PENNY & ANOR V COMMISSIONER OF INLAND REVENUE HC CHCH CIV-2007-409-1153

PENNY & ANOR V COMMISSIONER OF INLAND REVENUE HC CHCH CIV-2007-409-1153 19 March 2009IN THE HIGH COURT OF NEW ZEALAND CHRISTCHURCH REGISTRY CIV-2007-409-1153IN THE MATTER OF The Income Tax Act 1994 and the Tax Administration Act 1994 BETWEEN IAN DAVID PENNY Plaintiff AND THE COMMISSIONER OF INLAND REVENUE DefendantCIV-2007-409-1154AND IN THE MATTER OF The Income Tax Act 1994 and the Tax Administration Act 1994 BETWEEN GARY JOHN HOOPER Plaintiff AND THE COMMISSIONER OF INLAND REVENUE Defendant Hearing: 28-31 October 2008 Counsel: G J Harley and C E Bibbey for plaintiffs D J Goddard QC and H W Ebersohn for Defendant Judgment: 19 March 2009 at 2pm In accordance with r 11.5 I direct the Registrar to endorse this judgment with a delivery time of 2pm on the 19 th day of March 2009.RESERVED JUDGMENT OF MACKENZIE J TABLE OF CONTENTSIntroduction............................................................................................................... [1] Background facts ...................................................................................................... [3](a) Mr Hooper ........................................................................................................ [4](b) Mr Penny........................................................................................................... [7] Tax Treatment........................................................................................................... [8] The rival contentions .............................................................................................. [12] The legal principles................................................................................................. [14] The arrangement ..................................................................................................... [22](a) The formation of the company ........................................................................ [23](b) The fixing of the salary ................................................................................... [49](c) The benefit of the money ................................................................................. [68] Overall consideration.............................................................................................. [73] Result ...................................................................................................................... [82]Introduction[1] These two challenges by the plaintiff taxpayers to assessment by the Commission raise similar issues and were heard together. It is convenient to deliver a joint judgment. [2] Each of the plaintiffs is an orthopaedic surgeon in practice in Christchurch. They practise partly in the public health sector. For a portion of their time, each of them also conducts a private practice, for private fee paying patients. Initially, eachpractised on his own account. That is to say, the practice was conducted by them personally, and the income from the practice was the personal income of the surgeon. Subsequently, each incorporated his practice, so that the practice was carried on by a company, and the surgeon provided treatment on behalf of the company, pursuant to a contract of employment. The Commissioner formed the view that the totality of the arrangements involving the surgeon and the company constituted a tax avoidance arrangement, and has issued assessments for a number of income years in respect of each of the plaintiffs accordingly. The plaintiffs challenge the validity of those assessments.Background facts[3] I first describe briefly the basic facts as to the practice arrangements in each case. These facts are essentially not in issue. I leave for later discussion some more contentious factual issues on aspects relevant to a determination of the purpose and effect of these arrangements.(a) Mr Hooper[4] Mr Hooper has practised as a specialist orthopaedic surgeon in Christchurch since 1985, and has been employed in that capacity by the Canterbury District Health Board (CDHB) throughout that period. CDHB employs specialists for a proportion of their working time, measured in 10ths. Initially, he was employed on a 10/10ths basis. In 1989 he reduced this to 7/10ths. At that time he began to practise also in the private sector, initially by joining a group of specialists in the Leinster Orthopaedic Centre. In that Centre, there were a number of surgeons (five, after Mr Hooper joined the Centre) each conducting their own separate practices, but sharing staff, equipment and facilities under arrangements governed by a Deed of Management. In 1991, Mr Hooper and his wife were each the settlor of a Family Trust, in the form usually described as "mirror trusts". The Trustees of both Trusts were their solicitor, and their accountant. The beneficiaries were, in each case, the spouse, and their children and grandchildren. The Trusts were set up specifically to buy a half share each of a 1/5th interest in the premises occupied by the LeinsterOrthopaedic Centre, previously occupied under a Deed of Licence. Those arrangements had been intended to take effect when he first joined the Centre, but were delayed. [5] From 2000, the practice arrangements were restructured. A new company, Hooper Orthopaedic Limited (HOL), was formed with 1,000 shares, owned as to 495 shares each by the Family Trusts and five shares each by Mr Hooper and his wife. Mr Hooper was the sole director. Mr Hooper's orthopaedic practice was sold to the company for $332,473, which included $330,000 for goodwill. The company assumed Mr Hooper's obligations in respect of the Leinster Orthopaedic Centre. Mr Hooper was employed by the company to carry out the surgery work. Mr Hooper's evidence is that after the transfer of the practice to the company his workday remained essentially the same. He continued to practise as an orthopaedic surgeon with the same expertise and skill as before, he saw the same number of patients, he continued to operate on his set operating sessions at the two private hospitals in Christchurch and patients continued to look to him for their wellbeing. While the practice has been conducted by the company, the referral of patients has almost invariably been to Mr Hooper personally, not to the company. Letters are addressed to him personally. That is also the case with patients seen through CDHB, once he is the surgeon on record. Letters which he writes from the practice are written on letterhead which does not refer to the company. [6] Mr Hooper is paid a salary by the company. His evidence is that as sole director of the company he had to make a decision about how much he would be paid as an employee. In each of the 2001 to 2004 income years, a salary of $119,990 was fixed. That salary was the amount returned by Mr Hooper as his income in respect of the practice in each of those years. The income derived from fees paid by patients constituted income of the company which was, after deduction of expenses (including Mr Hooper's salary) returned as the company income. During those income years, each Trust received fully imputed dividends from the company. A portion of the Trust's income was distributed to Mr Hooper's three daughters and taxed as their income, the remainder was retained by the Trusts as Trustee income. The relevant figures are set out in the following table:Income of HOL Salary from HOL Salary from CDHB Dividends by HOL Year $ $ $ $2001 593,914 119,990 104,054 227,800 2002 447,915 119,990 104,086 341,700 2003 502,882 119,990 79,455 227,800 2004 140,095 *420,297 87,948 392,205* See paragraph [8](b) Mr Penny[7] Mr Penny is also a specialist orthopaedic surgeon who has worked in that capacity for the CDHB since 1989. Initially he worked on an 11/10ths basis. In 1991 he commenced private practice as a specialist orthopaedic surgeon. Initially he practised on his own account as a sole trader. In 1997 he incorporated Penny Orthopaedic Services Limited (POS), of which he was the sole shareholder, and Orthopaedic Surgical Consultancy Limited (OSCL), all shares in which were owned by A C Penny No 1 Trust (the Trust) which was set up at that time. The Trustees were Mr Penny's accountant and solicitors and the final beneficiaries were himself and his wife and their children and grandchildren. The premises in which the practise was conducted, which were to that point owned by Mr Penny, were leased by him to POS and then sold to the Trust. His orthopaedic practise was transferred to POS in February 1997 for the sum of $144,310, including $100,000 for goodwill. He entered into an employment contract with POS. In April 1997, OSCL purchased the surgical and medical practice from POS for $1,044,310. Goodwill was set at $1,000,000. This two-stage process for the transfer of the business to OSCL was part of a single restructuring plan. After the restructuring Mr Penny's day to day work arrangements remained essentially the same. Patients looked to him personally for their wellbeing. His letterhead was not changed, but invoices were issued in the name of the company. Each year, a salary was fixed, essentially by Mr Penny, and Mr Penny returned that amount as his income from private practise. The fees paid by patients formed the income of OSCL and that income was, after deduction ofexpenses (including Mr Penny's salary) returned as taxable income by the company. The Trust, as sole shareholder is OSCL, received fully imputed dividends from OSCL in each year and the dividends were substantially all retained as Trustee income, and returned as such to the Commissioner. The relevant figures are in the following table:Income of OSCL Salary from OSCL Dividends by OSCL Year $ $ $1998 299,365 *83,333 1999 432,962 ++ 259,999 2000 432,175 124,829 2001 484,779 99,996 133,064 2002 609,871 99,996 1,175,545 2003 566,183 99,996 348,400 2004 161,746 **485,235 348,400* plus $100,635 as a director's bonus++ plus $42,483 as a director's bonus ** see paragraph [8]Tax Treatment[8] In each case, tax returns were filed returning income for each of the relevant income years in accordance with the arrangements which I have briefly described. In each case, the Commissioner undertook reviews of the taxpayers' returns, commencing in April and May 2004. A notice of proposed adjustment was issued in respect of the relevant income years, the tax years ended 31 March 2002, 2003 and 2004. Speaking broadly, the effect of the adjustment in each case was to increase the taxable income of Mr Hooper and Mr Penny in each year by an amount equal to the difference between the salary actually paid by the company to the taxpayer, and what the Commissioner assessed as a commercially realistic salary for the services provided by the taxpayer to the company. In the case of each taxpayer, the investigation had commenced before the returns for the 2004 year were due. Bothtaxpayers were concerned about the potential penalty consequences if their previous practices as to salary were followed for that year. Accordingly, each taxpayer returned a larger salary than that actually received. However, each also followed the statutory procedure and gave a Notice of Proposed Adjustment (NOPA) seeking an adjustment to reflect the salary actually received. The amount in issue is, for the 2002 and 2003 years, the difference between the income returned by the taxpayer and the income assessed by the Commissioner. For the 2004 years, it is the difference between the income claimed in the taxpayer's NOPA and the income assessed by the Commissioner. It was not suggested in argument that this procedural distinction between the years would lead to any different outcome. [9] There would, in each case, have been a consequential adjustment to the income of the company of the same amount, to reflect the additional expenditure which would have been incurred by the company had the salary assessed by the Commissioner been paid. Those adjustments are not directly before me. It was common ground between the parties that such an adjustment would be a necessary consequence of the Commissioner's approach. [10] For taxation purposes, the significance of increasing the taxable income of the taxpayers, and reducing the taxable income of the companies, in accordance with the Commissioner's assessments, arises from the fact that in the relevant years the rates of tax payable on income derived by a company differ from those imposed on the income of an individual taxpayer. Tax was imposed on the taxable income of a company at the rate of 33 cents in the dollar. Tax on the income of individual taxpayers was payable on a graduated scale. The rate applicable to the income in question in these proceedings would in each case have been 39 cents in the dollar. The amounts of tax in issue arising from that rate differential as I understand them to be are set out in the following table. This table is intended by me to set out the practical effect of a determination as to whether or not the arrangements in each case constitute tax avoidance. It has regard not only to the income of the taxpayers, but also that of the companies, in that it assumes (although the position of the companies is not before me) that a corresponding adjustment is made to the income of the company in each case. The "additional salary" in each case is that assessed by theCommissioner, except that, for 2004, the amount is calculated by reference to the taxpayer's NOPA, rather than to the salary actually returned (as I have explained).Hooper 2002 2003 2004Additional salary $410,010 $410,010 $310,010 Tax difference (6¢ per $1) 24,600 24,600 18,600PennyAdditional salary $561,004 $561,004 $517,004 Tax difference (6¢ per $1) 33,660 33,660 31,020 [11] In each case, the statutory dispute resolution procedures were followed, and a review was conducted by the Adjudication Unit. Very comprehensive Adjudication Reports were issued, dated in each case 22 March 2007. The conclusions of the Adjudication Unit in each case were: (a) That based on the legal arrangements entered into the income was derived by the company, and that the personal exertion principle argued by the Commissioner did not apply in this context; therefore the income returned by the company could not be attributed to the taxpayer as income under ordinary concepts under section CD 5; and (b) That section BG 1 applies to the arrangement entered into by the taxpayer; the essential elements of that