directly or indirectly – (a) Its purpose or effect is tax avoidance; or (b) Where it has 2 or more purposes or effects (not being merely an incidental purpose or effect) is tax avoidance, whether or not any other or others of its purposes or effects relate to, or are referable to, ordinary business or family dealings, - whether or not any person affected by that arrangement is a party thereto. (3) Where an arrangement is void in accordance with sub-section (2) of this section, the assessable income … of any person affected by that arrangement shall be adjusted in such manner as the Commissioner considers appropriate so as to counteract any tax advantage obtained by that person from or under that arrangement, and, without limiting the generality of the foregoing provisions of this sub-section, the Commissioner may have regard to such income as, in his opinion, either – (a) That person would have, or might be expected to have, or would in all likelihood have, derived if that arrangement had not been made or entered into; or (b) That person would have derived if he had been entitled to the benefit of all income, or of such part thereof as the Commissioner considers proper, derived by any other person or persons as a result of that arrangement."[58]Section 99 was not the first anti-tax avoidance provision enacted in New Zealand. It was preceded by, and replaced, section 108 of the Land and Income Tax Act 1954. Section 108 (as amended in 1968) had provided that – "… every contract, agreement or arrangement made or entered into, whether before or after the commencement of this Act, shall be absolutely void as against the Commissioner for income tax purposes insofar as, directly or indirectly, it has or purports to have the purpose or effect of in any way altering the incidence of income tax, or relieving any person from his liability to pay income tax." Section 260 of the Commonwealth of Australia Income Tax etc Act 1936-1951 was in much the same terms as section 108. By contrast, the United Kingdom had, and has, no general anti-tax avoidance statutory provision. The courts of this jurisdiction have developed principles under which certain tax avoidance arrangements can be held to fail to achieve their intended fiscal effect. (See Ramsay (WT) Ltd v IRC [1982] AC 300 , IRC v McGuckian [1997] 1 WLR 991 and MacNiven v Westmoreland Investments Ltd [2003] 1 AC 311 ). But, as was pointed out by Thomas J in paragraph 74 of his dissenting judgment in Commissioner of Inland Revenue v BNZ Investments Ltd [2002] 1 NZLR 450 the jurisprudential development of these principles in the United Kingdom has little, if any, relevance to the correct interpretation and application of section 99. It is the legislature not the judiciary that has provided the counter to tax avoidance in New Zealand. Whether the application of section 99 by the Commissioner is permissible must be decided as a matter of statutory construction.[59]Before coming to the facts of the two appeals it is convenient to note some of the features and oddities of section 99. First, the section represents an explicit expansion of the statutory anti-tax avoidance net when compared with its statutory predecessor. An "arrangement" can be something as loose and informal as a 'plan' or an "understanding" (sub sec (1)). Second, the anti-tax avoidance net catches not only parties to the "arrangement" but also any person affected by the arrangement whether or not a party to it (sub sec (2)). The majority of the Court of Appeal in the BNZ Investments case held that an "arrangement" within section 99 required a "meeting of minds" (see para 49). Richardson J said that "… s99 bites on 'an arrangement made or entered into'. It presupposes there are two or more participants who enter into a contract or agreement or plan or understanding. They arrive at an understanding. They reach a consensus" (para 43) We would respectfully agree. But, nonetheless, it is clear from sub-section (2) that the tax advantage vulnerable to being nullified under sub-section (3) may be a tax advantage enjoyed by someone who is not part of that consensus, not "… a party thereto".[60]One of the main difficulties, as it seems to us, to which the application of the section may give rise – and indeed the main difficulty to which it does give rise on the facts of these appeals – is the difficulty of distinguishing between those tax advantages which are to be nullified by the Commissioner and those tax advantages which are legitimate and could not have been intended by the legislature to be at risk under section 99. The term "tax advantage" is usually used in order to draw a contrast between, at one extreme, "tax evasion", which is criminal and, at the other extreme, "tax mitigation", which is no more than legitimate tax planning. The line to be drawn between "tax evasion" and "tax avoidance" is clear enough. The former is criminal. The latter is not. It may be socially undesirable but is within the letter of the law. But the line to be drawn between "tax mitigation" and section 99 tax avoidance is by no means clear. Suppose a statutory regime under which the part of salary paid into a personal pension fund, earmarked to provide a pension on retirement, is free of income tax. We are very familiar with such a regime in this country. As a matter of ordinary language a salary earner who avails himself of this statutory privilege is doing so in part to provide for his retirement but in part to obtain the tax advantage that the regime offers. No one could sensibly suggest that the scheme agreed upon between the pension provider (usually an insurance company) and the salary earner was a section 99 "arrangement" that was vulnerable to being nullified under sub-section (3).