The Supreme Court - tax avoidance - and consequences for Trustees
The Supreme Court’s decision in Penny & Hooper v CIR [2011] NZSC 95 is generally regarded as a tax case - but it’s a Trust case too.
Two surgeons in Christchurch structured their practices so that each received an income that was much less than the fees they generated.
This was achieved with the assistance of Trusts.
In the case of Mr Hooper, he and his wife had “mirror” family Trusts. The trustees were their solicitor and accountant. The beneficiaries of the two Trusts were Mr and Mrs Hooper, the Hooper children and any Hooper grandchildren.
In the case of Mr Penny, the Trust that received the income from his services had as its trustees, “his solicitors and accountant” [13]. The beneficiaries were himself, his wife, their children and grandchildren.
The trustees of all the Trusts were solicitors and accountants.
During the years for which the structures were challenged, some of the dividends that the Hooper Trusts received were distributed to Mr Hooper’s three daughters. The rest were retained as trustee income and invested in the family home, a holiday home and in bank deposits. No distributions or loans were made to either Mr or Mrs Hooper.
In the case of Mr Penny, the family Trust advanced him $1.236m which he used to meet obligations to his estranged wife and to pay tuition fees for their children.
The Supreme Court held unanimously that the Penny and Hooper structures constituted tax avoidance.
The Court’s judgment contains the following sentence of significance for conventional family Trusts:
“Although neither taxpayer was a trustee, each could naturally expect that the trustees whom they had chosen would act as they in fact did, and that the benefits of the use of the funds would thereby be secured without the impost of the highest personal tax rate.” [35]
Today’s article is an attempt to understand the significance of this statement.
At a very basic level the Court was saying that the presence of “professional” trustees (lawyers and accountants) will not prevent a Court from finding that Trusts are being used for tax avoidance.
Next, the tears that fall from this decision are not confined to the Pennys and Hoopers of this world. They may also fall down the cheeks of the lawyers and accountants who agree to act as trustees of co-operating Trusts. The possibility – hopefully remote – that there may be an unlimited liability to pay tax, penalties and interest for Trusts that are held to be involved in tax avoidance should deter most lawyers and accountants from accepting appointment as trustees of Trusts that may be held to be involved in tax avoidance.
Might the case have some significance for the many Trusts that exist in relationship property disputes?
If the Supreme Court was able to say that Mr Penny and Mr Hooper “could naturally expect that the trustees whom they had chosen would act as they in fact did …” can the Family Court make the same prediction about the trustees of conventional family Trusts?
The use of the word “naturally” in the Supreme Court’s sentence suggests that carefully selected professional trustees will predictably favour the interests of a person who has significant involvement in the generation of a Trust’s wealth.
There may be some judges in the Family Court who think that if the Supreme Court is able to say that a spouse who has funded a Trust can “naturally expect that the trustees whom [he/she] has chosen” will do as he/she wants, they (the Family Court Judges) can make the same assumption. Hopefully they won’t.
My third reflection concerns sham Trusts. Although the Supreme Court was not considering whether the Penny and Hooper Trusts were shams, the way in which the Court felt free to say that professional trustees would inevitably favour the person whose wealth established the Trust, might be relevant in the context of a sham Trust contention.
The usual hallmark of a sham Trust is the existence of “effective control” of the Trust’s assets by one of a number of trustees or by a non-trustee. If control can be achieved by choosing trustees who can be expected to do what the influential person wants, even if it involves participating in schemes of marginal legality, it might be thought that there is a sufficient degree of “effective control” for doubt to be cast about the legitimacy of the Trust.
For lawyers in New Zealand this reflection need not be developed any further since it is clear from the Supreme Court’s decision in paragraph 23 of Kain v Hutton [2008] 3 NZLR 589 that the existence of “effective control” over a Trust by a person does not disqualify the legitimacy of a Trust.