arrangement involving the carrying on of the orthopaedic practice using the company structure and the fixing of the salary of the taxpayer at a level below a commercially realistic salary. The proceedings issued by each taxpayer followed these Adjudication Reports.The rival contentions[12] The Commissioner contends that the arrangements in respect of the private practice of each of Mr Penny and Mr Hooper constituted tax avoidance arrangements for the purposes of s BG 1 of the Income Tax Act 1994. Mr Goddard QC submits that this is a clear case of tax avoidance. He submits that the tax purpose, and lack of a commercial purpose, of the arrangements is demonstrated by the cumulative effect of features such as the following: (a) The artificially low salaries paid to Mr Hooper and Mr Penny by their practice companies; (b) The fact that Mr Hooper and Mr Penny controlled the companies and trusts, and that their families continued to live on the income coming from the same source (being their medical practices); (c) The availability of such income to Mr Hooper and Mr Penny (and the use of such income by them in such a way that it was not derived as income by them); (d) Mr Hooper and Mr Penny being prepared to assign away their future earnings for inadequate consideration; (e) The change in their practices not being commercially driven as demonstrated by the practices continuing in terms of day to day functioning as they had before; (f) The actual tax benefits that were the effect (and therefore also the purpose) of the arrangement; and (g) The lack of any other reasonable explanation for the arrangementsCounsel submits that for these reasons the arrangements had a more than merely incidental purpose of tax avoidance and were therefore tax avoidance arrangements. He submits that the Commissioner's case is, and has always been, that the tax avoidance is constituted by the manner in which the plaintiffs have used their company and trust structures. It is not the Commissioner's case that the failure to pay a commercially realistic salary is tax avoidance. He submits that the totality and cumulative effect of the arrangements must be considered. [13] Mr Harley for the taxpayers submits that in neither case is there a tax avoidance arrangement. The contention for both taxpayers is summed up in counsel's submissions in these terms: (a) There is no "tax avoidance arrangement" in s BG 1 terms, because the two taxpayers are employed by their Family Companies; (b) Neither of the taxpayers derives what the Commissioner considers to be employment income at his commercially realistic salary level; and (c) The Act does not within the purview of its statutory scheme – reflecting the Personal Services Attribution Rules – contain any notion of the commercially realistic salary concept. Rather, the Commissioner has made it up, in an effort to eliminate the Rate Advantage which became evident in April 2000, when the Government increased the maximum personal income tax rate from 33% to 39%.The legal principles[14] The applicable statutory provisions may be shortly stated. The key provision is s BG 1. That provides:BG 1 AvoidanceArrangement void(1) A tax avoidance arrangement is void as against the Commissioner for income tax purposes. Enforcement (2) The Commissioner, in accordance with Part G (Avoidance and Non-Market Transactions), may counteract a tax advantage obtained by a person from or under a tax avoidance arrangement.[15] The term "tax avoidance arrangement" is defined in s OB 1 in the following terms:Tax avoidance arrangement means an arrangement, whether entered into by the person affected by the arrangement or by another person, that directly or indirectly— (a) Has tax avoidance as its purpose or effect; or (b) Has tax avoidance as one of its purposes or effects, whether or not any other purpose or effect is referable to ordinary business or family dealings, if the purpose or effect is not merely incidental:[16] The term "tax avoidance" is in turn defined as follows:Tax avoidance, in sections BG 1, EH 1, EH 42, GB 1, and GC 12, includes— (a) Directly or indirectly altering the incidence of any income tax: (b) Directly or indirectly relieving any person from liability to pay income tax: (c) Directly or indirectly avoiding, reducing, or postponing any liability to income tax:[17] Where a tax avoidance arrangement is void under s BG 1, the Commission may make adjustments to counteract any tax advantage, under s GB 1(1) of which provides:GB 1 Agreements purporting to alter incidence of tax to be void(1) Where an arrangement is void in accordance with section BG 1, the amounts of gross income, allowable deductions and available net losses included in calculating the taxable income of any person affected by that arrangement may be adjusted by the Commissioner in the manner the Commissioner thinks appropriate, so as to counteract any tax advantage obtained by that person from or under that arrangement, [18] While the relevant provisions may be shortly stated, the principles governing their application cannot be so shortly expressed. These provisions, and their predecessors, have been the subject of intense judicial scrutiny, and much judicial ink has been spilt wrestling with the essential paradox inherent in the provision: that an arrangement which, on the literal application of the specific provisions of the Income Tax Act, leads to a particular incidence of and liability to pay tax, is nevertheless to be regarded as having the purpose or effect of avoiding some other incidence of and liability for tax. Counsel on both sides addressed at considerable length, and with great skill, the numerous authorities which discuss the approach to be adopted in addressing this paradox. I intend no disrespect to those arguments by not addressing the earlier authorities. Since the hearing before me, the Supreme Court has delivered its decision in Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115 and, at the same time, its decision on a related issue, tax avoidance in the GST context, in Glenharrow Holdings Ltd v Commissioner of Inland Revenue [2008] NZSC 116. Those cases had been heard before this hearing. Counsel, in a joint memorandum, have indicated that an opportunity to make further submissions in the light of those decisions is not sought. As the issues were very fully and ably argued, I have not found it necessary to seek further submissions. The Supreme Court has reviewed the relevant authorities in detail. It has restated the principles to be applied and the approach to be adopted when applying the tax avoidance provisions. It will not therefore be helpful for me to examine the authorities to which the Supreme Court has had regard in stating the relevant principles and approach. Rather, it is appropriate for me to apply the principles and approach enunciated to the facts of the cases before me. [19] The essence of the Supreme Court's decision is to endorse a 'scheme and purpose' approach. The majority (Tipping, McGrath and Gault JJ) discuss the authorities which are consistent with such an approach at paragraphs [84] to [99], and note the uncertainty which arises from a recent suggestion by the Privy Council that the role of the general anti-avoidance provision may be as a long-stop. They then express the approach to be adopted in these terms:[102] It is accordingly the task of the Courts to apply a principled approach which gives proper overall effect to statutory language that expresses different legislative policies. It has long been recognisedthose policies require reconciliation. The approach must ensure that the particular case before the court is examined by reference to the respective legislative policies. It must enable decisions to be made on individual cases through the application of a process of statutory construction focusing objectively on features of the arrangements involved, without being distracted by intuitive subjective impressions of the morality of what taxation advisers have set up. [103] We consider Parliament's overall purpose is best served by construing specific tax provisions and the general anti-avoidance provision so as to give appropriate effect to each. They are meant to work in tandem. Each provides a context which assists in determining the meaning and, in particular, the scope of the other. Neither should be regarded as overriding. Rather they work together. The presence in the New Zealand legislation of a general anti- avoidance provision suggests that our Parliament meant it to be the principal vehicle by means of which tax avoidance is addressed. The general anti-avoidance regime is designed for that purpose, whereas individual specific provisions have a focus which is determined primarily by their ordinary meaning, as established through their text in the light of their specific purpose. In short, the purpose of specific provisions must be distinguished from that of the general anti- avoidance provision. [104] Parliament must have envisaged that the way a specific provision was deployed would, in some circumstances, cross the line and turn what might otherwise have been a permissible arrangement into a tax avoidance arrangement. Ascertaining when that will be so should be firmly grounded in the statutory language of the provisions themselves. Judicial attempts to articulate how the line is to be drawn have in the past too often been seized on as if they were equivalent to statutory language. Judicial glosses and elaborations on the statutory language should be kept to a minimum. [105] The key statutory concept in the general anti-avoidance provision is of a tax avoidance arrangement, as Parliament has defined it. By means of the definition of tax avoidance, a tax avoidance arrangement includes an arrangement which directly or indirectly alters the incidence of any income tax. It is arrangements of that and allied kinds which are void against the Commissioner under s BG 1(1). An arrangement includes all steps and transactions by which it is carried out. Thus, tax avoidance can be found in individual steps or, more often, in a combination of steps. Indeed, even if all the steps in an arrangement are unobjectionable in themselves, their combination may give rise to a tax avoidance arrangement. [106] Put at the highest level of generality, a specific provision is designed to give the taxpayer a tax advantage if its use falls within its ordinary meaning. That will be a permissible tax advantage. The general provision is designed to avoid the fiscal effect of tax avoidance arrangements having a more than merely incidental purpose or effect of tax avoidance. Its function is to prevent uses of the specific provisions which fall outside their intended scope in the overall scheme of the Act. Such uses give rise to an impermissible tax advantage which the Commissioner may counteract. The generalanti-avoidance provision and its associated reconstruction power provide explicit authority for the Commissioner and New Zealand courts to avoid what has been done and to reconstruct tax avoidance arrangements. [107] When, as here, a case involves reliance by the taxpayer on specific provisions, the first inquiry concerns the application of those provisions. The taxpayer must satisfy the Court that the use made of the specific provision is within its intended scope. If that is shown, a further question arises based on the taxpayer's use of the specific provision viewed in the light of the arrangement as a whole. If, when viewed in that light, it is apparent that the taxpayer has used the specific provision, and thereby altered the incidence of income tax, in a way which cannot have been within the contemplation and purpose of Parliament when it enacted the provision, the arrangement will be a tax avoidance arrangement. For example the licence premium was payable for a "right to use land", according to the ordinary meaning of those words, which of course includes their purpose. But because of additional features, to which we will come, associated primarily with the method and timing of payment, it represented and was part of a tax avoidance arrangement. [108] The general anti-avoidance provision does not confine the Court as to the matters which may be taken into account when considering whether a tax avoidance arrangement exists. Hence the Commissioner and the courts may address a number of relevant factors, the significance of which will depend on the particular facts. The manner in which the arrangement is carried out will often be an important consideration. So will the role of all relevant parties and any relationship they may have with the taxpayer. The economic and commercial effect of documents and transactions may also be significant. Other features that may be relevant include the duration of the arrangement and the nature and extent of the financial consequences that it will have for the taxpayer. As indicated, it will often be the combination of various elements in the arrangement which is significant. A classic indicator of a use that is outside Parliamentary contemplation is the structuring of an arrangement so that the taxpayer gains the benefit of the specific provision in an artificial or contrived way. It is not within Parliament's purpose for specific provisions to be used in that manner. [109] In considering these matters, the courts are not limited to purely legal considerations. They should also consider the use made of the specific provision in the light of the commercial reality and the economic effect of that use. The ultimate question 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. If that is so, the arrangement will not, by reason of that use, be a tax avoidance arrangement. If the use of the specific provision is beyond Parliamentary contemplation, its use in that way will result in the arrangement being a tax avoidance arrangement.[113] Before concluding this section of our reasons, we should recognise that para (b) of the definition of a tax avoidance arrangement refers to cases where the tax avoidance purpose or effect of an arrangement is "merely incidental". If that is so, the arrangement is not a tax avoidance arrangement. It is apparent therefore that the use of a specific provision which alters the incidence of tax is permitted in two situations. [114] The first is when the specific provision is used in a manner which is within Parliamentary contemplation, as discussed above. The second is when the tax avoidance purpose or effect of the arrangement is "merely incidental". It will rarely be the case that the use of a specific provision in a manner which is outside Parliamentary contemplation could result in the tax avoidance purpose or effect of the arrangement being merely incidental. In the present case the appellants did not seek to rely on the merely incidental concept, so nothing more need be said on that subject.