[61]This is a problem about section 99 that was faced in Challenge Corporation Ltd v C.I.R. [1986] 2 NZLR 513. Woodhouse J in the Court of Appeal said that – "… it must be kept in mind that the section is concerned not with outright impropriety but with finding a line between what is acceptable and so unaffected by it and what is undeserving and so for tax purposes made void" (p.533) and Richardson J commented that "Clearly the legislature could not have intended that section 99 should override all other provisions of the Act so as to deprive the taxpaying community of structural choices, economic incentives, exemptions and allowances provided for by the Act itself" (p.548) Richardson J then pointed to the approach to be followed in trying to resolve the difficulty – "That is a matter of statutory construction and the twin pillars on which the approach to statutes mandated by s.5(j) of the Acts Interpretation Act 1924 rests are the scheme of the legislation and the relevant objectives of the legislation. Consideration of the scheme of the legislation requires a careful reading in its historical context of the whole statute, analysing its structure and examining the relationship between the various provisions and recognising any discernible themes and patterns and underlying policy considerations. (p.549) When the case reached the Privy Council nothing was said by their Lordships casting any doubt on the approach recommended by Richardson J. The approach is one that we would respectfully endorse. Tax relief for the cost of production of films[62]Tax relief is available to those who invest in the production of films. It is notorious that the cost of producing films for commercial release is very high and that a large number of the films that are produced with a view to general release are box office failures. Some, indeed, never achieve a commercial release at all. That being so, it is understandable that many countries offer tax incentives to those who are prepared to finance film production. New Zealand is among them. We were not referred to the section of the primary Act authorising the grant of such relief – counsel expressed some uncertainty as to which the section was that was applicable – but we were referred to IR 52.3, issued by the Inland Revenue, which, counsel were agreed, applied to both the films with which these appeals are concerned. The Ruling, so far as relevant, provides as follows:
"The tax treatment which applies to these films is: No distinction is drawn between investors in films and those persons who are engaged on a full time basis in the business of producing or distributing films. Each is entitled to offset his/her share of the costs of producing or marketing the film against income from the film and income from other sources … Non-recourse loans are treated in the same manner as normal commercial loans … costs of producing films are not deductible in the year incurred. Instead, they must be capitalised and depreciated at the rate of 50 per cent on cost price."
[63]We would make two comments on the content of IR 52.3. First, there is no reference in the Ruling to the cost of acquisition of the film. The text refers to the "costs of producing or marketing". Nevertheless counsel told us that they were agreed that the reference to "costs of producing" covered, in relation to investors, the cost of acquisition of the film. No statutory authority or Inland Revenue Ruling to that effect was given. It was put to us simply as an agreement by counsel.[64]Second, the ruling that non-recourse loans are to be treated in the same manner as normal commercial loans – a ruling repeated by the Inland Revenue in a letter dated 8 December 1982 to Mr McLean, the producer of one of the films – may, we think, depend on the terms of the non-recourse loan in question. If the non-recourse loan is granted on obviously uncommercial terms, the question whether the ruling is applicable, or whether section 99 is applicable, may well arise.[65]The right to depreciate the cost of producing a film and to deduct the depreciation from taxable income is undoubtedly, in ordinary language, a tax advantage. If the cost is met, or is purported to be met, by the proceeds of a non-recourse loan, is the tax advantage claimed by the borrower a tax advantage to which section 99 applies? If the approach recommended by Richardson J in the Challenge case is followed, and we think it should be, the answer to the question depends on whether the depreciation claim is within the purpose of the statutory depreciation regime. And, in particular, if it appears that the proceeds of the non-recourse loan have not in fact been used to meet the cost of production, the question will be whether the claim to depreciate the amount of the loan falls within that purpose. If it does not then, as it seems to us, section 99 should, in principle, be available for use by the Commissioner. The facts[66]The two films whose production has led to the dispute with the Commissioner were " The Lie of the Land " and " Utu ". They were produced by, and the arrangements for raising the finance for their production was orchestrated by, Mr McLean in the case of The Lie of the Land and a Mr Blakeney in the case of Utu. In both cases the producers were anxious to raise finance from investors in order to meet the expected costs of production. But, as has been mentioned, capital provided for film production is high risk capital. An attractive inducement must be offered to investors if they are to be persuaded to risk their capital in such a venture. One such inducement is, of course, the possibility of high reward if, against the odds, the film should turn out to be a box office success. Fortunes are possible. In addition, the tax advantages offered by IR52.3 are an inducement. The investor knows that he can depreciate over two years 100 per cent of his contribution to the cost of production. The depreciation will be an allowable deduction from his taxable income. If he is a high rate taxpayer, paying tax at the top marginal rate of 66 per cent, and we imagine that most investors in film production would fall into that category, the investor can recover via tax deductions 66 per cent of his investment even if the film does not earn a penny. But Mr McLean and Mr Blakeney were not content to offer merely those inducements. They wanted to offer something more. Each of them represented to the investors that the cost of production would be a significantly higher sum than the true expected cost. In each case the producer invited investors to meet the cost of production in two ways, first, by providing the producer with a cash sum and, second, by making available to the producer the proceeds of a non-recourse loan. In each case the amount of the non-recourse loan was, roughly, the amount by which the cost of production had been inflated by the producer's representations. The terms of the respective Deeds of Loan entered into by the investors had differences, some of them important, but both had in common the feature that the borrower had no personal liability in any circumstances to repay anything at all or to pay any interest to the lender. Repayment of the loan and payment of interest to the lender were to be made solely out of the income produced by the venture. If the venture produced no income, nothing would be paid. The lender would lose his money but the borrower would not be out of pocket. But the borrower, the film investor, would be entitled, under IR52.3, to depreciate the amount of the non-recourse loan in the same manner as he could depreciate the amount of the cash he had paid. So, without incurring any risk over and above the risk of losing the cash he had paid and in respect of which he was entitled to tax deductions, the investor would be entitled to tax deductions equal to 100 per cent of the amount of the non-recourse loan and thereby to tax savings equal to 66 per cent of that amount.[67]The attraction to an investor of the tax deductions attributable to a non-recourse loan can be easily demonstrated. Take the example of an investment of $20,000 provided as to $10,000 by a cash payment and as to the other $10,000 by a non-recourse loan. If the film were to fail the investor would stand to lose only his $10,000 cash payment. The $10,000 non-recourse loan would, theoretically at least, be a loss to the lender. But, whether the film were to succeed or fail, the investor, assuming he paid tax at the marginal rate of 66 per cent, would obtain a tax saving of 66 per cent of $20,000, ie $13,200. At worst, therefore, the investor would be $3,200 to the good. He could not lose and stood only to gain.[68]But what of the non-recourse loan lender? The lender stood to lose his money. The lender was, on the face of it, providing risk capital the recovery of which depended on the success of the film. But in the case of both films the money that was being provided by the lender was not needed to fund the production of the film. The representations about the cost of production, made by the producers, were false. So it is not surprising to find that in the case of each film the non-recourse loan money, after apparently being made available by the lender to the investors and by the investors to the production company, travelled a circuitous route unconnected with the cost of production of the film and, after a few days, found its way back to the lender.[69]The investors did not know that the cost of production had been inflated by the producers in order to justify the representation that there was a commercial need for the non-recourse loans. They did not know that the money representing the non-recourse loans had, very shortly after apparently being made available for the cost of production, travelled back to the lenders. They were apparently innocent dupes.[70]The description in the foregoing paragraphs of the arrangements made by the respective producers has been painted with a broad brush. There were in fact differences between the arrangements made regarding The Lie of the Land and those made regarding Utu . It is necessary to add a little detail. The Lie of the Land[71]The detailed facts are to be found set out in the judgment of 12 March 1999 of the Taxation Review Authority (the TRA), in which the appellant's objection to the disallowance of a tax deduction in respect of his share of the non-recourse loan was upheld, in the judgment of 19 February 2002 of Hammond J, in which the Commissioner's appeal against the TRA judgment was dismissed, and again in the judgment of the Court of Appeal of 19 February 2003 (delivered by Gault J) which allowed the Commissioner's appeal. It is not necessary to repeat these details here but we would draw attention to some of the terms of the non-recourse loan and to the manner in which the loan money was dealt with.