Tax avoidance Essay Example

of CLC was divided into two parts.

One portion was utilized for paying James' yearly salary of $130,000 as reported income determined by himself. This salary is notably lower compared to what cardiologists in public sector receive annually—$800,000. To compute taxable income for this portion, a multiplier based on the basic tax rate outlined in the Income Tax Act was employed.

Individuals earning more than $60,000 per year in 1998 were subject to a top marginal tax rate of 33%. Consequently, James needed to settle his taxes accordingly.

Once James' salary had been taxed and paid off by him personally or through deductions from his earnings or other means agreed upon between him and CLC's board or management team as authorized under applicable law or regulations; any remaining profit left within the company would be subjected to a 33% corporate tax payment directed towards Inland Revenue Department (RD).After paying the necessary taxes and following RD guidelines, the gross dividend amounts will be distributed as fully imputed dividends towards trustee income for the trust that owns CLC shares. These distributed dividends are not subject to any further taxation since they have already accounted for corporate tax responsibilities mentioned earlier, which are regulated by RD as the legal entity responsible for taxation matters within the jurisdictional boundaries where these actions occurred.

Under this trust umbrella, every penny earned is accumulated without any tax deductions, creating a tax-exempt educational fund. In the future, James' family members can use this fund without being obligated to pay any taxes on it. James' practice operates under a specific arrangement where costs are deducted and all profits are considered personal service income. This income is subject

to a 33% income tax by RD. Once taxed, the profit is transferred to a trust as income without requiring additional taxation. This aligns with the general attribution rule (s GABS- GABS), which states that if 80% or more of the income comes from personal services provided by an associated service provider or relevant individual, it is considered personal service income.All of CLC's income is attributed to James and categorized as his personal service income, subject to individual income tax. To offer alternatives or deter such arrangements, James implemented various measures. Firstly, he established a company instead of practicing personally. The company pays him a lower salary. Secondly, the profits of the company are distributed as dividends to a trust that undergoes company tax rather than individual income tax.

The Parliamentary Contemplation Test was introduced in 2008 by the Supreme Court in Ben Nevis and clarifies Parliament's intentions regarding taxation: 1) Any business profit earned by a company is taxable (s BC 6, s CB 1 and s YEA 1).2) The imputation regime (s GABS- s 6836) plays a crucial role in avoiding double taxation. It is important for individual salaries to match their contributions (Revenue Alert 11/02).

The company distributes taxed dividends to shareholders based on their share count while trustees pay taxes based on their respective incomes. The accumulated fund of the complying trust is exempt from tax. In order to fulfill Parliament's purpose, certain conditions must be met: James being a director of the company, the company operating its own business and earning income, taxed profits being distributed as dividends to shareholders and employees in the form of salaries, the trust receiving dividends as

trustee income, and all trustee income accumulating as an educational fund for beneficiaries.
Before the increase in the top marginal tax rate, James Smith ran a legitimate business and earned income. There is no evidence of artificiality, pretense, or circularity in this setup. James had taxable income that was taxed based on Parliament's current marginal rate. The family trust owned the company completely and received fully imputed dividends that were subject to company tax. During that time period, individual top marginal rates matched company tax rates.

A Supreme Court ruling in the Penny and Hooper CIRRI case determined that taxpayers have the right to choose between using a company or trust structure while still protecting their rights. The court concluded that James' creation of CLC and the family trust was legal and did not constitute tax avoidance. Therefore, despite having a different structure compared to typical arrangements, there were no tax savings involved.

However, when the top individual earning rate increased to 39%, signs of artificiality, pretense, and circularity emerged in the arrangement. James restructured his arrangements so only a portion of his salary was subjected to the new tax rate, unlike general arrangements where all CLC profits were taxed as James' income at the higher marginal rate. As a result, more income was required to cover taxes at a 39% rate under general arrangements compared to James' restructured ones.

Furthermore, CLC's income (excluding James' salary) faced a company tax rate of 33%, which should have been 6% higher than it actually was.From a commercial standpoint, the restructured arrangements of CLC have effectively facilitated lower marginal income tax rates on business-generated income. This has benefited both shareholders and beneficiaries

of CLC. Additionally, this case addresses the standard of James' salary based on Penny and Hooper v CIRRI Supreme Court Judgment. It establishes that CLC's income is directly dependent on James' personal skills, experience, and reputation. Therefore, it is essential to classify this income as James' personal service income and attribute it to him rather than the company.

The salary serves as an indicator of the employee's contribution to the company. Raid argues that when employees do not receive a reasonable salary considering their effort and achievements, it suggests a non-arms-length arrangement. If an employee demonstrates exceptional professionalism and contributes significantly to the company, they should be appropriately compensated with a higher salary or wage.