[20] Elias CJ and Anderson J, while agreeing with the majority as to the outcome, express reservations on aspects of the reasoning of the majority. They said:[2] We write separately to express reservations on aspects of the reasoning adopted by Tipping, McGrath and Gault JJ, not essential to their conclusions on the application of s BG 1 and the consequences. We differ from them in being of the view that the specific statutory allowances under the Income Tax Act are not in potential conflict with the general anti-avoidance provision and that the two do not need reconciliation. Rather, both are to be purposively and contextually interpreted, as is required by s 5 of the Interpretation Act 1999 and s AA 3 of the Income Tax Act. Recourse to the general anti-avoidance provision is not necessary "to prevent uses of the specific provisions which fall outside their intended scope in the overall scheme of the Act". If the use of a specific provision falls outside its intended scope in the scheme of the Act, the use is not authorised within the meaning of the specific provision. This approach is in our view required by settled principles of statutory construction. It avoids the distortion of overuse and unnecessary expansiveness in application of the general anti- avoidance provision. On this view, we do not think that there are stark differences between the general approach to statutory interpretation of specific tax provisions in New Zealand and in the United Kingdom, at least since W T Ramsay Ltd v Inland Revenue Commissioners and Furniss (Inspector of Taxes) v Dawson. The rejection of literal interpretation described by Lord Steyn and Lord Cooke in Inland Revenue Commissioners v McGuckian applies equally in construing the New Zealand specific tax provisions. [3] The first question is whether the claimed allowance or deduction falls within the meaning of the specific provision, purposively construed. If it does not, the Commissioner can disallow the claim and, if of the view that it is itself a tax avoidance arrangement (because its purpose or effect is to alter the incidence of tax), can treat it as void under s BG 1. If the claim is within the meaning ofthe specific tax provision, purposively interpreted, an arrangement on which it is based may nevertheless constitute tax avoidance if it has the purpose or effect of altering the incidence of tax. If however the basis of claim is not, in itself or as part of a wider scheme, an arrangement with the purpose or effect of altering the incidence of tax, it is not tax avoidance under s BG 1. [8] In Tayles v Commissioner of Inland Revenue, McMullin J (with whom the other members of the Court of Appeal expressed agreement) applied the approach adopted in Newton v Commissioner of Taxation of the Commonwealth of Australia26 that: The word 'purpose' means, not motive but the effect which it is sought to achieve – the end in view. The word 'effect' means the end accomplished or achieved. The whole set of words denotes concerted action to an end – the end of avoiding tax. More recently, Sir Anthony Mason, sitting in the Hong Kong Court of Final Appeal, has also said of the application of tax legislation purposively construed to a transaction or arrangement that it is concerned with "the aim or end in view". In this case it is not necessary to revisit that approach. Applying it, "effect" is part of a composite term so that the general anti-avoidance provision is concerned with arrangements having the "intended effect" or object of altering the incidence of tax. That is not to say that purpose is to be equated with the motive of the taxpayer or the motives of the architects of the arrangement. It is well established that motive is not determinative, although it may be evidence which sheds light on a purpose of tax avoidance and so is not wholly irrelevant. [9] Tax avoidance occurs when the object or end in view or design of an arrangement is alteration of the incidence of tax and that object is not incidental to a business purpose. Such assessment does not entail reconstruction of the arrangements entered into. It requires realistic assessment of their purpose or effect. The evaluation required is a "question of mixed fact and law", as Lord Cooke suggested inMcGuckian. The fact that some business effect is also achieved does not prevent a conclusion that the purpose or effect of an arrangement is to alter the incidence of tax. As s BG 1 makes clear, an arrangement tips into tax avoidance if the fiscal effect intended is more than "merely incidental" to the business or family purpose. The fiscal implications of an arrangement that is "merely incidental" to a business purpose may in some cases be substantial and still within the statutory scheme and purpose. "Merely incidental" may properly be contrasted with the end in view, the "purpose or effect".[21] I endeavour in the discussion which follows to apply the approach directed by the Supreme Court. I return as necessary to aspects of the reasoning of the Court in considering specific issues.The arrangement[22] As I have noted, counsel for the Commissioner submits that it is the totality of the steps taken, from the formation of the company, through the fixing and paying of the salary, and the payments from the companies through the trusts to the beneficiaries which constitute the arrangement. That submission receives support inBen Nevis, at paragraph [105]. The inquiry into scheme and purpose is to be conducted having regard to the arrangement as a whole, not to its constituent parts. However, where a tax avoidance arrangement is said to arise from the combination of a number of steps, each of which involves consideration of the effect of a different set of specific provisions in the Act, it appears to me to be necessary, in conducting the requisite scheme and purpose analysis, to consider the scheme and purpose of each set of specific provisions. That involves, as an initial step, a separate consideration of each step of the arrangement which is governed by a particular set of specific provisions.(a) The formation of the company[23] I use this description as a convenient shorthand to describe all of the steps involved in effecting the decision made by the taxpayer to change his mode of private practice from conducting that as a sole trader to conducting it through a company. Those include the formation of the company and the transfer of the business to it. It is common ground that there is, in the case of each taxpayer, a genuine and substantial business, the principal source of income of which is the fees payable by patients for orthopaedic surgery. It is also common ground that the ability to provide the services to patients for which their fees are payable is personal to the taxpayers. The services are dependent on the skill and training of the taxpayers, and are performed by them personally. The patients regard the taxpayer as their orthopaedic surgeon. It is also clear that the provision of the services to patients requires some resources which are not provided by the taxpayers personally. Mr Lyne's evidence (which I later discuss in more detail), analysing the accounts of each of the practices, illustrates this. For Mr Penny, external expenses, being those taken into account in calculating earnings before interest, tax and remuneration toMr Penny (EBITP), were in the range of 35% to 39% of total income for the relevant years. For Mr Hooper, the equivalent range was 43% to 48%. The business did not need extensive facilities or equipment: surgery was performed in private hospitals, and the fixed assets which were owned by the practice were limited. For Mr Penny, the book value of fixed assets employed was around 6% to 9% of total income, for Mr Hooper 1% to 2%. These facts are sufficient to demonstrate what is an important plank in the Commissioner's argument, namely that the income derived by the practice is in each case very substantially derived from the personal exertions and the personal expertise of the taxpayer. Indeed, that broad proposition is not challenged by the taxpayer. [24] On the plain words of the statute, the transfer of the practice to the company altered the incidence of tax. The decision to conduct the practice through the company had different tax consequences from those which applied when the practice was conducted personally. Tax is imposed on income. Here, the relevant income is the income of the practice – in broad terms, the fees paid by the patients. Previously, that income was derived by the taxpayer. After the company formation, it was derived by the company. The incidence of tax was altered by that arrangement, both because the tax was payable by a different taxpayer, and because the rates were different. To that extent then, on a literal reading of s BG 1 the formation of the company and the conduct of the practice by it had the effect of altering the incidence of tax. [25] However, on the scheme and purpose approach to the interpretation of the anti-avoidance provisions, that alteration is not, of itself, sufficient to bring the situation within the definition of the tax avoidance. It is necessary to consider, in the light of the specific provisions which determine by whom income is derived and what tax is payable by the person deriving that income, whether the incidence of tax is consistent with the intent of these specific provisions, as mandated in Ben Nevis at paragraph [108]. The relevant inquiry, in determining whether the step of incorporating the practice, so that the fee income from patients was derived not by the taxpayer but by the company was, or was part of, a tax avoidance arrangement, must be to investigate whether the alteration of the incidence of income tax which necessarily results from the earning of that income by the company rather than theindividual is consistent with the scheme and purpose of the Income Tax Act, which assigns the different tax consequences to these different categories of person. If it is consistent with that scheme and purpose, then it will not of itself constitute a tax avoidance arrangement, though further inquiry into the purposes of the adoption of the corporate vehicle in the context of the other steps in the arrangement will be necessary. If the formation of the company is not so consistent, then it may have a tax avoidance effect. A more detailed examination of the purposes of that step will be necessary, to determine the true purposes of the adoption of the corporate vehicle, and whether the tax change effect of it is more than merely incidental to some other purposes. [26] It is clear that that the decision to incorporate the practice was in each case the decision of the taxpayer. It was and is the taxpayer in each case who is in receipt of the referrals. It was the taxpayer who decided that in the future he would not conduct his practice as a sole trader, but would carry on what was essentially the same practice under the different legal arrangement involved. Some reliance was also placed by counsel for the Commissioner on the proposition that while the legal arrangement was different, the practical day to day arrangements did not change. Counsel pointed out (but did not stress) that the arrangements may not have complied with s 25 of the Companies Act 1993, which requires the use of the company name on all communications. It is not however suggested that the transfer of the practice to the company was a sham. [27] The formation of the company and the conduct of the practice through it was in commercial law terms a valid choice of business structure. The notion that the formation of a company which is under the effective control of one person is a misuse of the corporate form was rejected well over a century ago. In Salomon v Salomon and Co. [1897] AC 22 Lord Halsbury said: (p 33)My Lords, the learned judges appear to me not to have been absolutely certain in their own minds whether to treat the company as a real thing or not. If it was a real thing; if it had a legal existence, and if consequently the law attributed to it certain rights and liabilities in its constitution as a company, it appears to me to follow as a consequence that it is impossible to deny the validity of the transactions into which it has entered.Lord Macnaghten said: (p 53)It has become the fashion to call companies of this class 'one man companies.' That is a taking nickname, but it does not help one much in the way of argument. If it is intended to convey the meaning that a company which is under the absolute control of one person is not a company legally incorporated, although the requirements of the Act of 1862 may have been complied with, it is inaccurate and misleading: if it merely means that there is a predominant partner possessing an overwhelming influence and entitled practically to the whole of the profits, there is nothing in that that I can see contrary to the true intention of the Act of 1862, or against public policy, or detrimental to the interests of creditors.[28] That fundamental principle has been firmly established from a company law perspective. Its application in New Zealand was specifically affirmed by the Privy Council in Lee v Lee's Air Farming Limited [1961] NZLR 325, as was the consequential principle that the relationship of employer and employee may validly exist between such a company and the person who is its governing director. The principle was more recently affirmed by the Court of Appeal in Trevor Ivory Ltd v Anderson [1992] 2 NZLR 517. [29] From a tax perspective, the separate legal identity of a company and the individuals who control it, and the difference between an individual taxpayer and a company taxpayer, are also firmly established. Some provisions of the Income Tax Act apply to both companies and individuals, others apply to each of them separately. Importantly, for present purposes, the rate of tax payable by each is different. Accordingly, while on a literal reading of s BG 1 the structuring of the business through the company has the effect of altering the incidence of tax in the sense that the incidence is different from that which would apply if the person concerned were a sole trader, the effect is not one to which s BG 1 is directed, unless there is some other principle, expressed in or to be implied from the scheme and purpose of the Income Tax Act, which renders the use of the corporate form inappropriate for the achievement of the purposes of the Act. In the absence of some such principle, a choice made by a person who is able to conduct his or her profession, trade or calling either as an individual or through a company controlled and operated by that individual, to do so through a company does not fall outside the intended scheme and purpose of the Act. An important proposition in the Commissioner's case is that there is such a principle, namely that personal services income derived from the personal exertions of an individual is to be taxed as the income of that person. I turn to consider whether there is such a principle.