Double tax agreement interpretation in the spotlight again – Court of Appeal reverses foreign tax credits decision

Wednesday 28 March 2018

Author: Rebecca Rose

​​​The correct interpretation of New Zealand's double tax agreements (DTAs) is once again in the spotlight after a recent Court of Appeal decision treats them in the same way as private contracts. Previously, local and international rulings suggested the international context and purposes of ​such treaties should be taken into account.​

According to the Court of Appeal's recent decision in CIR v Lin,1 each of New Zealand's DTAs must be interpreted according to the same principles which apply to private contractual instruments. But because the terms of each DTA represent the result of careful bilateral negotiations and compromises by states, each DTA must be construed according to its own particular terms alone. In all cases, the proper focus is on the ordinary meaning of the relevant DTA's terms in context and in light of their object and purpose.

In addition to its conclusions about the proper interpretation of DTAs, the Lin decision also clarifies the ambit of the tax credit rules under the China-NZ DTA as the means of relieving double taxation. ​It is relevant to:

  • all taxpayers and potential investors with assets outside New Zealand in terms of its general DTA interpretation conclusions; and

  • more particularly, the scope and potential limitations of the credit mechanisms prevalent in New Zealand's DTAs as the means of reliving the incidence of double taxation arising through income attribution mechanisms such as the New Zealand controlled foreign companies (CFC) regime.

Background context

New Zealand resident taxpayers are generally liable to pay income tax on their income arising overseas. That income may also be taxed in the foreign country where it arises. That is because New Zealand taxes its tax residents on worldwide income regardless of source. In order to avoid the same income being taxed twice over, New Zealand has entered into DTAs with certain foreign countries under which both New Zealand and the relevant foreign country each agrees when taxing income arising in the other country to give a credit for the tax already paid on it. The Lin appeal concerns the application of a DTA of that kind and the tax consequences of a New Zealand taxpayers' investment in Chinese companies.

The respondent, Ms Lin, was a New Zealand tax resident. Because of her 30% interest in five Chinese-resident companies during 2005-2009, Ms Lin was an attributable taxpayer under the relevant CFC rules. The Commissioner assessed her New Zealand tax liability at $1.796m and allowed her tax credits of $926,968 for tax paid in China by the CFCs. That left a tax payable balance of $869,032. But Ms Lin also claimed additional credits under the China-NZ DTA of $588,135 for tax spared on the CFCs' income in China. Neither the CFCs nor Ms Lin had actually paid any tax in relation to the income spread under domestic Chinese law. The Commissioner refused Ms Lin's claim for credits arising from the tax spared to the CFCs.

In the High Court,2 Thomas J held that Ms Lin was entitled to the credits claimed under Article 23 of the China-NZ DTA. A key reason supporting the decision was that the purpose of sparing income from tax is to encourage investments in developing countries (here, China) and the view that the benefit of such concessions ought to remain with investors. The High Court was influenced by an article of the DTA that directed that, for the purposes of the New Zealand credit mechanism, tax payable by the New Zealand resident is deemed to include an amount of tax that would have been payable in China but for an exemption or reduction in taxes granted under Chinese law.

Issue on appeal

The sole issue on appeal was the proper construction of Article 23 of the China-NZ DTA. The issue for decision was stated neatly as being: "Is a New Zealand tax resident entitled to a credit against income tax liability in New Zealand for tax spared by China on income earned there by companies in which the resident has a relevant income interest?" This question, however, also required the Court to consider the DTA's relationship with other New Zealand revenue legislation, including the CFC regime under the Income Tax Act 2007.

In short, the Commissioner's and taxpayer's competing arguments regarding the appeal issue amounted to a difference about whether the relevant credit regime (i.e. Article 23 of the China-NZ DTA) operates on the basis of tax residence or income source and is intended to provide relief from juridical double taxation alone or from both juridical and economic double taxation.3

Court of Appeal decision

Ultimately, the Court of Appeal reversed the High Court decision and denied Ms Lin a credit in New Zealand for tax spared to the five CFCs in China.

In reaching its conclusion, the Court of Appeal held that tax spared in China is not "Chinese tax paid" by a New Zealand tax resident. It reasoned that that Article 23's repeatedly-used phrase "in respect of" is synonymous with the word "on" and that an essential precondition for a tax credit under Article 23 in New Zealand is that tax must have been paid on income derived by a New Zealand tax resident in China, not by a third party CFC.

