– The “Worthless Spouse”
(This article also appears in Taxation Today Issue 73)
In Inland Revenue’s February 2014 Tax Information Bulletin a new statement (QB 13/05), on the deductibility of companion travel expenses, was published. Quietly posed as an answer to a question asked of Inland Revenue, the statement updates and replaces two items published in 1973 and 1995 which apparently no longer reflect the Commissioner of Inland Revenue’s interpretation of the law. The new statement starts from the position that case law supports a conclusion that the earlier statements are incorrect and that the costs of a companion (spouse, partner or other family member) travelling with a taxpayer, or an employee of a taxpayer, “on business” will seldom be deductible at all.
Inland Revenue’s position is that a companion’s travel expenses can only be deductible if there is sufficient connection between the expenditure incurred and the taxpayer’s business activities. There is no magic in that – it is what the law requires. The problem is that Inland Revenue has redefined what provides sufficient connection or nexus. Specifically, a companion’s travel expenses will not be deductible if the companion is accompanying the taxpayer simply for companionship and support or to attend social functions in the company of the taxpayer or the taxpayer’s employee. Inland Revenue does not consider there to be a sufficient nexus with the taxpayer’s business or income earning activity in those instances. In the statement the Commissioner of Inland Revenue (“CIR”) also withdraws her view that a companion’s travel expenses may be deductible if the companion’s presence is required because of the ill-health of his or her partner.
New Zealand Cases
The CIR’s position is based primarily on, and is supported by her interpretation of, two New Zealand Taxation Review Authority (“TRA”) cases: Case 16 (1964) 2 NZTBR 119 (a decision of the Taxation Board of Review as was) and Case K75 (1988) 10 NZTC 602 (TRA). The analysis starts however with an excerpt from the decision of Richardson J in Commissioner of Inland Revenue v Haenga in which the Court of Appeal distinguished between deductible expenditure outlaid in the course of the income earning process and non deductible expenditure which, although enhancing a person’s ability to conduct business, is more properly characterised as personal consumption. The excerpt referred to the costs of travel to and from work and the costs of child care and went on to note that, unless lines were drawn, an argument could be made that basic items such as food, clothing and shelter could be seen as contributing to the earning of income. The Court noted that such an erosion of the income tax base could not have been contemplated when the nexus test was enacted.
The Haenga distinction is important in understanding the approach taken by Inland Revenue but it is not clear that the right balance has been struck in this new pronouncement on companion travel expenses. It is pertinent to look first at the cases cited by the CIR.
In Case 16, the taxpayer’s wife accompanied him on a business trip to the United Kingdom. The husband was a shareholder and managing director of a company that carried on the business of importing and selling wines and spirits. The wife was also a shareholder and director, but not an employee. However, she had a personal standing and business interests in the alcohol industry in the UK. A dispute arose with one of the company’s main whisky distributors and both husband and wife travelled to the UK to meet with the dissatisfied distributor. The wife’s travel expenses were held to be deductible because:
(a) her presence was essential to the visit;
(b) she was present at every meeting, took part in every business discussion and assisted in making decisions; and
(c) while she was not an employee of the company, her intimate knowledge of the business and standing within the licensed trade in the UK meant she was able to contribute in a material way to the business being undertaken on the trip.
Case K75 concerned the deductibility of travel expenditure incurred by spouses accompanying business executives on a number of business trips, including to conferences. The spouses assisted with networking and information gathering by meeting and assessing the integrity and competence of conference delegates, hosting dinners for business contacts and participating in discussions about the business.
Judge Barber held that the expenditure was deductible and noted:
(a) expenditure would be deductible if the spouse is travelling with the employee-executive to provide him or her with support, to a reasonably substantial degree, in undertaking the business of the employer, or, in other words, if the spouse is adding in a reasonably substantial manner to the contribution which the employee-executive would otherwise make to the business of the employer; however
(b) “wives would not usually have a sufficient knowledge or interest in the business of their husband’s employer to warrant deductibility”, and expenditure will not be deductible where the presence of the wife has no connection with the business activities undertaken by the employee husband and the wife is travelling as part of a “junket or joy-ride”.
Based on her interpretation of these cases, the CIR’s position is now that for a companion to provide support to a “reasonably substantial degree, in undertaking the business of the employer” the companion must have some knowledge of the business or some special skill or expertise to provide this support in a material way. Simply being supportive is not enough; the support must relate to the business being undertaken for a sufficient nexus to exist. In essence the CIR seems to say that the costs of having a companion present during avowedly business related travel is personal consumption, in the sense that the support provided by the companion is inherently private unless some other element or activity exists which makes the presence of the companion more directly supportive of the business activity being undertaken, rather than of the business person undertaking it.
For the reasons referred to later in this article it is arguable that the CIR’s conclusion does not seem to be borne out by a close reading of the decisions she relies on, especially that in Case K75. It is doubtful, therefore, that the new statement correctly reflects the law.
Be that as it may, the CIR’s position reflects that taken in other jurisdictions:
- The Australian Income Tax Assessment Act 1997 specifically prohibits a deduction for a relative’s travelling expenses, when the taxpayer is performing employment duties or carrying on a business, unless the relative performs “substantial duties” as the taxpayer’s employee or employer’s employee and it is reasonable to conclude that the relative would have accompanied the taxpayer despite the personal relationship with the taxpayer. This is a specific legislative response to the question whether such costs should be deductible or not.