[30] The scheme of the Income Tax Act is that it prescribes those items which fall within the scope of income which is assessed for tax. It also imposes tax consequences on that income. Those consequences may differ depending on the category of taxpayer who has derived the income – for example, a company, or an individual, or trustees. The Act does not, in general terms, prescribe that some items of income may be derived only by some categories of taxpayer. The income from the practices here is income derived from a business, governed by s CD3 which provides:The gross income of any person includes any amount derived from any business.The reference to "any person" indicates that the Income Tax Act is generally indifferent to the category of person by whom income from any business is derived. [31] Mr Goddard submits that, in the case of income from personal exertions, the scheme and purpose of the Act is not indifferent as to whether the income is derived by the individual whose exertions are involved, or by a company under the control of that person. He submits that the scheme and purpose of the Act indicate an intention that personal exertion income must be derived by the person by whose exertions the income is earned, so that an arrangement whereby the income from those exertions is derived instead by a company is contrary to the scheme and purpose of the Act. He further submits that the graduated rate structure which applies to individual taxpayers but not to corporate taxpayers indicates a statutory purpose which would be frustrated if income is not derived by the individual taxpayer, so that the effect of the graduated tax scale is avoided. [32] Mr Goddard places strong reliance, in support of both propositions (namely the proposition that personal exertion income must be derived by the person whose exertions are involved, and the importance of the graduated rate scale), on the decisions at all levels in Hadlee v Commissioner of Inland Revenue. In that case, a partner in a firm of chartered accountants was entitled to income from the partnership in proportion to the number of units of capital he owned in the partnership. He assigned a number of his units of capital to a Family Trust. In the High Court ([1989] 2 NZLR 447) Eichelbaum CJ held that the assignment did nottake effect sufficiently early to prevent the income from being regarded as income of the taxpayer assignor. Alternatively, the general anti avoidance provision applied. On the "personal exertion" issue, Eichelbaum CJ said (pp 463-4):The "personal services" groundThe Commissioner submitted that income from personal services was incapable of assignment per se, in that such income is always derived by the earner and, for tax purposes, cannot be the subject of an assignment taking effect in advance of its taxability. It was submitted that in New Zealand, the principle derived from Spratt v Commissioner of Inland Revenue [1964] NZLR 272 where Henry J said at p 277: "No taxpayer can, by way of assignment, escape assessment of tax on income resulting from his personal activities — such income always remains truly his income and is derived by him irrespective of the method he may adopt to dispose of it." That principle was adopted by Tompkins J as one of several grounds for finding in favour of the Commissioner in Johnstone's case in 1966, see [1966] NZLR 833 at pp 838-839 and likewise by Woodhouse J in Kelly's case in 1969, see [1970] NZLR 161 at p 165. In this country, the principle has never been tested at appellate level. As a matter of general law it is clear that, legislative prohibition apart, wages or salary may be the subject of valid assignment. Thus the doctrine must be a manifestation of tax law alone. One underlying rationale, at any rate, is not difficult to discern: that it is a premise of any income tax legislation based on a graduated scale of personal taxation, as has always been the case in New Zealand, that income generated by personal services will be "susceptible to the progressivity of the graduated rate structure by being taxed to the person whose personal exertion earned the income": Sir Ivor Richardson, "Appellate Court responsibilities and tax avoidance", (1985) 2 Australian Tax Forum 3, 14. On behalf of the objector it was submitted that the so-called principle had no basis in logic nor could it be justified by reference to any scheme or underlying objective of the Income Tax Act. On both sides the arguments appeared to take the New Zealand decision of Spratt as the genesis of the doctrine. However, reference to other material submitted to the Court shows that its origins go back much further. According to an article "The alienation and diversion of personal exertion income" by PJ Norman, (1986) 15 Australian Tax Review 209, 212 the principle was adopted by Australian Tax Review Boards in 1952, in reliance on Smyth v Stretton (1904) 5 Tax Cases 36, as interpreted in Parkins v Warwick (1943) 25 Tax Cases 419. The author commented that the history illustrated how a proposition founded on a somewhat dubious basis can "take on a life of its own" and "become reified in the conventional wisdom of tax jurisprudence". It has some support from Judges of the High Court of Australia, see Peate v Federal Commissioner of Taxation (1962) 111 CLR 443, 446 per Menzies J and Hollyock v Federal Commissioner of Taxation (1971) 125 CLR 647, 653 per Gibbs J. Against this background and in particular, acceptance of the principle as part of New Zealand tax law without dissent and without appellate examination for 25years, it is in my view inappropriate to review the underlying validity of the doctrine at first instance level. I propose to accept its correctness, and confine my examination to the question of the limits of the principle and its applicability to this case.[33] That decision was upheld in the Court of Appeal ([1991] 3 NZLR 517). On the personal exertion point, Cooke P accepted as correct the dictum of Henry J inSpratt v Commissioner of Inland Revenue [1964] NZLR 272, which had been cited by Eichelbaum CJ. He referred to Australian and United States authority, in particular the dissenting judgment of Murphy J in FC of T v Everett 80 ATC 4076 at p 4083-4085, and of Holmes J in Lucas v Earl 281 US 111 (1930), and said (at p 522):Mr Barton urged us not to follow Holmes J or Murphy J and not to endorse the New Zealand decisions at first instance. In my opinion, however, these authorities should be accepted and it should be held that the dictum of HenryJ correctly states the law of New Zealand. The Income Tax Act 1976 proceeds on the footing that all the profits derived from any business (including a profession) and all salary or wages (now subject to the PAYE regime) are part of the assessable income: see sec 65(2)(a) and (b). There is the corollary that, in calculating the assessable income of any taxpayer, any expenditure or loss may, except as otherwise provided in that Act, be deducted from the total income derived by the taxpayer to the extent to which it is incurred in gaining or producing the assessable income or is necessarily incurred in carrying on the business: see sec 104. As already indicated, the special section about partnerships interpreted in C of IR v Grover has a similar pattern: the effect is that the taxpayer returns his own gross income but is allowed his own permissible deductions for expenditure. Similarly, under sec 105 there is a standard deduction for every taxpayer who derives assessable income from employment: he is deemed to have incurred a certain amount of expenditure or loss in gaining or producing that income. These provisions contemplate that income is derived by the taxpayer who earns it. The considerations stated so vividly by Holmes J are cogent in relation to such a statutory scheme. The matter is further discussed in the judgment in this case of my brother Richardson, which I have had the advantage of seeing in draft, and I agree with all that he says about it. This is essentially an illustration of the approach of making the statute work, which this Court constantly tries to follow. The partner is trying to obtain a tax advantage over other chartered accountants and professional people and other earners who pay tax on their earnings. That is contrary to the intent of the Act as a whole and sec 99 in particular.[34] Richardson J said:Personal exertion incomeThere is a further consideration affecting the taxability of the income in this case. It concerns the nature of professional and personal earnings and the manner in which such earnings are derived. For much of its history the New Zealand tax legislation, along with parallel legislation in other jurisdictions, has drawn a clear distinction between earned and unearned income. That distinction has been important when differential rates have applied and in the grant of some exemptions. Underlying the differentiation is the statutory assumption that earned income is of a different nature or quality. In broad terms the distinction is between income from personal exertion and income from property. Personal exertion income of the self-employedThe next question is whether similar overriding considerations preclude recognising income splitting of other personal services income. In Spratt v CIR [1964] NZLR 272 at p 277, Henry J said: "No taxpayer can, by way of assignment, escape assessment of income tax resulting from his personal activities ⎯ such income always remains truly his income and is derived by him irrespective of the method he may adopt to dispose of it."Henry J did not articulate his reasons, nor did Woodhouse J in Kelly andTompkins J in Johnstone in adopting those propositions when discussing the partnerships with which they were concerned. But in policy terms the same general considerations that lead to the conclusion that the Income Tax Actrequires wage and salary earners to pay the tax on their earnings, must apply equally to the earnings of the self-employed from their personal exertions. The character or quality of the income which arises is the same in either case. Future wages and future receipts for personal services do not arise without that work. Personal exertion income has been deliberately distinguished from income from property in our legislation and in the legislation of other countries because of that perception that they are quite different in character. If the income is the product of personal exertion that stamp requires that it be taxed accordingly, and that any disposition of a related property interest should take effect subject to that charge for tax. The graduated rate structure is a basic feature of the New Zealand income tax system. If the income from an income earning activity can be divided between two or more taxpayers the total tax may be significantly less than had it been derived by one taxpayer. There is no justification in principle for differentiating between salary and wage earners and professionals whose income is the product of their personal exertion. In either case the person whose personal exertion earns the income derives the income. It would be wrong to impute an intention to Parliament that income splitting with its inevitable undermining of thegraduated rate structure should be widely available to professional and commercial taxpayers although denied to salary and wage earners. (p 523)[35] That decision was upheld in the Privy Council (Hadlee v Commissioner of Inland Revenue [1993] 2 NZLR 385). Their lordships said:Spratt v Commissioner of Inland Revenue related to an employee but Henry J's dictum was applied to partners by Tompkins J in Johnstone v Commissioner of Inland Revenue [1966] NZLR 833 and by Woodhouse J inKelly v Commissioner of Inland Revenue [1970] NZLR 161. In relation to these cases Cooke P said at p 522: "In my opinion, however, these authorities should be accepted and it should be held that the dictum of Henry J correctly states the law of New Zealand." Richardson J said at 533: "There is no justification in principle for differentiating between salary and wage earners and professionals whose income is the product of their personal exertion. In either case the person whose personal exertion earns the income derives the income." Their Lordships are in complete agreement with these comments and therefore conclude that the reasoning in Everett would not normally be applicable to the position of partners in New Zealand. Since no income producing proprietary interest was assigned by the taxpayer the argument fails.