The Court of Appeal also held that Article 23(2)(a) relieves solely against juridical double taxation, not economic and juridical double taxation.4 The fact that the China-NZ DTA expressly excluded only one type of economic double taxation (i.e. dividends paid on profits) was not evidence that the DTA's parties intended that a credit should be given for other types of economic double taxation. In any interpretation exercise, an important consideration is the legal nature of the relationship between the taxpayer and any CFCs. The fact that an ultimate income source is attributed to a New Zealand taxpayer from the Chinese CFCs does not justify ignoring Article 23(2)(a)'s focus on the source of "the income derived by a resident of New Zealand" and treating the two income streams – earned separately by the CFCs and the New Zealand taxpayer – as one for revenue purposes. In any interpretation/construction exercise, attempts to circumvent the plain meaning of a DTA will fail. Likewise, court decisions about the meaning of companion provisions in other differently-worded DTAs or international agreements are of little assistance.

Bell Gully comments

The Court of Appeal's decision and reasoning raises a number of important issues.

First,​​ if the Court of Appeal's reasoning is accepted and Article 23(2)(a) of the DTA requires tax to be paid in China by the New Zealand resident, the basis upon which the Commissioner allowed a credit for the $926,968.12 tax paid by Ms Lin in China is unclear. The decision records that a credit was permitted for tax paid by the CFCs against income attributed to her for New Zealand tax purposes. She did not directly derive any income in China nor pay tax on that income. If, as directed, the Commissioner casts reassessments consistently with the Court of Appeal's judgment, the on-going availability of this credit is questionable. This seems a most unsatisfactory outcome in terms of the purposes of New Zealand's DTAs to relieve the incidence of double taxation.

Secondly, the Court of Appeal's decision regarding the approach to interpretation of DTAs differs in part from that applied in earlier New Zealand decisions and by international courts when interpreting international instruments such as DTAs and other tax treaties.5

The Court of Appeal's approach suggests that where a court considers that the meaning of the text of a DTA is plain, reference to further materials or other domestic regimes is unnecessary. Earlier New Zealand and international approaches, however, recognise the international dimension which exists for treaties but which does not exist for private contracts. As such, they routinely refer to OCED Commentaries and other materials such as domestic and international case law to the extent that they consider such materials helpful. That is consistent with the recognised purposive approach to interpretation.

The Court of Appeal's confirmation that extraneous materials such as OECD and UN Commentaries do not have the status of legislation is welcomed. But the fundamental issue of whether New Zealand courts are to apply a generous or legalistic approach to interpretation and whether wider materials ought to continue to be used at least as a cross-check about meaning looks set to remain an issue in this area in the future. Supreme Court clarity regarding the correct approach may prove necessary.

The Court's decision does not directly consider other international tax agreements (e.g. Tax Information Exchange Agreements (TIEAs) with low-tax jurisdictions and the Multilateral Convention regarding information exchange6). But we expect that the Court's decision will be influential in any other case where interpretation issues are in play. The matters discussed in the Lin case (as well as earlier lines of authority) should therefore be considered in the application of other DTAs and international tax agreements to which New Zealand is a party.

If you have any questions regarding any issue raised above, please contact one of our team or your usual Bell Gully adviser.​


1 CIR v Lin [2018] NZCA 38.

2 Lin v CIR [2017] NZHC 969, (2017) 28 NZTC 23-016 (HC).

3 New Zealand's CFC regime results in economic double taxation, i.e. two separate legal persons in two different countries are taxed on the same income – the CFC in the foreign country and the investor by attribution in New Zealand. If an investor takes advantage of a foreign country's source tax concessions and is not allowed to claim sparing credits in New Zealand, the consequence is that an investor reduces its tax in the foreign country but loses foreign tax credits in its New Zealand tax return. The absence of a sparing provision therefore functions to transfer revenue from the foreign country to New Zealand. By contrast, where sparing credit claims are allowed, the taxpayer rather than the New Zealand government receives the benefit of the relevant concession in the foreign country and the investment incentives for tax sparing are said to apply as intended.

4 As accepted by the Court of Appeal at para [16] – juridical double taxation arises where comparable taxes are imposed by two different states on the same taxpayer for the same subject matter and for identical periods. This residence-based approach favours capital exporters. By contrast, economic double taxation occurs where the same income stream including derivative income is taxed in the hands of different taxpayers. This source-based approach favours capital importers.

5 For example R v Prevost Car Inc [2009] FCA 57, [2010] 2 FCR 65; Thiel v FCT (1988) 88 ATC 4094 (FCA); CIR v JFP Energy Inc [1990] 3 NZLR 536 (CA); and Chatfield & Co Ltd v CIR [2015] NZHC 2099, (2015) 18 ITLR 392, (2015) 27 NZTC 22-024 (HC), at paras [53]-[62].

6 Double Tax Agreements (Mutual Administrative Assistance) Order 2013.


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This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.

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