Asset stripping involves arrangements or transactions that result in the assets of a company being depleted so that the company has insufficient funds to fully meet its tax liabilities (existing or future). The Recovery Provisions were enacted to counteract such arrangements, enabling the Commissioner of the Inland Revenue to recover the tax liabilities of the company from its directors and/or shareholders. The Recovery Provisions make persons who were directors, controlling shareholders or who had a voting or market value interest in the company at the time the asset stripping arrangement was entered into potentially responsible, as agents, for the company’s tax liabilities. Tax liabilities for the purposes of the Recovery Provisions include income tax, GST, penalties and interest.

The Recovery Provisions apply when the following criteria are met:

• An arrangement has been entered into in relation to a company;
• An effect of that arrangement is that the company is unable to satisfy an existing or future tax liability; and
• It is reasonable to conclude that:
  • Had a director of the company made reasonable inquiries into the affairs of the company at the time of the arrangement, that director could have anticipated at that time that the tax liability would, or would likely, be required to be met, and
  • A purpose of the arrangement was to have the effect noted above.

It is sufficient that “a” purpose of the arrangement is to have the effect noted above i.e. it does not need to be the sole or dominant purpose but merely only one of the purposes.

The Commissioner has extended powers to give effect to the Recovery Provisions, such as being able to assess a company that has been liquidated (as if it had not been liquidated) and potentially apply time bar for a period of 4 years from the end of the tax year in which the company was liquidated.

The question that then arises is what date do the terms “liquidated” or “liquidation” refer to? Is it the date the company is wound up and put into liquidation, or is it the date on which the company is removed from the Companies Office register at the end of the liquidation process? This interpretation has yet to be tested in court and would have a significant effect on the time bar as a company may be in liquidation for many years (more than 4) before it is removed from the Companies Office register.

In this case, the Taxpayer was a citizen and resident of Australia, whilst being the sole director and shareholder of a New Zealand company (NZCo). The Taxpayer performed “computer programming services” in New Zealand through NZCo. The Taxpayer (trading as NZCo) entered into agreements to provide services to New Zealand registered companies. Payments received from the provision of these services were deposited into the New Zealand bank account of a related Australian company (which had a name similar to the NZCo) The Taxpayer was the sole signatory on that bank account. NZCo itself did not have a New Zealand bank account. Inland Revenue’s investigations determined that once payments were deposited into the New Zealand bank account, they were mostly transferred to an Australian bank account or to the Taxpayer’s joint account with his spouse. The funds left in the New Zealand account were just enough to cover the Taxpayer’s private costs until the next payment was received; no surpluses were retained in New Zealand.

After an investigation, Inland Revenue issued assessments of GST and income tax to NZCo. The assessments were not disputed and were deemed to be accepted. Inland Revenue then issued a notice of disputable decision and assessment determining that the Taxpayer was personally liable, as agent, for the GST and income tax debts of NZCo. This was disputed by the Taxpayer.

The TCO determined that the Taxpayer was liable as agent for NZCo’s tax obligations for the relevant periods under the Recovery Provisions as all of the requirements of these sections were met because:

• The Taxpayer, NZCo and the related Australian company (both operated by the Taxpayer) engaged in an arrangement that involved:
  • Receiving payments into the related Australian company’s New Zealand bank account;
  • Quickly transferring the build of the payments to Australian bank accounts under the Taxpayer’s control;
  • Causing NZCo’s tax liability to be understated in tax returns that were filed with Inland Revenue; and
  • Filing nil returns.
• Looked at objectively, this arrangement had an effect of depleting NZCo’s assets almost completely on a regular basis, which left NZCo unable to meet its tax liability, or any expected tax liability that would naturally arise from the activities NZCo engaged in.
• It was reasonable to conclude that:
  • A purpose of the arrangement was NZCo could not meet its tax liability as funds were kept in New Zealand only if they were needed to meet the Taxpayer’s and NZCo’s other expenses. All of these other expenses were met expect the tax liability, and funds were not retained in the account to meet any expected tax liability that might arise; and
  • The Taxpayer, as sole director of NZCo, could have anticipated that NZCo’s tax liability would arise.

In our experience, we have rarely seen the Commissioner invoke the Recovery Provisions. This is also reflected through the limited number of cases on these provisions. The facts in TDS 22/14 demonstrate a blatant attempt to deplete funds from a company which has had the effect of the company being unable to meet its tax liabilities and this this regard these facts sit at an extreme end of the spectrum. However, given the wide drafting of the Recovery Provisions, they have the potential to apply to other, less blatant, arrangements. Furthermore, with the potential increase in tax debts post-COVID-19 and in the current economic climate, the Commissioner may be prompted to rely on this recovery provision more often. If you would like to discuss this issue further, please contact your usual Deloitte adviser.