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Post reflection of Frucor: Inland Revenue releases finalised IS 23/01 to quell our questions on what permissible tax advantages are

Tax Alert - March 2023

By Christina Thompson & Kelly Kim

Inland Revenue has, at last, finalised its Interpretation Statement on tax avoidance and the interpretation of the general anti-avoidance provisions sections BG 1 and GA 1 of the Income Tax Act 2007 (IS 23/01). This statement replaces the previous equivalent statement issued in 2013 (IS 13/01) and provides clarifications and guidance around the application of the GAAR framework in light of the Supreme Court Frucor decision in September 2022 (which we have covered in our October 2022 Tax Alert article).
For those seeking to get to the crux of the lengthy 137-page document, Inland Revenue has provided an accompanying nine-page Fact Sheet that distils the key points and takeaways from the Interpretation Statement.

Inland Revenue has also issued two Questions We’ve Been Asked (QB 23/01 and QB 23/02) to update its analysis in relation to tax avoidance scenarios previously contained in IS 13/01, QB 14/11 and QB 15/11. The reasoning and conclusions in the new QBs are unchanged, reaffirming that an arrangement will be respected if the commercial and economic reality of the arrangement is consistent with Parliament’s purpose for the relevant provisions.

In this article, we briefly discuss our observations on the Commissioner’s refined approach to section BG 1 and comment on scenarios in the refreshed Questions We’ve Been Asked (QBs).

Overall, the content has remained largely unchanged following the consultation, with a few refinements to the Commissioner’s approach to section BG 1 (see our February 2021 article if you want to read more on the draft Statement).

IS 23/01 affirms that the proper and authoritative approach to applying section BG 1 is answering the “ultimate question” under the Parliamentary contemplation test. That is:

…whether the impugned arrangement, viewed in a commercially and economically realistic way, makes use of the specific provision in a manner that is consistent with Parliament’s purpose.

This requires both identifying and understanding Parliament’s purpose for the specific provisions that are used or circumvented by the arrangement, as well as understanding the commercial and economic reality of the arrangement, as a whole, having regard to the factors identified by the Courts.

The Commissioner has highlighted the following interrelated factors to be of significant importance when considering both Parliament’s purpose for specific provisions and the arrangement’s purposes, tax effects and commercial economic reality as a whole:

  • the presence or absence of artificiality, contrivance or pretence;
  • the veracity of the arrangement’s commercial or private purposes (in contrast to the clarity or otherwise of the arrangement’s tax advantages);
  • whether or not the use or circumvention of the relevant specific provisions is consistent with Parliament’s purposes for the provision.

Taking into account the above, one should consider, “does the arrangement when viewed as a whole and in a commercially and economically realistic way, use (or circumvent) the specific provisions in a manner that is consistent with Parliament’s purpose for those provisions?” If the answer is no, the next step is to apply the merely incidental test and consider whether the tax avoidance purpose or effect flows naturally from, or is subordinate or subsidiary to, another purpose.

Comments on changes

A welcomed revision to IS 23/01 is the inclusion of examples from cases to illustrate factors identified by the courts that are taken into consideration when examining the commercial and economic reality of the arrangement.

Greater emphasis is placed on the ‘commercial or private purposes’ of the arrangement (previously referred to as ‘non-tax avoidance purposes’) when considering the factors identified by the Courts, and in particular, assessing whether the ‘commercial and economic reality’ of the arrangement is explicable from a commercial or private point of view. This is a significant shift in the Commissioner’s approach in IS 13/01, noting the Commissioner previously disagreed that non-tax avoidance purposes were relevant to the Parliamentary contemplation test (IS 13/01, para 362).

However, less emphasis is placed on identifying the facts, features or attributes of specific provisions. Whilst examining facts, features and attributes was previously seen as a requisite, IS 23/01 frames it more as a useful/practical tool for determining Parliament’s purpose. We understand that this change is to clarify that it is Parliament’s purpose for the specific provisions that are relevant, and that facts, features or attributes are an optional way of considering them in the context of the arrangement’s commercial and economic reality. Although based on the Commissioner’s approach to the scenarios in the QBs, these factors still play a significant role in the Commissioner’s approach to section BG 1.