[36] The eminence and high authority of that decision is undoubted. However, its authority does not, in my view, extend to the proposition for which it is relied upon here. Hadlee was concerned with the assignment of income. This case is concerned with the derivation of income. These two concepts are quite different, in tax terms.Hadlee involved a partnership which derived income. As a partnership is not a taxpaying entity, the income of the partnership was that of the taxpayer partners. The issue was as to the effectiveness of an assignment of the income, which continued to be derived by the partnership (and hence by the partners). I do not consider that the case can safely or properly be relied upon in the quite different situation when the income is never derived by the professional person, but is instead derived by the company. Hadlee was concerned with a profession then ordinarily carried on by individual taxpayers, either alone or through partnerships. I would not lightly infer that the Courts there had in mind the possibility that the professional practice might be conducted by a company. If Cooke P's comments are taken to extend to that possibility, they are difficult to reconcile with his earlier decision atfirst instance in Loader v Commissioner of Inland Revenue [1974] 2 NZLR 472. There, an earthmoving contractor who had traded on his own account transferred his business to a company owned by a family trust, and he became an employee of the company. The Commissioner challenged the arrangements as tax avoidance. Cooke J said:At least it can be said, however, that incorporation of a company, establishment of a family trust, and sales and bailment of machinery are familiar types of transactions, which it would be natural to adopt to achieve the three objects. On this footing, assuming tax saving to have been a purpose also, I find it difficult to see on what ground the Court could be justified in singling that out as the sole or the principal purpose of the whole arrangement. The answer suggested by counsel for the Commissioner was the artificiality of a situation in which one man controls or very largely controls the administration of both trust and company and yet carries on the business much on the same lines in fact (apart from the increase in the size of the business) as before incorporation. Having regard to the familiar concepts of the separate identities of companies and trusts already mentioned, the situation does not appeal abnormally artificial. Moreover it would have been natural for the objector to retain day-to-day control to the extent enabled by the arrangement, even if the arrangement had been totally unconnected with any tax advantage.I do not consider that case to be inconsistent with Hadlee; rather, it deals with a quite different issue. Loader is closer to the facts of this case than is Hadlee. [37] The last sentence in the passage I have cited from the Privy Council decision also suggests that their Lordships did not have in mind a case where the entity by which the income was earned was no longer the individual taxpayer. In this case, the income producing proprietary interest, ownership of the practice, has been transferred to the company. [38] For similar reasons, I do not consider that Richardson J's comments on the importance of the graduated rate scale for individual taxpayers are to be read as extending to a case where the income is no longer derived by an individual taxpayer. The potential differentiation to which he refers is between different categories of individual taxpayer, namely employees and self employed. His comment that "the person whose personal exertion earns the income derives the income" would require elaboration if it were intended to apply to the situation where the income is as a matter of company law and of specific provision in the Income Tax Act derived by a company.[39] Counsel for the Commissioner also relies on P v CIR (1987) 9 NZTC 6,167. In that case, an engineering partnership had restructured its business, resulting in the creation of separate family trusts and a service company which provided ancillary services to the engineering firm. Cooke P, delivering the judgment of the Court of Appeal, approved this reasoning of Hardie Boys J at first instance:The purpose of introducing family trusts had nothing to do with the object of income maximisation. Its purpose was quite different. Its purpose was to divert to the partners' families what was essentially the professional income of the partnership, to the earning of which they had contributed nothing and would in the future contribute nothing other than the ownership of assets which they had rather artificially acquired. The addition of this feature makes no business sense. I cannot regard it as incidental to the business purpose. It must in my judgment be regarded as a significant purpose of its own, and so turns what would have otherwise been unexceptionable into an arrangement which falls squarely within the section.In that case, too, the partnership remained in place, and the income was that of the partnership. I do not consider that it supports the proposition that the transfer of a personal services business to a company involves a tax avoidance arrangement. [40] Looking at the scheme and purpose of the Act for myself, I do not discern any general intention to distinguish between business income which is the product of personal exertion and that which is not, so far as its derivation is concerned. None is suggested by the wording of s CD 3, as I have pointed out. A very wide range of professions, trades or callings may be conducted as businesses. Generally speaking, the proprietor of a "one-man" business has the choice whether to conduct that business as a sole trader or through a company (or perhaps some other entity). Any principle that a particular category of business income can be derived only by individual taxpayers would have to be clearly prescribed in the legislation. Such a principle cannot properly be derived from an inference which could be based only on some general notion of morality or equity. If there is to be some restriction on that choice, so far as tax is concerned, then some bounds to that restriction would be necessary. Would the restriction apply only to these professions or trades where the element of personal exertion income reflected in the fees charged by the business was high? Would it extend to cases where the fees charged also include a significant component for the use of capital equipment, such as the earthmoving contractor inLoader? Would the restriction be confined to "one-man" businesses, or would itextend to cases where two or more professionals chose to practice through a company rather than as a partnership? Answers to questions such as these are essential to establishing the contemplation and purpose of Parliament, against which the alteration of the incidence of taxation is to be tested under the general anti avoidance provision. The lack of clear answers to them in the way the principle contended for is articulated by the Commissioner points against the proposition that such a principle is within the scheme and purpose of the Income Tax Act. [41] A further aspect of the scheme of the Act relevant to the question whether its purpose is such as to preclude the derivation of personal services income by a company are the Personal Services Attribution (PSA) Rules in ss GC 14B – 14E, which were introduced at the same time as the change in the top personal tax rate. The PSA Rules deal with cases where a company providing personal services has a concentration of earnings from a single source. They require the income of the company to be attributed to the person providing the services. These Rules are directed at situations where the company does not have a genuinely independent business, and the relationship with the income provider is akin to one of employment. That legislative intention is clear from the report of the Finance and Expenditure Committee on the Taxation (Annual Rates, GST and Miscellaneous Provisions) Bill 2000:Alienation of income from employment – the attribution ruleThe attribution rule is an anti-avoidance rule which aims to ensure that, in defined circumstances, a person's income from personal exertion is attributed to that person for tax purposes. The rule is broadly intended for employees who circumvent the top personal tax rate of 39 percent by interposing a company, trust or partnership between themselves and their employer in order to have their income taxed at a lower rate. The rule will attribute what generally is, in substance, employment income to the employee. It supports the general anti-avoidance provisions of the Income Tax Act 1994.[42] Mr Goddard submits that the taxpayers' submissions on the PSA Rules do no more than assert that they have complied with the 'black letter' provisions, and this is not conclusive on the issue of tax avoidance. I do not agree. I consider that this case is not one where the PSA Rules are engaged in either their strict letter, or their intent purposively interpreted. The relevant income, the fees paid by patients, is not, in substance, employment income. It is income of a business (whether carried on bythe taxpayer or by the company). The enactment of the PSA Rules, to deal with a particular, but quite different, potential for tax erosion, does not indicate a legislative purpose with regard to income derived by a person conducting an independent business. [43] A similar conclusion is reached if the matter is viewed not from the perspective of the derivation of income but from the perspective of the imposition of tax. The tax advantage here arises from the differential between the rate at which tax is imposed on the income of companies and the top marginal rate for individuals. The fixing of these rates indicates a clear intention that tax is to apply differently to companies and individuals. I can discern no general legislative intention that, for some categories of income, the rate applicable to individuals should apply to income derived by a company. [44] The conclusion which I have reached, viewing this step in the arrangement in isolation, is that the change in the incidence of tax which resulted from the transfer of the business to the company was a change which was consistent with the specific provisions of the Act, and not contrary to any principle to be discerned from the scheme and purpose of the Act. On that conclusion (applying to reasoning in Ben Nevis at paragraphs [109] and [114]) the tax change effect is not one to which s BG 1 is directed, so no further consideration of the purpose of that step, in isolation, is required. However, in case I am wrong in that view, I go on to consider the purpose of the transfer of the business to the company. [45] It is clear law that, in applying s BG1, the purpose of an arrangement is to be objectively discerned. It is the purpose of the arrangement, not the subjective intentions of the participants in the arrangement, which is determinative. Examples of the matters which may be taken into account when considering whether a tax avoidance arrangement exists under s BG 1 are set out in Ben Nevis at paragraphs [108] and [109]. That does not suggest any inquiry which is focussed upon the particular reason which taxpayers in general may have, or which a particular taxpayer may have, for choosing the corporate structure. Objectively considered, there may be many reasons why a person might choose to adopt the corporate form for the conduct of a business. It may provide a higher level of protection againstpersonal liability than would be available to a sole trader. It may make the obtaining of finance more efficient. It may provide asset protection against other potential liabilities. Considerations such as those may be important motives for the choice. The distinction between purpose and motive was referred to in Ben Nevis, both by the majority (at paragraph [73], not set out above) and by the minority at paragraph [8]. Applying the distinction here, I consider that the purpose of the choice of the company structure is to conduct the business through that particular corporate form. In this case the adoption of that corporate form involves an entirely orthodox commercial decision. For the reasons I have given, there is, in law, no element of artifice or contrivance in the conduct of the practice through a company. [46] The evidence of both taxpayers is that, to a greater or less extent, one of the reasons for adopting that corporate structure was a view that it may assist in reducing the surgeons' exposure to potential claims. Mr Penny's evidence is that there was in 1996 much talk in the medical community of an increased willingness to sue doctors personally and of possible avenues for such litigation not covered by the exclusion of litigation under the ACC scheme. He said that he became concerned as to his exposure in the event of a claim against him personally or in relation to other business ventures he might become involved in. Mr Hooper's evidence is that in the late 1990s he became increasingly concerned as to his potential exposure to claims by disgruntled patients. He was aware of problems arising from that phenomenon in New South Wales in 2000. Mr Goddard cross-examined both witnesses on the extent to which these concerns may have been realistic. I accept their evidence that these concerns were present in their minds. While the distinction between purpose and motive is not clear-cut, I regard such concerns as falling within the category of motive rather than purpose. The validity or strength of those concerns as a motivation for the choice of corporate structure is not determinative, and, to the extent that they are relevant, I accept the taxpayers' evidence that they were a genuine motive, along with other motives, for the choices which they made. [47] Mr Goddard includes among the indicia of tax avoidance which I have summarised at paragraph [12] a lack of commercial purpose, and submits that the change in the practice is not commercially driven. Lack of commerciality can be an important consideration in determining whether an arrangement involving the use ofa specific provision is within the contemplation of Parliament. It may, where there is artificiality in the arrangement, be an indicator of a tax avoidance purpose. However where the choice of corporate form is a commercially orthodox one, I do not consider that a taxpayer is required to demonstrate a commercial justification for the choice of one form of practice over another. [48] Approaching the question in the way suggested in Ben Nevis, I consider that the objective purpose of the formation of the company was to adopt a normal and permissible structure for the conduct of the business. The tax effect which results from the derivation of income by the company rather than the taxpayer is merely incidental to that purpose.