A complex scheme under which two construction company directors received 600,0000 punts in tax-free dividends can be disallowed by the Revenue because it was a tax avoidance transaction involving a misuse of export sales tax reliefs, the Supreme Court has decided.
The judgment involves important findings on the meaning of Section 86 of the Finance Act 1989 - the only anti-avoidance measure in Irish law.
The Supreme Court today, by a three to two majority, dismissed an appeal by O'Flynn Construction Ltd (OFC) and its directors Michael and John O'Flynn, of Kilcrea, Ovens, Co Cork, against a High Court ruling the scheme was a tax avoidance scheme involving misuse of the export sales relief scheme (ESRS).
The Revenue in 1997 found the scheme was a disallowable tax avoidance scheme entered into by OFC and the O'Flynn's to extract funds from OFC in a way avoiding liability to Advance Corporation Tax by the company and avoiding payment of income tax by the O'Flynn's on dividends.
The Revenue Appeals Commissioners in 2002 upheld OFC's appeal against that Revenue finding but the High Court overturned the Appeals Commissioners decision in 2006.
The disputed scheme involved export relief reserves in a company in the Dairygold group being transferred via 40 separate steps to OFC. Michael O'Flynn and John O'Flynn each received £298,000 in January 1992 in tax-free ESR dividends, funded by the write-off of a loan of £650,000 by OFC.
Giving the majority Supreme Court judgment, Mr Justice Donal O'Donnell, with whom Mr Justice Nial Fennelly and Mr Justice Joseph Finnegan agreed, said the scheme was "highly artificial", involving more than 40 steps between December 5 1991 and January 24 1992.
The scheme involved profits of OFC, which would attract tax if distributed to shareholders, being paid by a "circuitous route" to those shareholders without attracting tax, all done via "a series of steps devised for the sole purpose of achieving that result". This was "the antithesis" of the export reliefs scheme.
"It is possible to admire the ingenuity with which the scheme was devised and efficiency with which it was executed but lament the fact that such skills are put to use for the sole objective of avoiding tax," he said. This was a tax avoidance transaction which could be disallowed as it was a misuse and/or abuse of the export relief scheme, he ruled.
This transaction was not the realisation of profits in the ordinary course of business activities but was arranged primarily to give rise to a tax advantage, he said. A scheme which allowed shareholders in a non-exporting company to benefit from export sales reliefs on the profits of the non-exporting company "is surely a misuse" of the ESRS.
The ESRS itself made no provision for the sale or trade in export sales relief reserves, he noted
The case centred on construction of Section 86 of the Finance Act 1989, described by Mr Justice O'Donnell as a provision "of almost mind-numbing complexity".
The main issue was whether Section 86 permitted the Revenue to find the disputed transaction was a tax avoidance transaction which could be disallowed. Section 86.3.b allows the Revenue withdraw a tax advantage where a transaction can be said to result directly or indirectly in "misuse or abuse" of the relevant relief, in this case, the ESRS.
Mr Justice O'Donnell said Section 86 sought to make "a decisive change in the approach to taxation schemes" and was directed at making "the difficult distinction" between a commercial transaction legitimately structured to mitigate the tax due and "a purely tax driven transaction designed to give rise to a tax advantage".
The fact a transaction gives rise to a tax advantage was not sufficient to disallow it but Section 86 provided the Revenue could have regard to the "results" of the transaction and its "form and substance".
In this case, the tax free nature of the dividends was used to avoid tax otherwise payable on a distribution of the profits of OFC. Section 86 intended "only appropriate use" of the relief provisions should get the benefit of the tax relief.