As a final comment, IS 23/01 confirms the merely incidental test remains applicable where the arrangement does not have tax avoidance as its sole purpose or effect. Although, given the emphasis on commercial or private purposes of an arrangement as part of the Parliamentary contemplation test, if it is concluded that an arrangement uses (or circumvents) a specific provision in a manner that is outside Parliament’s purpose, it is less likely that the merely incidental test would be satisfied.


As was the case in the previous draft Statement, the new Statement still lacks practical examples of the application of the general anti-avoidance provisions. Additionally, the accompanying QBs unhelpfully only cover one scenario where the Commissioner considers section BG 1 would apply.

Below we have commented on some of the Commissioner’s scenarios:

Refinancing with a private element

The first scenario involves the tax treatment of interest deductions on borrowings used to repay shareholder loans, which are ultimately used by the shareholder for private purposes.

This scenario outlines that Parliament’s purpose for the specific provision governing interest deductions is satisfied where the loan capital relating to that interest is used in a business. Although the arrangement had a private purpose of allowing the family trust to reinvest its funds in a holiday home, it also had a commercial purpose of refinancing debt to continue its business operations.

Viewing the arrangement as a whole and in a commercially and economically realistic way, there was no private use of funds used in the business. Therefore, the arrangement does not use or circumvent specific provisions in a manner outside Parliament’s contemplation. The scenario reemphasizes that the Commissioner cannot postulate “counterfactual” arrangements or “economic equivalence” when applying section BG 1 (noting they may consider these factors when applying section GA 1).

In one scenario, the Commissioner reaffirms that a taxpayer with a marginal rate of 39% investing in a PIE to benefit from the rate of 28% would not constitute tax avoidance. This is because investing is a PIE to secure the tax advantage of the maximum prescribed investor rate of 28% is within Parliament’s contemplation.

On the contrary, borrowing funds from a bank and investing in a PIE sponsored by the same bank at a lower return rate, would be regarded as a tax avoidance arrangement.

The facts, features or attributes indicate that the taxpayer is essentially borrowing to invest in a fund that returns less than the cost of borrowing, leading to a pre-tax negative/post-tax positive outcome. As a result, the facts, features or attributes do not align with the commercial and economic reality of the arrangement – the PIE was not part of the taxpayer’s savings and investment activities and uses specific provisions for a tax arbitrage in a manner outside Parliament’s contemplation. This scenario also notes that if section BG 1 applies, the Commissioner may apply section GA 1 to reconstruct the arrangement to achieve tax neutrality.

This scenario reaffirms that taking into consideration the tax profile of a beneficiary when distributing income from a discretionary trust does not, without more, constitute a tax avoidance arrangement. Provided the distributions are made in accordance with the terms of the trust deed, the Trusts Act 2019, and general law, and there is no suggestion the beneficiaries are not, in reality, entitled under the trust, or that they will not benefit from the distribution of income to them.

The Commissioner sets out factors that may give rise for concern and notes that a resolution to pay beneficiaries by crediting their account and retaining those funds for use within the trust would not, on its own, be a problem. However, if in commercial and economic reality, there is no realistic prospect of the beneficiaries ever benefiting from the income allocated to them, this would be outside Parliament’s purpose for the relevant provisions.

While the updated Interpretation Statement provides guidance on the Commissioner’s approach, when considering the potential application of section BG 1, it is still concerning to us that there are not enough practical examples that address grey areas. For instance, there is no discussion on the debt capitalisation scenario where debt forgiveness is not pro-rata to ownership interests.

As the potential application of section BG 1 is an intensely fact-based inquiry, it is important to always look at the overall arrangement being entered into and consider whether any tax advantages arise. If so, consider whether those advantages could be viewed as being outside Parliament’s contemplation. You may also want to consider applying for a binding ruling to obtain certainty from Inland Revenue as a safeguard before implementing certain arrangements or structures. Please contact your usual Deloitte advisor if you have any further queries.

March 2023 - Tax Alerts

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