Loans from Company Treated as Income

Case Z 23 (2010) 24 NZTC 14,334

Summary accessed from CCH NZ


The Taxation Review Authority (TRA) has confirmed the Commissioner's assessments and held that current account drawings treated as loans totalling $5,094,442 over a 12-year period were part of a tax avoidance arrangement and must be reconstructed as income of the taxpayer. The taxpayer was also liable for an abusive tax position shortfall penalty. 

The taxpayer was a property developer and an entrepreneur. He had been involved in a large number of property developments and investments. The activities were carried out through special purpose entities, generally one for each project. Typically, these were trusts with a corporate trustee and, often, the taxpayer was a beneficiary of the trust.

Regular drawings were taken by the taxpayer from the corporate trustees. Generally, no salary was paid to him and the drawings were treated by his accountants, and for the purposes of his tax position, as loans of capital. This was unnoticed by the Inland Revenue Department for many years, until one of the development projects led to significant losses. In examining the fallout from that failure, the regular and systematic loans to the taxpayer became apparent possibly because creditors saw them as an asset of the lender trustees to be repaid by the taxpayer.

The Commissioner contended that the loans taken by the taxpayer from his associated entities were part of a tax avoidance arrangement. The Commissioner considered that the reconstruction of the loans, as income of the taxpayer, was reasonable. The Commissioner also contended that he was not time-barred from reassessing the taxpayer, and the taxpayer was liable for an abusive tax position shortfall penalty.

The decision

The TRA held:

• The steps put in place by the taxpayer created an arrangement in terms of the definition in s OB 1 of the Income Tax Act 1994.

• The steps could not be explained in terms of ordinary commercial purposes and could only be explained in terms of a concerted series of steps aimed at obtaining a tax benefit.

• The arrangement reduced the tax payable by the taxpayer by ensuring that he received significant funds without receiving any income.

• The repayments were merely circular flows of funds that had no economic effect on the taxpayer's entities other than that the loan balance was reduced or cancelled.

• The money for the repayment of the loans was provided by the entities with the repayment being returned to those entities, although not necessarily the same entity.

• The arrangement reduced the tax payable by the taxpayer by ensuring that he received significant funds without receiving any income.

• The arrangement directly or indirectly had tax avoidance as a purpose or effect, other than a merely incidental purpose or effect.

• The commercial reality was that, notwithstanding legal form, the amounts paid as loans were paid because of the services the taxpayer rendered to his associated entities. Amounts paid for services are inherently income in nature.

• The failure to pay the taxpayer any reward for his services was contrived and artificial and could not be explained in terms of any commercial purpose.

• Parliament did not contemplate that specific provisions would be used in contrived and artificial arrangements or in arrangements that lacked a commercial purpose. The taxpayer used the arrangement to avoid the specific provisions and relieve and/or reduce his liability for income tax.

• The Commissioner's reconstruction was confirmed. If the arrangement had not been entered into, the taxpayer would have been required to take his drawings as income and not as loans. It was therefore appropriate that the amounts received under the loans were reconstructed onto the taxpayer as his income. Such a reconstruction mirrored the economic reality of the arrangement.

• The Commissioner was entitled to reopen the taxpayer's returns outside the four-year time bar period, as the taxpayer had omitted all income of a particular nature and from a particular source in the tax returns, namely, that reassessed to him as income being the regular drawings.

The TRA confirmed that the taxpayer was liable in each of the 1998/2001 income years for a penalty under s 141D of the Tax Administration Act 1994 for taking an abusive tax position.


This decision stems from the finding that the sums being drawn from the corporate taxpayers were in substance revenue sums being applied by the taxpayer to his living requirements. They were regular sums taken by him in circumstances where he controlled whether and when any repayment would occur.

The IRD may not have needed to run an avoidance argument at all but seems to have done so to put beyond question its ability to reconstruct the loans as income and to impose a sizable penalty for taking an abusive tax position.

It is worth considering whether the TRA would have been prepared to find tax avoidance if the taxpayer had taken and returned a reasonable remuneration as an executive of the Trusts and treated the loans as advances against a future distribution by the Trusts of capital gains. The case seems to have attracted the attention of the IRD because little if any income was returned over several years, despite the fact that the taxpayer worked full time for the Trusts. A case perhaps of the taxpayer trying for too much of a good thing. 

For a note on a similar decision recently given in Australia, see Re Martinazzo and FCT [2009] AATA 61

The decision of the TRA has been upheld by the High Court in Krukziener v CIR CIV-2010-4040-728 High Court Auckland 17 september 2010 per Courtney J. 


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