Anti-avoidance mechanism in Sales Tax Act, 1990

Individuals and businesses make arrangements through which they alienate their real income in order to be taxed at lower rates. This effort attracts application of those provisions of law which forbid avoidance of tax schemes. Such provisions are present both in direct and indirect taxes. This paper examines anti-avoidance provisions present in Federal Sales Tax Law.
The Sales Tax Act, 1990 (hereinafter referred to as the Act) taxes supplies of goods1 by registered persons on their value of supply2 in the course of their taxable activities3 ("output tax") but permits such persons to claim deductions for the amounts they expend in connection with those activities ("input tax deductions"). The rate of tax is 16% and hence the "tax fraction" applicable to the deductions is one-twelfth. At the end of each "taxable period" a person registered under the Act must make a sales tax return bringing to account both outputs and inputs and then either pay the debit balance or claim the credit balance or the sales tax refund.
"Goods" means all kinds of personal or real property other than chooses in action or money.4 Where the consideration for a supply is a consideration in money the value of a supply is the amount of the money.5 Where the consideration is not a consideration in money or the parties are associated persons, the value is the "open market price"6 of the consideration.7 The provisions of the Act, 1990, which need to be considered are, of course, the limits provided to check anti-avoidances.8 These limits are as under:
(i) where the consideration for a supply is in kind or is partly in kind and partly in money, the value of the supply will be the open market price of the supply (excluding the amount of tax);
(ii) where the supplier and recipient are associated persons and the supply is made for no consideration (or for a consideration which is lower than the open market price), the value of supply will be the open market price of the supply (excluding the amount of tax);
(iii) where a taxable supply is made to a consumer from general public on instalment basis on a price inclusive of mark-up or surcharge rendering it higher than open market price, the value will be the open market price of the supply excluding the amount of tax;
(iv) where a trade discount has been allowed the value of the goods will be, the discounted price excluding the amount of tax;9
(v) where for any special nature of transaction, it is difficult to ascertain the value of a supply, the open market price;
(vi) in case of imported goods, the value determined under section 25 of the Customs Act, 1969 including the amount of customs-duties and central excise duty levied thereon;
(vii) where there is sufficient reason to believe that the value of a supply has not been correctly declared in the invoice, the value determined;10 and
(viii) of processing, the value will be the price excluding the amount of sales tax leviable on such goods.
In the said provisions, there exists the arrangement constituting tax avoidance mechanism because in economic terms it is a conditional obligation to repay the money without having any definitive commitment to repay it irrespective of the success or failure of the venture would constitute a special nature transaction. For example, mere completion of loan documents and the swapping of cheques would be insufficient to constitute the economic sacrifice Parliament intended in limiting the refund payment to the extent that payment is made in the period in question. Such expressed legal obligations are generally artificial.
Where the obligation to pay the purchase price was replaced, in commercial terms, by only a conditional commitment to repay the line limiting the obligation, it stands crossed into tax avoidance. And it is not for the court or the commissioner to say how much a taxpayer ought to spend in obtaining his income. Nevertheless the commissioner may be satisfied that the arrangement which he wishes to treat as void has been "entered into between persons to defeat the intent and application" of the Act or any of its provisions.
The onus is on the taxpayer to show that how the commissioner could not properly stood satisfied.11 And there must exist circumstances12 as provided in the law so as to reject the value of supply and to bring it into the ambit of disputed transaction to constitute a tax avoidance act. And this arrangement must have been entered into between the parties to defeat the intent and application of the law or any of the provisions of the act.
The courts are on much firmer ground disregarding subjective purpose, as they have always done in applying general anti-avoidance provisions in the income tax statutes.
In Newton v Commissioner of Taxation of the Commonwealth of Australia,13 in giving the advice of the Judicial Committee, Lord Denning said that in the phrase
"purpose or effect" in the Australian general anti-avoidance provision of that time the word "purpose" meant not motive but the effect which it was sought to achieve - the end in view. The word "effect" meant the end accomplished or achieved. It was necessary, his Lordship said, to look at the arrangement itself and see its effect irrespective of the motives of the person who made it.
The position is summed up in a passage from the advice of the Privy Council in Ashton v Commissioner of Inland Revenue,14 where Viscount Dilhorne said:
"If an arrangement has a particular purpose, then that will be its intended effect. If it has a particular effect, then that will be its purpose and oral evidence to show that it has a different purpose or different effect to that which is shown by the arrangement itself is irrelevant to the determination of the question whether the arrangement 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."
The intention of the act stands defeated if an arrangement has been structured to enable the avoidance of output tax, or the obtaining of an input deduction in circumstances where that consequence is outside the purpose and contemplation of the relevant statutory provisions. Compliance and administration costs preclude perfect neutrality ever achieved.15 It may be kept in mind that sales tax is a multi-stage tax imposed on the value-added at every stage of the business activity by which goods or services reach the ultimate consumer.16
The consideration on which the parties act upon can be expected to be an open market price. Where parties are associated persons and hence are not at arm's length, there is obvious potential for adoption of an unrealistic value which may create distortion, and the act, therefore, requires an accounting on the basis of an open market price, which is either the value the goods or services would normally fetch or as determined by the commissioner in accordance with a method provided in the act, on the basis of a sufficiently objective approximation.
