AWA: Academic Writing at Auckland

Lord MacNaghten states in London County Council v Attorney General 1 and Tennant v Smith2 that income tax should be paid only on amounts that are received, whether generated through property or skill, and not amounts that a taxpayer is saved from spending. This makes clear that he believes in the global tax base. While in theory New Zealand follows this idea, there are contradictions within the legislation and case law between the global tax base and the schedular roots of English tax law. This essay will explain points for and against Lord MacNaghten’s proclamations in relation to the New Zealand tax base.

Income is defined as amounts designated income under either provisions in the Income Tax Act 2007, or through ordinary concepts3. There are five key components that make an amount income according to case law, being that it is “something that comes in” (as established by Lord MacNaghten himself in Tennant v Smith4), it is money or money’s worth, the product of property or labour, has a certain quality in the recipient’s hands, and has periodicity, recurrence and regularity. Transactions that meet these conditions are revenue, those that do not are put through five capital tests to determine a capital nature. In accordance with Lord MacNaghten, none of the Income Tax Act’s provisions explicitly state that a saving constitutes income.14

The binary of transactions being designated on revenue account (subject to income tax), or capital can try Lord MacNaghten’s assertions. What may appear to be income as it “comes in”4 is not necessarily. For example, Withers (Inspector of Taxes) v Nethersole5 established that payments for part ownership of an asset do not constitute revenue, despite the ability to resell these rights in future. Strictly following Lord MacNaghten, as Nethersole had an “actual receipt”4 tax would be due as whether the money is generated through fixed property or wits (the latter in this case), it is income. This was not the finding. However, the capital and revenue distinction can also support Lord MacNaghten’s statements. Impracticality and inefficiency prevent taxing all money that anyone ever receives thus a line must be drawn - transactions’ nature changes depending on the circumstances. Continuing the above example, money from an asset’s partial sale was deemed on capital account as the owner was not in trade.5 However, if the rights term was one year and the owner annually sold rights to the highest bidder then there would be periodicity, recurrence, and regularity thus could be in trade and become subject to income tax. Therefore, capital and revenue distinction is necessary and in line with Lord MacNaghten’s statements as people generally do not “live”6 through money received in capital transactions. When they become regular and reliable, necessary for most people’s financial situations, they become income.

The income versus capital distinction is also relevant to expenditure as expenses on capital account cannot be deducted against income receipts. There is no symmetry under the Income Tax Act 2007 - it is irrelevant whether the payer is being taxed (such as under FBT (fringe benefit tax)), only what the expense is related to, as per Usher’s Wiltshire Brewery Ltd v Bruce7. The four tests established in Hallstroms Pty Ltd v FCT8 determine if an expense has a capital nature, focusing on the overall effect on the business. This is relevant to Lord MacNaghten’s statements as it can change a taxpayer’s emphasis on the capital or income nature of a transaction to reduce their tax bill. He states that:4

“a person is chargeable for income tax… not on what he saves his pocket, but on what goes into his pocket,”

so it is important to determine if the inverse is true – whether deductions be allowed for what comes out of a pocket, and when. Under the Income Tax Act 2007 deductions are not allowed for a saving. There must be a nexus with income9, and as a saving is not income there is no nexus. Thus, Lord MacNaghten’s comments are applicable to expenditure in New Zealand as well as income.

Lord MacNaghten’s comment that:6

“one man has fixed property, another lives by his wits,”

has been used in case law and forms one of the fundamental tests in determining income, showing his continued application and relevance. Brent v FCT10 established that income must be the product of property or labour. Brent argued that the money she received was not income as it was a one-off sale of property (her story). It was important to establish what the money was paid for – personal services or property. The judgment stated that legally, knowledge nor information were not property so the amount was income as it was payment for Brent’s labour.10 New Zealand’s lack of capital gains tax makes this case particularly important. People have an interest in having receipts declared to be on capital account as they are then tax-free, and Brent v FCT10 narrowed the conditions for which this is possible.