[72]The terms of the non-recourse loan are to be found in the Deed of Loan dated 5 July 1984. The parties were Steadfold Ltd, described as "of Andorra" but in fact an English company, and South Pacific Broadcasting Corp. Ltd and Company, described as "a Special Partnership established under the provisions of Part II of the Partnership Act (NZ) 1908 acting through its General Partner South Pacific Broadcasting Corporation Limited". South Pacific Broadcasting Corp Ltd and Company (SPBCC) was the investment vehicle, shares in which were taken by the investors. South Pacific Broadcasting Corp Ltd (SPBC) was the general or managing partner of the special partnership. Mr McLean was a director of SPBC and signed the Deed on behalf of SPBC and, thereby, on behalf also of SPBCC. The Commissioner's investigations failed to discover whether Steadfold had ever carried on any business (other than being the lender under the Deed of Loan). Its name was removed from the register of companies in 1987.[73]The Deed recited that "[SPBCC] intends to make and produce in New Zealand for sale and exploitation worldwide a film [The Lie] at a total cost of approximately $NZ2,760,000 to be financed by cash contributions of [SPBCC] totalling $NZ1,200,000 and borrowings of $NZ1,560,000." Steadfold agreed to advance the $1,560,000 to SPBCC on the terms and conditions set out in the Deed. Clause 3(a) of the Deed assigned to Steadfold the right to exploit and market the film in the home video market in the USA and required all net receipts therefrom to be applied in repayment of the loan. But net receipts from the exploitation and marketing of the film everywhere other than in the USA were to be applied first in repaying to the SPBCC Partners their $1,200,000 cash contributions plus any income tax payable on those receipts. In other words these net receipts were to be applied first in producing a sum which after deduction of income tax at 66 per cent would produce $1,200,000. That sum was to be applied in reimbursing the investors their respective contributions to the $1,200,000. Only after that had been done were the net receipts (other than any USA receipts) to go towards repayment of the loan and interest thereon (at 10 per cent per annum with yearly rests). A final provision of the Deed that must be mentioned is paragraph 3(c) which expressly limited Steadfold's right to repayment of the loan and interest thereon to the rights already referred to and stated that "the Lender shall have no recourse against the Borrower in respect of the loan or interest thereon."[74]The terms of this Deed of Loan do not seem to us to allow the loan to be described as a commercial non-recourse loan. Would a commercial lender advance capital where repayment entirely depended on the success of the film to be produced with the advanced money, where the borrower's own investment in the production was to be repaid free of tax out of income generated by the film before any repayment of the advance or payment of any interest thereon to the lender could be made, and where the rate of interest on the loan was no more than 10 per cent? We think the answer must be "No".[75]We now come to the way in which the $1,560,000 was made available to Filmcraft, and to the fate of the money. Leigh Carr & Partners (Leigh Carr) were a firm of London accountants whose clients included Mr McLean or Filmcraft (or both). Mr Ralph de Sousa was a partner in Leigh Carr. In a telex from Mr McLean to Mr de Sousa sent shortly before 19 June 1984, Mr McLean gave Mr de Sousa these instructions – "1. You will receive a cheque from Steadfold Ltd for UK £702,000 2. Please deposit same in Leigh Carr Trust Account then establish escrow for special partnership [i.e. SPBCC] 3. Send telex to Euan Wright Arthur Young & Co … advising that you have received funds being loan from Steadfold and request instructions 4. You will receive instructions by telex to pay Creative Arts Ltd 5. Creative Arts will repay the loan". On 19 June 1984 Mr de Sousa telexed Mr Wright of Arthur Young & Co in New Zealand confirming that his firm had received "funds being loaned from Steadfold" and requesting instructions. The funds received were £702,000, the equivalent at the then rate of exchange of NZ$1,560,000. And, finally, a telex dated 19 July 1984 from Arthur Young & Co in London to Mr Wright in New Zealand said that Mr de Sousa had confirmed that Steadfold had paid Leigh Carr £702,000 and that Leigh Carr had paid Creative Arts the £702,000.