There is, however, potential for registered taxpayers knowingly or otherwise to create distortions at the boundary between themselves and unregistered persons. The same can occur where transactions are between those registered on payments basis and those registered on an invoice basis (as in Ch'elle and Nicholls v Commissioner of Inland Revenue17). The general anti-avoidance provision is available to stop or counteract both these distortions. The possibility of distortion exists in the former situation because, in order to preserve neutrality where a registered person is acquiring goods from an unregistered person, it is necessary to allow the registered person to claim an input tax credit which reflects the sales tax already included in the acquisition price. Otherwise, there would not be neutrality because taxable goods would be taxed twice and would thus bear a higher tax burden. Neutrality can be achieved by providing a special regime in respect of specified goods,18 which permits an input deduction for a notional tax element in the price paid by the registered purchaser notwithstanding that the unregistered vendor will not have to account for any corresponding amount of sales tax. There is still likely to be the controlling influence of market forces where the parties are not associated persons but the absence of a sales tax accounting at both ends gives rise to the possibility of a transaction being structured so as to have the effect of producing an artificially enhanced consideration or an artificial advancement of the point at which a deduction is claimable.19
The whole premise of the act is that transactions will be driven by market forces: that their commercial and fiscal effects will be produced by those forces and will not contain distortions which affect (ie defeat) the contemplated application of the act. It is when market forces do not prevail that provisions of section 2(46) are available to the commissioner. Take an obvious example, an unregistered vendor and a registered purchaser, not being associated persons, inflate the price of goods in return for a non-recourse loan to the purchaser by the vendor. The purchaser obtains the advantage of a higher input tax deduction/refund. This would plainly defeat the intent and application of the act, namely that the purchaser's deduction would be no more than the tax fraction of the market price of the goods. If the prices were influenced by the tax advantage, the purchaser may be achieving something not contemplated by the act - an artificially enhanced deduction. It is the same if the structure of the transaction enables the purchaser to obtain an artificially early deduction, that is, one which is unrelated to the market realities of the transaction.
It may be said that to approach the question of the intent and application of the act in this way is not to respect the bargain struck by the parties and would allow the commissioner to restructure their bargain for them with different sales tax consequences, and would thus be productive of uncertainty. But that uncertainty is inherent where transactions have artificial features combined with advantageous tax consequences not contemplated by the scheme and purpose of the act. There will also inevitably be uncertainty whenever a taxing statute contains a general anti-avoidance provision intended to deal with and counteract such artificially favourable transactions. It is simply not possible to meet the objectives of a general anti-avoidance provision by the use, for example, of precise definitions, as may be able to be done where an anti-avoidance provision is directed at a specified type of transaction.
Transactions which are driven only by commercial imperatives are unlikely to produce tax consequences outside the purpose of the legislation and, in any isolated case in which the commercial drivers do have unusual consequences, the existence of those consequences will surely alert the parties to the possibility that the commissioner may consider invoking the general anti-avoidance provision and may have to be persuaded that the intent of the legislation is not actually offended. For example, an advance ruling can be sought. Because, it is not the price but the "payment" that creates the distorting effect.20
It may be stated that, the commissioner may properly be satisfied that the arrangement was entered into between the parties to defeat the intent and application of the act, and he may treat such arrangements to be void for the purposes of the act. The commissioner may then adjust the amount of the tax which is refundable "in such a manner as the commissioner considers appropriate so as to counteract any tax advantage obtained ... from or under that arrangement".21
(The writer is an advocate and is currently working as an associate with Azim-ud-Din Law Associates)
1.Section 3 of the Sales Tax Act, 1990 (hereinafter referred to as the Act).
2. In respect of a taxable supply, the consideration in money including all Federal and Provincial duties and taxes, if any, which the supplier receives from the recipient for that supply but excluding the amount of tax.
3. Id n.1
4. Sub-section (12) of Section 2 of the Act.
5. Sub-section (46) of Section 2 of the Act.
6. Id n.4
7. Id n.4
8. Sub-section (46) of Section 2 of the Act, 1990.
9. Provided that the tax invoice shows the discounted price and the related tax and the discount allowed is in conformity with the normal business practices.
10. By the Valuation Committee comprising representatives of trade and the Inland Revenue constituted by the Commissioner.
11. In terms of the sub section (46) of Section 2
12. See the circumstances as defined in sub-section (46) of Section (2) of the Act.
13. Newton v CIT: (1958) AC 450.
14. Ashton v CIR: [1975] 32 NZLR 717.
15. Clough, A Study of New Zealand's Experience with the Goods and Services Tax (1958) Working Paper 1988/27 (Wellington: NZIER).
16. Tait, Alan A.: Value Added Tax: International Practice and Problems: International Monetary Fund Washington, D.C. (1988).
17. Nicholls v CIR (1999) 19 NZTC 15.
18. See Section 2 of the Act.
19. Ben Nevis Forestry Ventures Ltd v CIR [2008] NZSC 115.
20. Id n.3 ante.
21. See Section 2(46) of the Act.