In James' case, his role as the sole cardiologist at CLC plays a crucial role in generating revenue for the company. Thus, it is only fair that he receives a high salary. However, his current salary of $130,000 falls significantly below the average salaries paid to cardiologists in the public sector which amounts to $800,000 per year.

Furthermore, according to the ruling in Penny and Hooper v CIRRI case, a company director/employee cannot decrease their salary to less than one fifth of an appropriate comparable salary; yet James' current salary fails to meet this threshold.
In line with section YEA (Taxation Act), determining if an arrangement has a tax avoidance purpose or effect involves considering various factors. Tax avoidance includes activities that directly or indirectly alter income tax obligations, exempt individuals from paying income tax or potential future income tax liability, as well as evade, delay or reduce liability for income tax or potential future income tax liability. A tax avoidance arrangement refers to

any arrangement designed to avoid taxes either directly or indirectly. While such arrangements may involve ordinary business or family activities, if their primary purpose or effect is not incidental but rather aimed at avoiding taxes, they are considered tax avoidance arrangements.

James made changes to ten arrangements involving Ana Pal's income resulting in the transfer of income to shareholders through a trust. According to both commercial and economic perspectives, as well as Parliament, individuals should be subject to income provisions. The restructuring done by James did not provide any tax advantage to CLC before the increase in individual tax rate based on sections BIG 1 or KGB 44 of the Income Tax Act 2007; thus no tax avoidance was involved. However, following the increase in the tax rate, James and his family continued receiving all profit distributions from the business which resulted in their effective tax rate decreasing from 39% to 33%, thereby reducing the overall company's tax payment.
From a commercial and economic perspective, it is evident that James received a lower salary compared to public sector cardiologists. This contradicts Parliament's intentions and suggests an intention to avoid taxes. Additionally, when individual income taxes increased, James ended up paying less than he should have paid in taxes, indicating potential tax avoidance. The Supreme Court has stated that setting a low salary is strong evidence of engaging in tax avoidance practices. Revenue Alert 11/02 provides four valid reasons for controllers to pay reduced salaries, including adverse business conditions, retaining profits for future difficulties, setting aside funds for acquiring assets, or being associated with a charity without misadventure. James did not provide any of these reasons when restructuring

his arrangement, suggesting an intention to avoid taxes. Thus, it can be concluded that the arrangement had the purpose or effect of tax avoidance. However, in Newton's case, if something has a "merely incidental purpose or effect," it means that it is naturally associated with another purpose or effect without intentional manipulation. Determining whether a tax-saving purpose or effect is "merely incidental" relies on an objective assessment based on the arrangement itself. In James' specific case, he made changes to his arrangements before the change in tax rates and could not anticipate future rate fluctuations.In addition, James did not make any further adjustments to his arrangement after the implementation of the new tax rate. This suggests that he took advantage of a tax incidence rather than intentionally engaging in tax avoidance tactics. The confirmation that James' arrangements were more than just incidental came from CLC paying him a lower salary. The presence of a tax avoidance arrangement can impact taxpayers. If the arrangement is deemed void according to BIG, then s GA 1 will be implemented, which involves the power of reconstruction by CIRRI. As per s GA 1(2), the Commissioner has discretionary authority to adjust taxable income arrangements for taxpayers to gain tax advantages. These adjustments occur in three stages.

Stage one determines if s BIG completely nullifies any tax advantages from tax avoidance. If there are remaining tax advantages, s GAG is utilized; otherwise, it proceeds to stage two. In stage two, it is assessed if s BIG has eliminated legitimate tax outcomes. If legitimate tax outcomes are removed, s GAG comes into play; otherwise, it moves on to stage three.

Stage three determines if

consequential adjustments are necessary for appropriate outcomes. If so, s GAG is applied; if not needed, s GAG does not take effect.The Income Tax Act 2007 provides guidelines for penalties and the Tax Administration Act 1994 also applies penalties when arrangements are void (including sections 141D, 1416 and 141FEB).The penalty rules indicate that a breach can lead to civil and criminal penalties. Only one penalty is given for each tax shortfall, with the highest penalty applied if multiple penalties are relevant. If an offense is prosecuted, civil penalties may be imposed. However, if a shortfall penalty has already been enforced, there will be no further prosecution. In James' specific situation, his taxable income must be adjusted accordingly. His salary should be increased to match the average level and he must also pay the shortfall amount along with three separate types of penalties: penalty, use of money interest, and late payment penalty.