[76]Creative Arts Ltd was a company incorporated in Liberia. It appears to have carried on business from Jersey, Channel Islands. It too was a client of Mr de Sousa, and there was some evidence that it was controlled by Mr McLean (see para 14 of the Court of Appeal's judgment). Creative Arts was party to an Agreement dated 14 June 1984, the other parties to which were Filmcraft and South Pacific Media Distributors Ltd (SPMD), a company of which Mr McLean was governing director. The Agreement said that in return for $1,560,000, which Filmcraft was to pay to Creative Arts, Creative Arts would procure for the purposes of The Lie of the Land the acting services of a named actress and various other services required for the production, marketing and exploitation of the film. This Agreement, signed by Mr McLean on behalf both of Filmcraft and SPMD, might be thought to explain why Mr McLean instructed Mr de Sousa to pay the £702,000 to Creative Arts. But the clear inferences to be drawn from Filmcraft's draft accounts for the relevant years were that the services for which Filmcraft had apparently paid Creative Arts $1,560,000 were in fact all paid for by Filmcraft itself.[77]There was no positive evidence of any payment by Creative Arts to Steadfold. But there were two items of evidence which supported the inference that the £702,000 found its way back to Steadfold. First, there was the telex from Mr McLean to Mr de Sousa saying that "Creative Arts will repay the loan". Second, a hand written note was found in Mr McLean's London office which said "Asked J Ruther to lend money + circle same day". Mr J Rutherford was the director of Steadfold who signed the Deed of Loan on Steadfold's behalf. No record of the receipt by Filmcraft of the £702,000 (or of $1,560,000) from Steadfold (or the investors) or of the payment of that sum by Filmcraft to Creative Arts appeared in any of Filmcraft's accounts.[78]The Court of Appeal expressed the opinion that "on the evidence … it was open to the Commissioner to take the view that the amount of the non-recourse loan had been returned to Steadfold in repayment of the loan". We agree with this. Any other conclusion would be shutting one's eyes to the obvious. Utu[79]As with The Lie of the Land, the Utu facts are to be found set out in the judgments of the TRA, Hammond J and the Court of Appeal, each of which dismissed the appellant's objections to the Commissioner's disallowance of the tax deductions in issue. It is not necessary to repeat all those details here. A brief summary will suffice. It was represented by Mr Blakeney to the investors that the expenditure expected to be incurred for the production and marketing of Utu was $3,100,000 (see para.3.2 of the Deed of Production dated 20 March 1982). The production company was Utu Productions Ltd, a company controlled by Mr Blakeney. Paragraph 4.1(c) of the Deed of Production required the investors to make the $3,100,000 available to the production company in tranches with 50 per cent of the amount to be paid by 1 April 1982. But paragraph 4(d) said that no investor would be obliged to contribute any amount unless a "Loan Contribution" at least equal to 50 per cent of the amount to be contributed had been provided under the proposed Deed of Loan. The Deed of Loan provided, therefore, for a non-recourse loan of $1,550,000 to be made available to the investors.[80]The "lender" in respect of the $1,550,000 non-recourse loan was to be Utu Funding Ltd, a company incorporated in New Zealand on 17 March 1982 with a share capital of $100. 90 of the 100 shares were owned by Mr Blakeney. Utu Funding was plainly in no position to provide the $1,550,000 from its own resources. But US $800,000 (equivalent to NZ$1,143,000 at the then rate of exchange) was to be made available to Utu Funding by Glitteron Films Ltd under a loan document dated 1 August 1982 and $350,000 was to be provided to Utu Funding by the New Zealand Film Commission (the NZFC). Glitteron Films Ltd was a shadowy company incorporated in Hong Kong. The identity of those who controlled the company was never established. Much time appears to have been taken before the TRA in examining the reality of the US $800,000 loan which Glitteron Films purported to have made to Utu Funding and the judgment of the TRA records that – "By the end of the hearing the objector conceded that the 'loan' from Glitteron was never made." (p.8)[81]As to the $350,000 that the NZFC was to make available to Utu Funding, the provenance of this is explained in a letter dated 12 March 1982 from Mr Blakeney to the Finance Director of the NZFC. The letter said that – "The private investors will not part with their money until they are satisfied that the project is fully funded and that loans arranged by Utu Funding Ltd are available." and then went on to propose that – "(a) The NZFC pay Utu Funding Ltd $350,000. (b) Utu Funding Ltd pay Wilkinson Wilberfoss Trust Account $350,000. (c) Wilkinson Wilberfoss pay Utu Productions Ltd $350,000. (d) Utu Productions Ltd pay the NZFC $350,000." Wilkinson Wilberfoss were the firm of accountants advising the investors. The TRA succinctly summed up this 'loan' arrangement. "The proposal was a fraud on the investors. It was intended to induce them to believe (and they did believe) that the Film Commission had loaned $350,000 to Utu Funding Ltd for use in making the film. In fact it had not and at that time was never intended to. With the full knowledge of the Film Commission, they were only out of pocket for $350,000 overnight. The money was returned to them the next day."[82]There is no suggestion that the investors or Wilkinson Wilberfoss knew that the $1,550,000 "loan" by Utu Funding was not intended to meet production costs. As Hammond J commented "The loan from Utu Funding flowed in a complete circle by way of a round robin of 13 cheques. This was a fraud on the investors and was designed to cause the investors to put in their own cash."