(b) The fixing of the salary[49] I use this heading to include all aspects of the employment arrangement between the company, which in legal and contractual terms provides the services to patients, and the taxpayer surgeon, who actually performs the work. The legal relationship between the company and the taxpayer for the provision of the services is that of employer and employee. Mr Penny's evidence is that OSCL did not have written employment contracts, either with himself or with its other employees, who were a surgical assistant, a practice nurse and administrative assistant, and secretaries. His evidence is that their employment terms and conditions were as agreed between him and them from time to time. His understanding was that as the sole director of OSCL he had authority to negotiate with the other staff and that it was in the company's interest to keep the contracts as flexible as possible. He returned income from OSCL by way of salary and director's bonuses as set out in the table in paragraph [7]. His evidence is that he was paid more in 1999 and 2000 income years on the basis that he had spent more time in practice administration and also sought a higher level of remuneration due to the increased work load. The higher salary in 2004 arose for the reasons set in paragraph [8]. The salary claimed in Mr Penny's NOPA was $184,572.99. Mr Hooper's evidence was that he did not have a written employment agreement with HOL. The terms and conditions were informally agreed by him and HOL (where he was the sole director). He did notarrange for the other staff of HOL to have written employment contracts and their conditions of employment were as agreed from time to time. As sole director of HOL, he had to make a decision about how much would be paid to him as an employee. He spoke to other colleagues in a similar situation and to a colleague at Christchurch Public Hospital. He gained the understanding that a common bench mark was a salary commensurate with a public hospital salary. After discussions with his accountant he decided that a greater salary than what he was paid in the public hospital was appropriate and fixed a salary at about 1.4 times his salary from CDHB. The figures are shown in the table in paragraph [6]. The 2004 salary claimed by his NOPA was $119,990. [50] The Commissioner in reviewing the cases sought advice from Mr Lyne, a specialist independent investigating accountant. In his evidence, he said that his instructions were to express his opinion on the commerciality of the arrangement whereby each of the taxpayers carried on the medical practice through the company and received income by way of salary and benefits. One of the matters he was particularly asked to consider was the salary paid in each case in the relevant years and whether those amounts were commercially realistic. He analysed the financial statements for the practices and related documents and also made a comparison of earnings from private practice with those from public practice. He found that the private practice income was much higher than that for the public sector practice and expressed his understanding that this discrepancy in remuneration is common to orthopaedic surgeons operating in both the public and private sectors. He described his approach to the assessment of a commercially realistic salary. He said that to assess whether the income paid by the company to the taxpayer was reasonable, he undertook his own assessment of a commercially realistic salary. He considered the most appropriate measure of a commercially realistic salary for an orthopaedic surgeon working in a salaried position in the private sector would be that set by reference to actual market evidence of individuals in that position. A comprehensive review of possible sources of such market evidence was unsuccessful in that he saw no comparable market evidence, including market salaries, rules of thumb, salary surveys, or industry statistics for orthopaedic surgeons working as sole practitioners in salaried positions in the private sector. This led him to suspect that comparable market information does not exist because historically specialist orthopaedicsurgeons have worked on a self employed basis in the private sector rather than on a salaried basis. He then considered whether the salary received for public practice work might be a suitable bench mark, but found that because those income levels were artificially constrained by a collective agreement and a number of other non- pecuniary factors which he outlined, he did not consider that they reflect the income that a practitioner could obtain working in the private sector where no such market constraints apply and the normal forces of supply and demand apply. [51] He then concluded that in the absence of any relevant market based information an alternative measure is required. He considered the assessment of a commercially realistic salary may be made by consideration of the earnings the specialist could derive in private practice being self employed, less the return an arms length third party owner of the practice would expect to receive from the practice to cover expenses, contingencies, and an adequate return on capital for the risks involved. In his view, the earnings which each of the taxpayers could derive in private practice being self employed are an appropriate starting point for his assessment because, due to the specialised nature of the occupation, these earnings largely reflect the skills, qualifications, experience and personal reputation, factors which are typically taken into account in determining an appropriate arms length market salary. He considered it appropriate for his assessment to allocate all of the practice earnings to the taxpayer and none to the contributions made by other employees of the company. He regarded that as an appropriate assumption because the taxpayer is the sole source of the practice income with the services provided by other employees being part of the cost structure, not a revenue driver. He also regarded the assumption that all of the practice earnings should be allocated to the taxpayer as consistent with his understanding of case law regarding the valuation of sole practitioner specialist medical practices for relationship property purposes. He considered that a third party owner would bear the risks of and expect a return from, the capital employed in the business and the risks associated with ownership of the practice. He allowed a return for these items. The essence of this assessment was that the total earnings of the practice, less that return, were to be attributed to the taxpayer as a commercially realistic salary. That salary would vary depending on the level of practice income. He noted that it is not unusual for the employee to be paid a variable remuneration depending on the performance of the business, but to ensurethat any significant income fluctuations year on year did not materially affect his assessment. He based his assessment for the 2002 to 2004 income years over the longer period for which information is available, and also assessed his assessment as the mid point of a range within which a commercially realistic salary may lie. He acknowledged that that approach uses hindsight to some extent. [52] The taxpayers do not take issue with Mr Lyne's evidence as to what a commercially realistic salary amount was in the years in question. They admit that the salary paid in each case was not a commercially realistic salary as Mr Lyne has defined it. Their challenge is at a more fundamental level. They contend that the concept of a commercially realistic salary is not a concept known to tax law, and not a concept which provides a basis for determining whether or not a particular arrangement constitutes tax avoidance. [53] The taxpayers advance the proposition that the concept of a commercially realistic salary is not a concept known to tax law both by submission, and by expert evidence. Mr Shewan, a tax practitioner who has specialised in tax for the last 30 years, was called by the taxpayers. He noted, from the Commissioner's adjudication report, that the Commissioner had taken the view that a family company must pay a family member employed by it a commercially realistic salary. He was instructed to accept the Commissioner's contention that the companies did not pay to the taxpayers a salary from employment which was sufficient to be a commercially realistic salary. On that express basis, he was instructed to express his opinion as an expert in tax advisory work concerning the concept of, and his experience with, commercially realistic salaries in the context of such family employment arrangements, both before and after 1 April 2000, on which date the maximum personal rate of taxation was increased from 33% to 39%, with the company and trust rates remaining at 33%. He summarised his opinion that he is unfamiliar with the concept of a commercially realistic salary in the context of a family company whether for persons in the taxpayers position or for any other taxpayer employed by such a family company. His opinion is that there is no such concept within the scheme of the Income Tax Act as asserted by the Commissioner in the Adjudication Reports, and as contended for by the Commissioner in these proceedings.[54] The Commissioner has objected to the critical parts of Mr Shewan's evidence, on the following grounds:(a) These sections of his evidence set out Mr Shewan's opinion on certain legal issues, and his views on the opinions of others on certain legal issues; (b) Opinion evidence on questions of law is not admissible under ss 23- 25 of the Evidence Act 2006; (c) Mr Shewan is not a qualified lawyer, and could not give evidence on matters of law under s 25 even if evidence on such matters were to be admissible; (d) Admission of the evidence would be unfairly prejudicial to the defendant. This prejudice outweighs any probative value, in terms of s 8 Evidence Act 2006; (e) The brief was served late, underscoring the prejudice to the defendant from the admission of this material.[55] The evidence was given de bene esse with the objection to admissibility to be determined in this substantive judgment. The admissibility of evidence similar to that involved here has recently been the subject of consideration by the Court of Appeal in CIR v BNZ Investments Ltd [2009] NZCA 47. Under s 7 of the Evidence Act 2006, all relevant evidence is admissible unless excluded. Under s 25, an opinion by an expert is admissible if the fact-finder is likely to obtain substantial help from it in ascertaining any fact that is of consequence to the determination of the proceedings. Whether the purpose or effect of an arrangement in tax avoidance is at least in part a question of fact, which must be determined having regard to the scheme and purpose of the Act. The evidence of an experienced tax practitioner as to the witness' understanding of the way in which the provisions are applied in practice may be helpful. As the Court of Appeal noted in CIR v BNZ at [28], evidence which is in the nature of submissions on legal issues is not helpful in that it intermingles the roles of counsel and expert witness. I do not consider that Mr Shewan's evidence crosses the boundary to an impermissible extent. His evidence describes some basic income tax concepts. He also describes some policy changes, and their effect on taxpayer behaviour. Such evidence is not simply opinion evidence on a question of law. It can assist a Judge who must resolve the questions of law to understand the context in which the questions are to be decided. I havefound Mr Shewan's evidence of some assistance in this regard. I rule that it is admissible. [56] Whether an arrangement between the company and taxpayer as to the rate of salary which will be paid in circumstances such as this may constitute a tax avoidance arrangement depends in the first instance upon whether it is possible to discern, from the scheme and purpose of the Act, an intention which will be improperly frustrated if a commercially realistic salary is not paid. The starting point in that inquiry is the proposition which I have already discussed, namely that, in situations such as the present, a taxpayer who is conducting a business which consists wholly or principally of the conduct of a profession, trade or calling, involving the provision of services by way of personal exertion may properly, without infringing the scheme and purpose of the Act, choose to conduct that business through a taxpaying entity other than that individual. The incidence of taxation as provided for in the Act, and consistent with its scheme and purpose, is that the income of that business is the income of the entity by which the business is conducted, and is subject to tax accordingly. The incidence of tax on that income can be (and in this case is) different from that which would apply if a different taxpaying entity had derived in the income. As I have held, that result is not of itself tax avoidance. [57] The next relevant proposition is that except in special defined situations, the Act does not dictate the level of income which a particular taxpayer must earn. Rather, the Act defines what is income and taxes what is actually received by a taxpayer in accordance with those definitions. It does not (again except in special cases) seek to direct what an appropriate quantum of income will be in a particular situation: it simply determines whether an actual receipt is or is not income. Any salary payment will have the effect of reducing the taxable income of the employer and increasing the taxable income of the employee by the amount of the salary paid. The scheme and purpose of the Act is not to dictate, in a particular case, what the quantum of that salary payment will be. Generally the level of payments from an employer to an employee will be determined by market forces. There is however no express provision to that effect and the Act must apply to situations where thediscipline of market forces is not applicable. Here, as Mr Lyne's evidence demonstrates, it is not possible to determine a salary by reference to market forces. [58] The Act does recognise certain exceptions to the general proposition that the quantum of particular transactions resulting in income will generally be determined by market forces rather than by prescription under the Act. Part G of the Act is specifically directed to a number of instances where market forces may not impose the discipline necessary to ensure that transactions are attributed a value which achieves the objects to which the Income Tax Act is directed. Parts GD and GE deal both generally and specifically with non market transactions. Remuneration in the form of salary and wages is specifically dealt with in s GD 3. That gives the Commissioner powers of reallocation of income where