New Zealand is one of just eight OECD countries that does not have a capital gains tax.11 If a receipt meets five tests established in case law to be classified as capital then it is not considered income nor subject to tax. Consequently, two people may sell their houses in the same way and earn an identical profit, but one would be taxed on the profit if they were in business, while the other would not be taxed. This opposes Lord MacNaghten’s global approach as if two people are earning the same money from the same activity it would be expected that they would be taxed equally for it, but this is not the case.

Around the world there are two main approaches to taxation: schedular and global.13 Under the schedular system income is taxed depending on how it was derived, with each channel and its matched relevant deductible expenses assessed separately.12 The global system considers all income and deductible expenses are in entirety and are taxed at a single rate. Originally most countries used schedular taxes however through the 1940s many countries began to switch to global taxes as it would provide a more reliable, consistent income stream which was needed to fund World War II and the following baby boom.13

The main arguments for a schedular system, as laid out by economist Antonio de Viti de Marco13, are that effort and expenses related to different forms of income are not incurred uniformly and thus should be taxed differently. Lord MacNaghten’s comments oppose this sentiment, as he states that all income is income, regardless of how it is earnt and thus should be treated equally.

New Zealand uses the global approach of taxation as generally income and receipts are considered wholly rather than individually.14 However, all income is not treated as the same under the act. Employment, business, trust and beneficiary, and agricultural income, along with income derived from the sale of personal property and land, from investments, and from petroleum and mineral mining have various rules surrounding exempt and excluded income and deductible expenses.14 For example, employees are not permitted deductible expenses15, while there are many allowable deductions under business income. Additionally, there is no one set of tax rates covering all income, rather employment income is progressively taxed, companies are taxed at 28%, trusts at 33%, and the like.16 This shows that while New Zealand has a broadly global system, there are still many schedular components. This is generally in line with Lord MacNaghten’s comments that it is only:6

“standard of assessment [that] varies according to the nature of the source from which taxable income is derived,”

as this is where New Zealand taxation strays from the global approach.

In-kind benefits provided to employees by their employers from which they gain a personal benefit are taxed under the FBT regime, with the intention of taxing employers an equivalent amount to which the employee would be under PAYE.17 As FBT is paid by an employer it is a tax on consumption rather than an income tax, despite falling under the Income Tax Act 2007. However, FBT still supports the global approach as it follows the idea that receipt of cash, services, or physical goods should all be taxed, regardless of how they are earnt.

Lord MacNaghten’s comments in Tennant v Smith2 are particularly interesting in a New Zealand context. He states that income tax should only be charged on what comes in, and that a saving of spending does not constitute income4 (further strengthened in FCT v Cooke & Sherden18). However, under the Income Tax Act 2007 the very example that Lord MacNaghten provides is not valid. Rather than being taxed under FBT provisions as other non-monetary benefits are, an exception is made for employees’ accommodation provided on the employer’s premises. It is employment income and thus subject to PAYE.19 This exception20 is made with the justification that the accommodation is provided in relation to employment and it would be difficult to tax under FBT due to having to find a valid comparison point. This exception detracts from the global approach by creating another category. It also raises the question of what other benefits currently taxed under FBT could come under PAYE for similar reasons.

The consequence of making accommodation subject to PAYE as employment income sets a precedent for expansions of CX 28, exchanging a tax on consumption (FBT) for a tax on income that is actually a saving. For example, presently the provision of a vehicle by an employer to an employee is taxed under FBT21, given that it is available for private use. However, Accident Rehabilitation and Compensation Insurance Corporation v Lewis22 under the Accident Compensation Act 1984, found the income-based compensation based should factor in the vehicle that Lewis had been using. If this finding, combined with the argument that provision of a vehicle (which would save the taxpayer from having to buy their own) was analogous to the provision of accommodation, then there would be blurring between non- monetary benefits provided for under FBT and under employment income. Already the definition of income has been expanded to include purchases by an employer on account of an employee23, further clouding the line between income and consumption taxes. Thus Lord MacNaghten’s findings have become less true in a New Zealand setting.