[83]The falsity of the arrangements regarding this non-recourse loan was not confined to the misrepresentations made to the investors to induce them to part with their own money. In addition, false invoices, totalling $1,152,010, were produced purporting to show how the money had been spent (see para. 10 of Hammond J's judgment).[84]The Deed of Loan which set out the terms on which the non-recourse loan would be made available was dated 20 March 1982. The parties were Utu Funding Ltd and the investors. The $1,550,000 was to be made available to the investors in tranches to be paid on the same dates as those specified in the Production Deed for the payments the investors were to make to Utu Productions Ltd. Paragraphs3.1 and3.2 of the Deed of Loan provided, in effect, that instead of the right to require repayment by the borrowers of the loan (with interest at 15 per cent per annum), the lender would receive a specified percentage of the "Net Proceeds of the Exploitation" of the film that were received by the borrowers.[85]The terms of this Deed of Loan were not so obviously uncommercial as those of The Lie of the Land Deed of Loan. But for present purposes the terms do not perhaps matter because it seems clear that no part of either of the non-recourse loans was applied in payment of any of the costs of production or distribution of the films.[86]A distinction between The Lie of the Land and Utu that should be mentioned is that Utu , unlike The Lie of the Land which never achieved a commercial release, was a great box office success. Repayment of the amount of the non-recourse loan was, presumably, made out of the receipts. Whether the loan was in fact repayable, having regard to the TRA finding that the Glitteron loan to Utu Funding never took place, is questionable. But nothing, for present purposes, turns on these post-production and distribution events. Conclusions[87]In relation to each of these films, was there an "arrangement made or entered into …" for section 99(2) purposes? It seems to us clear that there was. The steps taken in order to induce investors to invest money in the production of the films fit very easily within the definition of "arrangement" in sub-section(1). The "plan" included in each case the following features:(1) representations were made to investors about the expected cost of production and marketing that deliberately inflated the expected cost:(2) it was intended that the amount of the inflation would be met by a non-recourse loan:(3) it was intended that the sum advanced by means of the non-recourse loan would not be applied in meeting any of the costs of production or marketing but would, after the lapse of no more than a few days, be returned back to the lender:(4) false or misleading documents were to be created in order to conceal the fact that the money had not been used in meeting any of the costs of production or marketing and in order to serve the pretence that the money had been so used:(5) the purpose of the plan was to allow the investors to claim tax deductions equal to the face value of the non-recourse loan. The plan was carried into effect. It seems to us clear that this plan was an "arrangement" as defined in section 99(1).[88]The next question is whether the purpose or effect of this "plan" or "arrangement" was tax avoidance (s99(2)). The purpose was to produce a capital sum that could, for IR52.3 purposes, be treated as part of the cost of production of the film, thereby enabling the borrower to claim tax deductions equal in amount to that capital sum. The appellant says that the effect of the plan, once it had been implemented, was to entitle the investors to those tax deductions. The obtaining of the right to make deductions from assessable income is, in ordinary language, obtaining a tax advantage. In our opinion, this "plan" or "arrangement" is clearly within the language of sub-section (2). If that is so, then the mandatory consequence imposed by sub-section (3) would seem to follow, "… the assessable income … of any person affected by that arrangement shall be adjusted in such manner as the Commissioner considers appropriate …" (emphasis added).[89]But the question still to be answered is whether the "tax advantage" obtained by the investors from the arrangement should be regarded as acceptable tax mitigation, and thus free from attack under section 99. On this critical question a number of considerations have been pressed on behalf of the appellant. It has been stressed that the investors were ignorant of the various falsities for which the producers (Mr McLean and Mr Blakeney) were responsible. They (the investors) thought that the sum to be advanced as a non-recourse loan was needed for, and would be used for, the costs of production and marketing of the film. The investors were not part of the consensus underlying the "plan" or "arrangement" as described; they were not parties to it. We would accept, on the findings of the courts below, that that is so. But sub-section (2) says, in terms, that the arrangement "shall be absolutely void as against the Commissioner … whether or not any person affected by the arrangement is a party thereto". The fact that the investors were not parties to the arrangement cannot be enough to allow them to escape section 99. Any other conclusion would involve a judicial rewriting of section 99(2).