excessive salary is paid. The provision does not apply in the reverse situation here, where the Commissioner considers that inadequate salary is are paid. The PSA Rules provide for income to be attributed to the person providing services. However, for the reasons I have given neither the letter nor the intent of these Rules is infringed here. [59] What is to be gleaned as to the scheme and purpose of the Act from the presence of such provisions? It is clear that the legislature has recognised a potential erosion of tax revenue arising from the fact that not all employment relationships will be governed by market forces. On the one hand, it might be inferred that the legislative intention is that any potential erosion is addressed by making specific provision. On the other hand, it might be inferred that the fact that the legislature has recognised, and addressed, the erosion of the tax base which may arise in those specific cases, is to be taken as indicating also an implicit intention that an erosion of the tax base which may arise from other non-market transactions will be caught by the general anti avoidance provisions. [60] If the latter inference is adopted, then, in the application of the general anti avoidance provisions, some mechanism for determining a "correct" salary in a non market situation must be available to the Court, without the benefit of specific legislative direction as is provided by the specific provisions to which I have referred. Mr Lyne's evidence is that no market benchmark is available. At its core, the Commissioner's contention, and Mr Lyne's approach to the calculation of acommercially realistic salary, is premised on the proposition that the income from the practice is properly that of the surgeon, not the company. For the reasons I have given, I do not consider that that premise is valid. Mr Lyne's calculation of a commercially realistic salary rests on two fundamental propositions: (a) That it is not legitimate for the benefits of a business conducted by a company to be derived by that company except to the extent of the contribution by the shareholders, in their capacity as shareholders; and (b) That the arrangements between the company and the person performing the services which constitute the company's business must be structured in such a way as to attribute the balance of the income derived from the business to that person in essentially the same way as if the person were a sole trader. [61] For the reasons I have given in dealing with the first step, the formation of the company, I do not consider that either of those propositions is evident from the scheme of the Income Tax Act, so that an arrangement which reaches a different result is necessarily inconsistent with the scheme and purpose of the Income Tax Act. If, as I consider to be the case, the starting point is that the choice of corporate structure for the business is a legitimate commercial decision, then the arrangements must accommodate the legal reality that while the company conducting the business may be under the control of the person actually performing the work, they are different legal entities. The services of the surgeon are essential to the company's business, and these must be secured. In an arms length transaction, the services might also be secured in a number of ways. One might be to pay to the surgeon a salary calculated as Mr Lyne has done. But that is not the only way. The services of the surgeon might be secured to the company by a fixed term employment contract and a restraint of trade covenant. The consideration for such an arrangement would be likely to be a payment in the nature of goodwill. That would have different tax consequences for both the company and the surgeon.[62] In both these cases, goodwill payments are involved. Mr Hooper's evidence is that the figure of $330,000 for goodwill was fixed after discussion with colleagues and his accountant. He knew that, with his commitment to work for HOL, it was purchasing a viable business where goodwill at an even higher level could have been charged. There was no evidence of any formal contract to secure his commitment to work for HOL. In Mr Penny's case, the goodwill ultimately paid, in two stages, was $1m. He entered into a 10 years employment contract, under which he was to work only for POS, apart from his CDHB work. The services of the surgeon to the company in each case are secure, because of the arrangements and the relationship between the parties, so that the goodwill in the practice has been secured to the company. It has been paid for in a way which is not challenged as a sham. [63] Mr Goddard includes among his indicia of tax avoidance which I have set out at paragraph [12] that the taxpayers have been prepared to assign away their future earnings for inadequate consideration. It is implicit in that submission that receipt of a goodwill payment cannot constitute proper consideration. Counsel submits that it makes no commercial sense that a successful practitioner would, for the relatively minor sum of goodwill paid, give up significant income while diligently continuing to perform his practice obligation. There is no evidence on which I am able to assess what the value of the personal goodwill in the practice might be. The starting point is that (as I have held at the first step) the surgeon may transfer the practice to a company owned or controlled by him or related interests. The terms upon which that transfer takes place, and their effect on the salary arrangement which must necessarily be put in place cannot then be assessed as if the income remained properly that of the surgeon. The fact that the company is able to derive the practice income in return for that goodwill payment must be taken into account in determining whether the salary level involves tax avoidance. I do not consider that the goodwill payment, not challenged as a sham, can be ignored. [64] Mr Lyne's calculations do not take into account any return to the company reflecting the value which it has obtained from the goodwill payment. In Mr Hooper's case, he notes that there is no written employment contract between Mr Hooper and the company. He acknowledges that possibility of an implied term as to a restraint of trade, which might explain the level of goodwill purchased by thecompany but has seen no evidence of an implicit term. In Mr Penny's case, he is aware of a restraint of trade, but says that if the practice was sold to an independent third party, he believes such a purchaser would not have paid for any business goodwill, since any goodwill is personal to Mr Penny, not the practice. In both cases he says that his assumption that all of the practice earnings should be allocated to the taxpayer is consistent with his understanding of settled case law relating to the value of sole practitioner specialist medical practices for relationship property purposes, and refers to cases, in particular Newman v Newman [1999] NZFLR 839 in D v C[2000] NZFLR 514, in which it was recognised that there was no business goodwill, but only personal goodwill, because all of the income of the practice was found to be derived from the individual skills of the medical specialist. [65] I consider that care needs to be exercised in applying the principles applied in relationship property cases to the quite different questions which arise here. InNewman, the surgeon was a sole trader, practising in a group with others. (Coincidentally, the same group practice as Mr Hooper's.) The spouse contended that there was a goodwill component arising from the grouping of the five individual practices, over and above the personal goodwill based on the surgeon's own skill. That contention was rejected. The case does not address the issue whether the goodwill which was based on the surgeon's own skill was capable of assignment. InD v C the issue was whether there was goodwill as an identifiable property right based on a contractual relationship with a public health provider. It was held on the facts that the arrangement with the public health provider was not a property right. Mr Lyne's proposition that all of the income is derived from the personal skills of the medical specialist is undoubtedly correct, and these cases support it. The question here, is whether the benefit of that income earning capacity is capable of being transferred to another. [66] In arms length sales of many small businesses, goodwill derived from the personal attributes and skill of the proprietor will be an important asset. The proprietor as vendor may ordinarily expect to receive, by way of a goodwill payment, value for the asset. The proprietor may well covenant with the purchaser to perform certain services to ensure that the purchaser receives the goodwill for which it has paid. Such a transaction is a perfectly ordinary business arrangement,on an arms length basis. The Commissioner's contention, and Mr Lyne's calculations, would deprive the taxpayer of that ability, notwithstanding that (as I have held, at the first stage of the inquiry) the transfer of the business to the company is an ordinary commercial arrangement, and not a tax avoidance arrangement. In this case, goodwill payments have been made. They have had commercial and financial consequences. In Mr Penny's case, this has had relationship property consequences, by the use of the goodwill payment to reduce relationship debt. I do not consider that there is, in the scheme and purpose of the Income Tax Act, to be found some principle that requires that these arrangements must be ignored, or that, where a personal services business is carried on by a company, a commercially realistic salary, calculated without regard to such goodwill arrangements, must be paid. [67] For these reasons, I find nothing in the scheme and purpose of the Act which supports the proposition that payment of a commercially realistic salary in non arms length transactions is a general and over-riding requirement of the Income Tax Act. I do not consider that the basis upon which Mr Lyne's calculation of a commercially realistic salary has been made demonstrates that the fixing of the salary is part of a tax avoidance arrangement. I am supported in that conclusion by Mr Shewan's evidence to the effect that, in his very extensive experience as a tax practitioner, he has not found that tax practice has recognised the existence of the concept of a commercially realistic salary.(c) The benefit of the money[68] In the Adjudication Report, the two factors which I have discussed, namely the derivation of practice income by the company, and the choice of salary paid to the surgeon, were the only factors relied upon in support of the conclusion that this was a tax avoidance arrangement. Mr Goddard in this Court relies upon a wider range of matters. In particular, he refers to Mr Lyne's evidence of his analysis of the relevant cash flows and submits that, in Mr Penny's case in particular, there was de facto control by the taxpayer of all of the funds derived ultimately from the practice income. Mr Lyne has analysed the cash flows, which show that the profits of OSCLin the relevant period have all been distributed to the Trust, the sole shareholder, as dividends. The cash flows further show that the after tax profits of the Trust have delivered an increase in net assets of the Trust of $1.8m over the relevant years, of which $1.1 has been advanced to Mr Penny for his personal use, on a no interest basis and with no specific repayment terms. [69] Counsel for the taxpayers objects to that part of Mr Lyne's evidence, and challenges the ability of the Commissioner to advance the submissions based upon the access of Mr Penny to the money which was initially derived from the practice income. Counsel submits that the Commissioner's raising of these matters at this stage is contrary to s 138G of the Tax Administration Act 1994, which limits the parties to the facts, evidence and issues, and the propositions of law, disclosed in their respective statements of position. In the event, for the reasons which follow, I attach little weight to the ultimate receipt by Mr Penny of the income from the Trust. In those circumstances I do not consider it necessary to examine in detail whether, in strict terms, the Commissioner is barred from raising this aspect of the case. It is better (particularly in case this matter goes further) that I address the Commissioner's broad proposition. That is that the effect of the various transactions allowing Mr Penny to have access to and to benefit from the funds arising from the profits of OSCL without deriving such funds as income supports the contention that there is a tax avoidance arrangement. [70] Circularity of money flows can be an important indicator of artificiality in an arrangement, and so an indicator of tax avoidance. In this case, what is relied upon is not a circulatory of flows, but a situation where the same economic outcome has been reached by a different legal route, and with different tax consequences from those which the Commissioner contends are appropriate. The Supreme Court in Ben Nevis reflects some difference of view between the minority and the majority on the relative importance of form and substance. The minority, at paragraph [4], described as "a myth" the proposition "that in tax case to an extent unknown in other areas of the law, form prevails over substance". The majority at paragraph [47] said:[47] In proceeding in this way, the Court must also respect the fact that frequently in commerce there are different means of producing the same economic outcome which have different tax consequences.When considering the application of a specific tax provision, before reaching any question of avoidance, the Court is concerned primarily with the legal structures and obligations the parties have created and not with conducting an analysis in terms of their economic substance and consequences, or of alternative means that were available for achieving the substantive result. [71] I approach the question in this case on the basis that the legal form by which the economic consequence of access to the funds by the taxpayer was effected must be respected, except to the extent that the scheme and purpose of the Act requires that another legal form for achieving that economic substance must be adopted, so that the use of the chosen legal form is a device to avoid the adoption of the correct legal