The treatment of accommodation under the Income Tax Act 2007 is more in line with economists’ view of income than Lord MacNaghten’s. This is that personal income is not just what comes in but the product of consumption and change in savings of a taxpayer. Alvin Warren, Jr suggested that applying this rule more widely would create a fairer, more efficient income tax system as people use their money in different ways which are not always taxed equally.24 It would however be difficult to implement, due to the need to find valid comparison points in rare and unique situations, such as in Sixton v CIR.25 Thus New Zealand has strayed from Lord MacNaghten’s view however is unlikely to do so much further due to the inefficiency of doing so.

In conclusion, Lord MacNaghten’s comments in both London County Council v Attorney General 1 and Tennant v Smith2 have had a significant impact on New Zealand’s tax system. He argues that a global approach should be used in taxation, but that by definition income must be something that comes in. New Zealand generally follows both principles, although there are exceptions in a lack of capital gains tax and accommodation falling under employment income. Thus, his statements may be found to be on the whole true in relation to the New Zealand tax base, but changes in society over the past one hundred years justify modifications.

Bibliography:

A Cases:

• New Zealand

Accident Rehabilitation and Compensation Insurance Corporation v Lewis (1994) 16 NZTC 11,234.

Sixton v CIR (1982) 5 NZTC 61,285.

• Australia

Brent v FCT [1971] HCA 48.

FCT v Cooke & Sherden [1980] ATC 4140.

Hallstroms Pty Ltd v FCT 8 ATD 190.

• England and Wales

London County Council v Attorney General [1901] AC 26 (HL).

Tennant v Smith [1892] AC 150 (HL).

Usher’s Wiltshire Brewery Ltd v Bruce [1915] AC 433, (1914) 6 TC 399.

Withers (Inspector of Taxes) v Nethersole [1948] 1 All ER 400 (HL).

B Legislation:

1 New Zealand Income Tax Act 2007.

C Journal Articles:

V Tanzi “Globalization, Tax Systems, and the Architecture of the Global Economic System” (2008) Latin American Integration at 401.

Victor Thuronyi “Tax Law Design & Drafting” (1998) 2 International Monetary Fund 14.

Alvin Warren, Jr “Fairness and a Consumption-Type or Cash Flow Personal Income Tax” (1975) 88 Harvard Law Review 931.

D Internet Resources:

EY “Corporate dividend and capital gains taxation: A comparison of the United States to other developed nations” (2015) 15.

1 London County Council v Attorney General [1901] AC 26 (HL).

2 Tennant v Smith [1892] AC 150 (HL).

3 Income Tax Act 2007, s BD 1, YA 1, Part C.

4 At 164.

5 Withers (Inspector of Taxes) v Nethersole [1948] 1 All ER 400 (HL).

6 London County Council v Attorney General [1901] AC 26 (HL) at 164.

7 Usher’s Wiltshire Brewery Ltd v Bruce [1915] AC 433, (1914) 6 TC 399.

8 Hallstroms Pty Ltd v FCT 8 ATD 190.

9 Income Tax Act 2007, s DA 1.

10 Brent v FCT [1971] HCA 48.

11 EY Corporate dividend and capital gains taxation: A comparison of the United States to other developed nations 15.

12 Victor Thuronyi Tax Law Design & Drafting (1998) 2 International Monetary Fund 14.

13 V Tanzi Globalization, Tax Systems, and the Architecture of the Global Economic System (2008) Latin American Integration 401.

14 Income Tax Act 2007.

15 Income Tax Act 2007 s DA 2(4).

16 Income Tax Act 2007 section 1 Part A.

17 Income Tax Act 2007 s CX 2.

18 FCT v Cooke & Sherden [1980] ATC 4140.

19 Income Tax Act 2007 s CE 1.

20 Income Tax Act 2007 s CE 1B(1).

21 Income Tax Act 2007 s CX 6.

22 Accident Rehabilitation and Compensation Insurance Corporation v Lewis (1994) 16 NZTC 11,234.

23 Income Tax Act 2007 s CE 5.

24 Alvin Warren, Jr “Fairness and a Consumption-Type or Cash Flow Personal Income Tax” (1975) 88 Harvard Law Review 931.

25 Sixton v CIR (1982) 5 NZTC 61,285.