Complex software case may set tax, depreciation precedent

Sorting out exactly what was paid for in an alleged tax avoidance scheme involving software investment is key to a legal case coming to a head in the next two months.

Sorting out exactly what was paid for in an alleged tax avoidance scheme involving software investment is key to a legal case coming to a head in the next two months.

As well as being apparently New Zealand’s second biggest case in the tax avoidance arena, larger than the infamous “Winebox” scheme, it could set significant precedents in the tax and depreciation treatment of software and rights pertaining to software.

An early December date has been provisionally set for a hearing in a long-running case of alleged tax avoidance involving Wellington software company Actonz. But the Inland Revenue department wants the hearing taken out of the closed-doors environment of the Taxation Review Authority (TRA) and into the High Court, and is appealing the August judgement that placed the question under the TRA’s jurisdiction.

Actonz, in 1996, set up a scheme whereby 420 individuals of “high net worth” invested in a joint venture to market and further develop software, primarily for telephone billing.

Little cash changed hands for investors’ purchase of the right to the software, “though there was some”, says Actonz managing director Scott Anderson. He explains it as being “vendor financed”, much like the purchase of a house through a mortgage where the previous owner has decided to wear almost 100% of the cost in expectation of future payment.

The investors claimed depreciation on the software as an income tax deduction and further claimed for GST on the purchase. The sums involved total around $226 million in the tax claim and $60 million in the GST claim.

This too, is normal, Anderson claims. “There are always losses at the beginning of a new venture.”

It is not clear what exactly was being purchased in the deal, says IRD’s director of litigation, Mike Leonard. “The right to use software, by way of a licence, is depreciable,” he says. “But whether that was, in fact, what was transferred in this case is in some doubt.”

Tied up with this is the status of software as a good, which can be depreciated, or a service, which usually cannot.

Possibly influential in this definition is the Consumer Protection (Definition of Goods and Services) Bill. The bill is currently with parliament’s commerce select committee, which is scheduled to deliver its report on November 29. However, a definition in one part of the law, in this case relating to consumer rights, does not necessarily influence the definition in a different part (depreciation).

The question of whether the software, if a “good”, was new or second-hand, is also pertinent to the GST aspect, since GST is not charged on second-hand goods.

The true value of the software is also in dispute, with Actonz standing by an evaluation made at the time it acquired the software, by PriceWaterhouse (now PricewaterhouseCoopers) and US-based AUS Consultants. Scott Anderson acknowledges that it is worth “a lot less now” because of the dot-com crash and changes in the telecommunications market since 1996.

But the matter occupying the minds of the disputants and their lawyers at present is the venue for the hearing. In August, Justice J Hammond found that the action was most appropriately placed in the TRA, but IRD is appealing this decision, with the appeal due to be heard on October 30.

As well as being more in the public eye, a High Court hearing is likely to establish a more powerful precedent for the tax treatment of software than would a TRA hearing, says Leonard. “In general, the higher a case goes, the more precedential [influential by way of precedent] is the finding.” But he denies that the establishment of a firmer precedent is part of IRD’s aim. Even if the case is heard in the TRA, he says, the losing party will probably appeal it to the High Court, “and thence to the Court of Appeal and perhaps even the Privy Council. We are simply attempting to remove one layer of this process.”

IRD argues that the case is more appropriately heard in the High Court, as this is the usual forum for cases of some complexity involving large sums of money.

The GST case is to be heard in the High Court, but IRD applied for a stay on those proceedings until the depreciation case had been heard.

Justice Hammond denied both applications. “I take the view that the respective proceedings should remain in the forums in which they were commenced — essentially for practical reasons.”

Footnote: IRD declines to identify New Zealand’s largest alleged tax avoidance scheme, but says it was not the Winebox deals.

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