form. The ability of Mr Penny to access, through the Trust, funds which had been paid by OSCL as dividends arose from his status as a discretionary beneficiary of the Trust. The proposition that his access to those funds constituted part of a tax avoidance arrangement, or was evidence which supports the proposition that the steps of formation of the company and fixing of the salary constituted a tax avoidance agreement, is based on the same fundamental premise as underlies the Commissioner's submissions on those two steps. The proposition is that the income of the practice was Mr Penny's income, and the diversion of it to the company so that it bore tax at the company rate not the top individual rate, constituted tax avoidance. For the reasons I have given I have held that those two steps did not constitute tax avoidance. My conclusions to that effect are not altered by the fact that, in another capacity, Mr Penny was able to obtain the use of funds derived from the income of the practice, upon which tax had been paid both by the company and, as appropriate, by the Trust in respect of dividends derived from the company. [72] There are two (or possibly more) potential routes which might be chosen, by which the income of the practice may ultimately be available to the taxpayer. Each of those routes will have different tax consequences. There is no suggestion of tax avoidance in the route actually chosen here: the tax applicable to the money flows has been paid. The fact that Mr Penny has the ultimate benefit of the funds can be an indicator of tax avoidance only if the scheme and purpose of the Income Tax Act is such as to require that, if he is to receive the ultimate benefit, it is permissible forhim to do so only by deriving the funds as personal income. For the reasons I have given, I find that the scheme and purpose do not so require.Overall consideration[73] Having dealt with each of the constituent steps relied on as part of the arrangement, it is now necessary to stand back and view the matter overall, to consider whether, although there is no tax avoidance in the constituent parts, there is tax avoidance in the whole. As I have noted, the fundamental proposition which underlies the Commissioner's contention that the totality of the arrangements constitutes tax avoidance is that income from a business which is dependent on the personal exertions of an individual is intended to be taxed as the income of that individual. That reasoning is an essential element of the Commissioner's case at all steps. The submission is put by Mr Goddard in these terms:9.4 The provisions that Mr Hooper and Mr Penny are avoiding by these arrangements are those that make a payment/reward for services income, and that provide for payment of tax on income from personal exertions at a graduated rate. Income that would ordinarily be theirs is being diverted, and taxed at a lower rate than would otherwise be the case. These are not incentive provisions seeking to encourage particular types of behaviour. Certainly they are not designed to encourage the sort of behaviour that the two taxpayers have engaged in, in this case.[74] Counsel submits that s BG 1 can apply in cases where, on the face of a specific provision in the Act, a taxpayer has a choice, so that the taxpayer's exercise of that choice is not exempt from consideration as possible tax avoidance. That is correct, and is confirmed by the reasoning in Ben Nevis. However, if the tax effect of a choice available under the specific provisions of the Income Tax Act is to be overridden by the operation of s BG 1, there must be a legislative indication apparent from the scheme of the Act of the circumstances in which the choice may or may not legitimately be made. Mr Goddard submits:10.3 The plaintiffs in essence say that because the Income Tax Act provides different tax rates for different types of taxpayers, and because they have acted in a manner that falls within the black letter law provisions, they are entitled to succeed. Their submissions do not make any attempt to assess what type of choices Parliamentintended the taxpayer to have, or engage with the points made by the Court of Appeal in Hadlee concerning the fundamental nature of the graduated rate structure. Rather the plaintiffs say irrespective of the contrivance and artificiality of the plaintiffs' choice, Parliament intended that the plaintiffs should have the benefit as they complied with the black letter law. 10.4 This approach involves two fundamental errors. 10.5 The first fundamental error is that it ignores the guidance provided by Richardson J in Hadlee concerning the importance of the graduated rate structure as a feature of New Zealand income tax legislation, and the implausibility of Parliament intending to condone income splitting by professionals. 10.6 The second fundamental error is that the entire analysis ignores the role of s BG 1 in the tax legislation.[75] As to the first of those "fundamental errors", I have endeavoured to explain, in dealing with the first step in the arrangement, why the principles in Hadlee do not extend to this case, where what is in issue is the derivation of income, not an assignment of income. There is a further, more general, reason why I do not consider that the proposition that it is implausible that Parliament intended to condone income splitting by professionals can provide a proper basis for a finding of tax avoidance. As Ben Nevis at paragraph [102] indicates, the approach to tax avoidance must ensure that the particular case is examined by reference to the legislative policies, and must enable decisions to be made in individual cases through the application of an objectively focussed process of statutory construction without being distracted by intuitive subjective impressions of morality. The proper application of that approach requires that the legislative policies to which regard must be paid must be able to be discerned from the scheme of the Income Tax Act itself. I have endeavoured to explain why I do not discern, in the scheme of the Act, a general legislative intention to proscribe the choice of the corporate form for a personal services business. Mr Goddard's proposition that it is implausible that Parliament intended to condone income splitting by professionals is not, on my assessment, derived from the scheme of the Act viewed objectively. Rather, it involves an intuitive subjective impression of the morality of income splitting by professionals, and seeks to interpret the Income Tax Act through that subjective lens. [76] That conclusion is relevant to Mr Goddard's second "fundamental error". Section BG 1 is indeed an important element of the scheme and purpose of theIncome Tax Act. However, its function is not to supplement the specific provisions by proscribing arrangements which fall within the scheme and purpose of the Act objectively construed, but which are contrary to some notion of morality external to the Act. [77] It is convenient to address here two decisions of the Taxation Review Authority on issues similar to these here which were the subject of close attention in submissions. They are Case V20 (2002) 20 NZTC 10,233 and Case W33 (2004) 21 NZTC 11,321. Despite their different names both cases are concerned with the same taxpayer, for different years. The taxpayer was a dentist, practising in partnership with another dentist under a group name. The taxpayer set up a family trust, with a company as trustee. The dentist's share in the practice was sold to the trust, and the taxpayer entered into an employment contract with that trading trust. That arrangement was challenged as tax avoidance. [78] Judge Barber said:[101] Frankly, the restructuring undertaken by the dentist seems to me to be no more than a prudent format for being a dentist. The tax consequences are not in any way contrived or brought about by any artificial steps, and are not particularly great for the years now in issue. In any case, the tax consequences seem no different from those allowed non-professional persons in running their businesses through trusts or companies and, apparently, are no different from those allowed for professional persons starting up business in their particular profession. However, I shall now proceed to deal with the salient issues put to me by each party in this particular case. [105] In any case as I have covered above, s 99(2) requires the tax avoidance purpose of the taxpayer to be more than "incidental". I am well aware that not only were the taxpayer and his advisers well aware of the tax savings available under the trading trust structure, but also that at least one adviser emphasised this factor to the disputant dentist's bank; although, probably, without the disputant dentist's authority. Nevertheless, standing back and looking at the evidence as a whole and bearing in mind that I find the evidence of the disputant dentist and his witnesses (and, indeed, all the respondent's witnesses also) credible, I do not regard the tax avoidance, or saving, purpose or effect to be more than "incidental" for 1995 in all the circumstances of this case. [106] Having said that one wonders whether a tax saving is merely incidental to the arrangement if the disputant dentist controls theincome allocation between himself and his family. However, that aspect needs to be looked at in context. [123] Insofar as Mr Beck submitted that the transaction must have been implemented in the particular way it was in order to achieve tax advantages, it seems to me that if a person structures his/her business activities on a corporate or trust model rather than that of a sole trader, which a businessperson must be perfectly entitled to do, it is standard practice to place some ownership of assets with the person's family whether by way of a family trust or by their holding shares in the trading company or a holding company or whatever. These situations are matters of degree bearing in mind the Commissioner of Inland Revenue v Duke of Westminster [1936] AC 1 case concept of being able to order one's affairs from the best point of view in terms of liability to income tax, and the need for there not be tax avoidance as defined by statute. I accept, of course, that the Duke of Westminster principle is abrogated by statutory provisions such as s 99. [134] It is not for me to analyse precisely the type of professional and personal liability situations of concern to a dentist. However, the techniques taken after professional advice by the disputant dentist seem consistent with endeavouring to obtain asset protection and liability protection. It seems that tax saving was merely incidental for 1995. [135] In more simple terms, I find that, prima facie, there is a tax avoidance arrangement but that for 1995 its effect is merely incidental. However, with regard to 1996 there is, presently, insufficient evidence for me to re-adjust income under s 99(3) or, put another way, it is not yet clear to me what tax was avoided for 1996 because the proper comparison may be with a corporate structure rather than with the previous sole trading situation.[79] The next case, W33, was concerned with the 1996 year. That case was focussed to a considerable extent on the issue raised in Case V20 at paragraph [135], namely a comparison between the trading trust structure and a corporate structure. It was held that the trading trust restructuring was an arrangement, and that, for the 1996 year, the tax avoidance effect was not merely incidental, because it had been achieved by fixing the salary at an artificially low figure. Judge Barber said:[75] Essentially, it seems to me that while, in severing himself from the structure of a two-dentist partnership, the dentist is entitled to order his affairs to minimise the incidence of income tax in terms of the Duke of Westminster principle, he needs to take care that any income tax saving from the previous business structure is "merelyincidental", and this cannot be so when he is paid an artificially low salary. [80] Dealing with both cases together, I agree with the thrust of Judge Barber's reasoning in Case V20 in the passages I have cited, with one qualification. His remarks, particularly when read together with Case W33, might be taken to infer that a significant factor in holding the tax avoidance purpose or effect in 1995 to be merely incidental was the small amount of tax involved. If that is the intent of his remarks, then I would respectfully differ. In my view, the quantum of tax involved is unlikely to be, on its own, a reliable indicator of whether the tax avoidance purpose or effect is merely incidental to some other purpose. Tax avoidance may be a merely incidental purpose even though the tax advantage is large, or it may be a central purpose even though the tax advantage is small. I do not consider that, where the same arrangement is in place over multiple years, an arrangement is likely to be properly seen as merely incidental in one year but not in another, simply because the quantum of the tax advantage is different. As to the reasoning in W33, I would, for the reasons I have given, differ from Judge Barber as to the effect of paying "an artificially low salary". [81] For these reasons, and those I have given in considering the constituent parts of the arrangement, I have reached the view that the arrangement as a whole is not one which has the purpose or effect of tax avoidance, or, alternatively, if it does so, the that purpose or effect is merely incidental to the purpose of adopting the corporate form of practice.Result[82] The outcome is that the taxpayers have established that the Commissioner's assessments are wrong, and that they are entitled to relief pursuant to s 138P of the Tax Administration Act 1994. There will be orders in each case cancelling the assessments dated 29 March 2007 (in the case of Mr Hooper) and 30 March 2007 (in the case of Mr Penny) and directing the Commissioner to make an assessment in accordance with the amounts returned by the taxpayer in each case and, in respect of the 2004 year, in accordance with each taxpayer's NOPA. In case some moredetailed description of the appropriate relief is necessary, leave is reserved to both parties to apply further. [83] Costs are reserved. If the parties are unable to agree, memoranda may be submitted."A D MacKenzie J"Solicitors: Tomlinson Paull, Christchurch for Plaintiffs Crown Law Office, Wellington for Defendant