[90]It is said that the whole of the $2,760,000 in the case of The Lie of the Land and of the $3,100,000 in the case of Utu constituted the cost required to be paid and actually paid by the investors to acquire their rights in the respective films, that IR52.3 allows depreciation of the cost of acquisition of film rights as well as the cost of production of film rights (see paragraph 62 above) and, therefore, that they, the investors, were doing no more than claiming the tax deductions that the statutory regime intended they should have. The case, they say, should be regarded as acceptable tax mitigation.[91]It has been suggested, in support of the argument referred to, that if an investor is asked to pay and agrees to pay an inflated price for the film rights in a particular film, he is entitled under IR53.2 to depreciate the whole of the cost of acquisition, whether inflated or not. We doubt this proposition. The statutory right to depreciate an item of cost and to deduct the amount of the depreciation from assessable income is plainly a tax advantage. Whether it is a tax advantage vulnerable to attack under section 99 depends, in our opinion, on whether it is within the purpose of the statutory regime. We cannot believe that if the cost of acquisition of a film is inflated for no commercial reason other than that of qualifying for a higher tax deduction than would otherwise be available the amount of the inflation could be regarded as the sort of cost that the statutory regime was intended to assist or encourage. In any event, in the present case the amount of each non-recourse loan was not presented to the investors as a premium on the cost of production that they had to pay. It was presented to them on the basis that the amount was needed for the cost of production and that it would qualify for depreciation as part of the cost of production. The non-recourse loan was, in fact, nothing of the sort but was no more than a device to produce a higher capital sum to be depreciated and, thereby, a higher tax deduction. Moreover the amounts represented by the non-recourse loans were not received by the respective production companies as premiums that had to be paid as part of the investors' acquisition costs. They were not recorded in their books as having been received at all.[92]If the approach recommended by Richardson J in The Challenge case is followed (see para 61 above) it seems to us that these appeals cannot succeed. The arrangements devised by Mr McLean and Mr Blakeney were tax avoidance arrangements of a plainly undesirable kind and of a kind that cannot, in our opinion, be reconciled with the statutory purpose of encouraging investment in the production of films. To hold that the apparent ignorance of the investors excuses them from vulnerability to the statutory avoidance measures provided by section 99 would be, in our opinion, to emasculate the section. We are not willing to be party to that emasculation and would advise that these appeals ought to be dismissed. Post Script[93]Since writing the above dissent we have had the advantage of considering the full reasons of the majority as set out in the opinion prepared by Lord Millett. We respectfully concur in the conclusions expressed by Lord Millett in paragraphs 33 and 34 of the opinion and that the "critical question" (para. 35) is whether the tax advantage obtained by the investors amounted to "tax avoidance" for the purposes of section 99. The opinion of the majority that it did not appears to us to be based on the proposition that, on the facts as found by the TRA in each case, the $y (adopting Lord Millett's symbolism) represented a payment by the investors to discharge a "genuine liability" (see para. 45), with the consequence that it could be characterised as a "fact" that they had suffered "the economic burden" of paying the $y (para. 44).[94]We would protest that this representation of the $y not only is not supported by, but indeed is inconsistent with, the TRA's findings of fact.[95]Utu(i) At page 2 of the TRA judgment they record that it was accepted by the investors that "the loan transactions which evidence these purported payments were … a fraud on the investors".(ii) At page 8 the TRA record that the investors "conceded that the "loan" from Glitteron was never made , conceding that this aspect of the transaction was a fraud on the investors and therefore a sham for tax purposes" (emphasis added).(iii) At page 11, the TRA refer to the $350,000 allegedly loaned by the Film Commission to Utu Funding Ltd and say "The proposal was a fraud on the investors intended to induce them to believe (and they did believe) that the Film Commission had loaned $350,000 to Utu Funding Ltd for use in making the film. In fact it had not and at that time was never intended to" (emphasis added).(iv) At page 15, the TRA repeat that "… in this case there is no evidence of such loans" and say that "This was a transaction involving the making and selling of a film for a sum of money significantly less [ie by $y] than that alleged by the objector."