In this edition, I will discuss the “Parliamentary Contemplation Test”, established by the Supreme Court through the recent case Ben Nevis.
The Parliamentary Contemplation Test is examined and applied in six stages. To begin with, we need to ascertain the “arrangement”. We then need to examine the “arrangement” in the eyes of the parliament’s purpose(s) (stage 2) and then obtain understanding of the arrangements. Parliament’s purpose(s) can be identified by reference to the statutes, case laws and any relevant extrinsic materials (stage 3). Then, we need to identify any facts, features, and attributes that need to be present (or absent) to give effect to that purpose(s) of the Parliament (stage 4). Then, we need to examine the whole arrangements from the point of view of its commercial reality and economic effects, having particular regard to the facts, features and attributes that need to be present (or absent) to give effect to Parliament’s purpose (stage 5). Finally, we need to consider the final question – whether the arrangement, viewed in commercially and economically realistic way, use (or circumvent) the relevant provisions in a manner that is consistent with the purpose of the Parliament.
Let us take an example. A taxpayer borrows from one of the major banks to buy a residential property on standard terms and conditions. The taxpayer rents out that property through management/agent company. Expenses incurred on account of insurance, rates and interest are deducted from the income. The expenses exceeded the total amount of rental income earned in the hands of the property owner. The question is whether section BG1 is applicable to this arrangement in the light of the fact that the rental expenses exceed rental income and can be offset off-set against the taxpayer’s other income such as his salaries from his employment.
Let us turn to the stage 1 and the question to ask is what is (or are) the arrangement? The taxpayer obtained a loan from a bank and purchased a property and then rented out the property and then incurred expenses.
Let us turn to the stage 2 and the issue to determine is what is (or are) the tax effect of the arrangement? sCC1 provides income from the rental is taxable. sDA1 & sDA2 provide expenses incurred are deductible. sDB6 provides that interest incurred is deductible to the extent it is not capital expenditure. sBC2 provides annual gross income. sBC3 provides annual total deductions. sBC4 provides net income and net loss and the final net amount is treated to be taxable income by virtue of sBC5.
Let us turn to stage 3 and the question is to ascertain the intention of the Parliament by reference to statues, case laws and any extrinsic materials. The Parliament intends that rental income is assessable by virtue of sBB2, sBB3 and sCC1. Parliament also intends to allow deductions of the expenses provided the expenses are not a private nature and non-capital by virtue of sDA 1 and Ben Nevis. Interest expenses is deductible to the extent, only to the extent, the expenses are applied to generate assessable income by virtue of sDB6 and Pacific Rendevours. Importantly, the interest expense is not limited to the total amount of income generated by virtue of sBC5 and Eggers. Again, if the expenses exceed the income earned, the excessive portion may be offset against the other income of the taxpayer (such as employment income) by virtue of sBC5 and Grieve.
What is the next stage? We need to identify the features and attributes of the arrangements that need to be present (or absent). We need to make sure the subject income is only from the rental property. We also need to make sure that the expenses claimed are from the expenses incurred in deriving the rental income, not elsewhere, following that there is no element of private expenditure. We also need to make sure the loan is wholly used toward the rental property, not elsewhere. We need to accept that the taxpayer has another source of income – salary and potentially offset is to be done provided the entity is the same.
Now let us turn to stage 5 – examination of the entire arrangement. You will see that the loan was obtained on an arm’s length conditions. There is no element of artificiality in it. The rental is arranged through market, not through someone associated with the taxpayer. All the claimed deductions are genuine and there is no element of private or employment related expenditure.
Accordingly, it is reasonable to see that an audience can reach a view that the arrangement does not contain any element of tax avoidance.
We, after completing this article, realized that there are reasonable number of technical terminologies (if not too many), causing difficulties for ordinary member of the public to follow. If you are one of those, we recommend you to take an expert advice on this. Actually the concept is simple and straight.
We will continue further discussion using another example in the next issue.
This article is designed to give general information to the audiences and readers of this article. This is not designed to provide a legal advice to a particular person of particular circumstance. If you have any enquiries, you should seek legal advice on that issue. A. B. Lawyers Limited does not accept any liability arising from misjudgment by the audience, without having independent legal advice on his/her case.
The writer advises that translation to Chinese, from English version, is done by one of the office legal assistant. There may be occasions you notice misinterpretation, despite we do our best to make correct translation. If you notice that, it is much appreciated you let us know that.