[96]We would respectfully suggest that in the face of these findings the contention that the TRA found as a fact that the investors had paid the $y is unsustainable. The source of the $y that the investors allegedly paid was the non-recourse loans. But the loans were never made. The investors were unaware of the falsity of the representations that had led them to think that $y had been expended on their behalf, but a clearer case can hardly be imagined of an arrangement that has not in fact involved the taxpayer "in the loss or expenditure which entitles him to that reduction" (per Lord Templeman in the Challenge Corporation case cited at para.37 of Lord Millett's opinion).[97]As to the alleged repayment of the Utu loan via the receipts earned by the film on its commercial release, since, as the TRA found, neither the Glitteron loan nor the Film Commission loan was ever made, the retention of receipts to be applied in repayment was unlawful and the "lender" would be accountable to the investors for those receipts. So, too, in our opinion, would be the individuals and companies responsible for the false representations on which the investors acted. The Lie of the Land[98]The TRA's findings of fact regarding the Lie of the Land non-recourse loan are less clearcut that those regarding the Utu loan, but we think they lead to the same conclusion. They show -(i) that the accounts of the alleged recipient of the $1.56million loan money from the investors, i.e. Filmcraft, showed no record of receipt of the money (p.9);(ii) that although the purported application of the $1.56million loan was a payment of that sum by Filmcraft to Creative Arts for "services", the accounts of Filmcraft contained no record of such a payment having been made or of any services rendered by Creative Arts (pp.8,9,22);(iii) and, in relation to the evidence suggesting that there had been an arrangement for the loan money to travel in circular fashion from Steadfold (the lender), to Filmcraft, to Creative Arts and back to the lender, that the investors had not been aware of this arrangement (pp.11 and 12). The TRA took the view that, since the investors had not known of this intended circularity, it did not detract from their claim that the $1.56 million, the $y, represented a loan to and expenditure by them qualifying for a depreciation allowance. It is implicit, however, in the TRA findings that they accepted the fact of this circularity.[99]The Court of Appeal concentrated on the fact that the loan had apparently been repaid to the lender very shortly after it had been made – "In our view [the] crucial issue is whether or not the loan from Steadfold to the partnership was repaid …" (paras 31 and 34) They pointed out that if the loan had been repaid, nothing remained owing by the investors and there was nothing left of $y to depreciate (paras 32 to 34).[100]The description in Lord Millett's opinion of the circumstances in which a section 99 challenge to an "arrangement" could properly be made seem to us to fit the The Lie of the Land circumstances.(i) In para.42 it is said that the Commissioner needed to show that the investors "had not suffered the economic burden of [the] expenditure before tax which Parliament intended …" But, if the true position was that the loan had been repaid to Steadfold by Creative Arts, that indeed was the position. See also para.44 where there is another reference to the investors suffering the "economic burden of paying the full amount of $x+y". They did not pay the full or any part of the $y. The money was returned to the lender by Creative Arts.(ii) In para.43 it is said that the inflation of the costs of making the film meant that the production company made a "secret profit at the investors' expense" but did not alter the fact that the investors had incurred a liability to pay $x+y. But there was no "secret profit". The $1.56 million, the $y, simply travelled in a circle. It did not end up with Filmcraft. The fraudulent misrepresentation was not intended to enrich Filmcraft; it was intended to boost the depreciation allowance and thereby induce investors to support the film by investing the $x. Filmcraft did not make a profit of $y at the expense of the investors. The analysis in para.43 is not in accordance with the facts.(iii) In para. 45 there is reference to the "money arrangements" discharging a "genuine liability". There is no evidence that the movement of the money from Creative Arts to Steadfold was in discharge of any liability other than that created by the arrangement under which Steadfold made the money available in the first place.[101]The issue regarding the $y, so far as The Lie of the Land is concerned, is whether the courts, in deciding whether section 99 can be employed to reverse the undoubted tax advantage that would otherwise be claimable, must shut their eyes to what happens to the $y after it has left the hands of the investors. The majority have taken the view that that is the position. But in our opinion so to hold would deprive section 99 of its proper effect in relation to transactions such as these. If the later events show that the money, the $y, had nothing to do with the cost of production of the film, and nothing to do with the price that the vendor of the film wanted to extract for the rights in the film that he was selling, but was simply a means of boosting the depreciation allowance that could be claimed, we find it extraordinary to rule out the application of section 99. We confirm our dissent.

Cited in 5 later judgments