- The United States’ IRS takes a position that is similar to Australia’s. That is, if a spouse, dependent, or other individual goes with the taxpayer (or the taxpayer’s employee) on a business trip or to a business convention, those travel expenses cannot generally be deducted. The accompanying person’s travel expenses can be deducted if:
(a) that person is the taxpayer’s employee;
(b) has a bona fide business purpose for the travel; and
(c) would otherwise be allowed to deduct the travel expenses.The IRS commentary states that a bona fide business purpose exists if the taxpayer can prove a real business purpose for the individual’s presence. Incidental services, such as typing notes, or assisting in entertaining customers, are not enough to make the expenses deductible.
- In the United Kingdom, HMRC has released general guidance on the conditions that must be met before a deduction is permitted for the travel expenses of an accompanying spouse:
(a) the spouse must have some special skill or qualification associated with the taxpayer’s job that is needed on the trip, although not necessarily full-time. An example is where the spouse is a competent linguist and acts as an interpreter at business meetings; or
(b) the presence of the spouse must be essential to host a series of business entertaining occasions that the taxpayer is required to organise as part of his or her duties. It is not enough that the couple merely attend functions at which other guests are accompanied by their spouses; or
(c) the taxpayer’s health is so poor that is would be unreasonable for him or her to travel alone. It is unclear from Inland Revenue’s statement whether the CIR considered the approach taken in these jurisdictions, however there appears to be a remarkable degree of alignment between her announced position and them. The question remains whether the CIR’s conclusions as to the required nexus between companion travel costs and the derivation of income are borne out by a close examination of the latest decision on which she relies.
The findings of fact by the TRA in Case K75 are informative and suggest that the CIR is unjustifiably narrowing the decision. In that decision Judge Barber noted a number of conclusions about the involvement of “Mrs G”, the wife of the company’s managing director. These included:
(a) She “not only buoyed up Mr G’s spirits so he could complete a long and rigorous overseas business trip … but she participated … in assessing the advice he was given each day, especially on matters such as assessing integrity and competence …”.
(b) She “facilitated his rapport with important business persons by attending functions and some meetings with him, setting up dinners, and the like.”
(c) Evening functions were part of the daily business being undertaken by Mr G and Mrs G’s participation in them was “significant and constructive and sought by Mr G.”
The Judge then went on to identify specifics that set Mrs G apart from what he termed a “mere travelling companion”, namely that she and the wives of her husband’s business colleagues “ate, drank and slept the business of newspaper publishing”. But those factors do not suggest that the Judge meant such a degree of involvement was required in every case in order to be able to show a “reasonably substantial” contribution which would justify the deduction of companion travel costs. Different businesses and professions will require and allow different degrees of involvement. What is important is to consider the outcomes that Judge Barber considered Mrs G had contributed in Case K75. He summarised again:
(a) Mr G was able to meet business associates in the presence of their wives and at dinner so that he could converse business in a more effective and cordial atmosphere as a friend as much as a fellow businessman.
(b) He was able by his wife’s presence to establish his business and social credibility and status.
(c) He had the company of someone who understood the relevant business and Mr G’s role in it and could offer judgements and comment on the information picked up during the social events, and the personalities being engaged with.
Judge Barber certainly noted that he had begun his analysis thinking that a spouse would seldom have sufficient knowledge or interest in the relevant business to warrant deductibility, but that observation is not part of the ratio of his decision or the factual findings he arrived at. The comment is also somewhat of its time and suggests he had in mind the “dutiful wife” who sees her husband off to his place of work without ever really knowing much of what he does.
With respect, there are very many degrees to which one companion knows or understands the business objectives of the other. The objectives that Judge Barber identified as being sufficiently connected with business in Case K75 do not require in every case that a companion “eat, drink and sleep” his or her partner’s business. That was the position as found in that case but, put more generally, the questions or tests that arise from the decision are:
- Does the presence of the companion at business related functions provide a meaningful sounding board, relevant to the business principal?
- Does the presence of the companion facilitate a rapport for the business principal through attendance by the companion at business related social functions, dinners and the like?
- Are such functions a natural extension of the business pursuits of the principal?
- Is the involvement of the companion conducive to a more effective and cordial atmosphere for the benefit of the business principal and his or her objectives?
- Does the companion’s presence establish or enhance the business and social credibility and status of the business principal?
None of these necessarily requires that the companion must have some special skill or knowledge to justify deductibility of his or her travel expenses. Special knowledge certainly existed in the case of the well connected companion in Case 16 and the highly engaged newspaper publishers’ companions in Case K75. However that does not mean such knowledge must exist before a companion can contribute to the outcomes which, when expressed in the form of more general tests, Case K75 suggests warrant deductibility.
A balance will always be necessary. The Judge noted his satisfaction that none of the expenditure related to “a junket or joy-ride or holiday”, although he went on to state that where a significant holiday or touring content existed there may be insufficient nexus to justify deductibility, or some apportionment may be required. That observation does not suggest that attendance at business-related social functions is necessarily insufficient companion involvement. It begs the question.
Not a joy-ride
In the author’s view, the CIR’s position is shortsighted and unrealistic for a nation which relies on successful international connections. Anyone who has travelled alone on business outside New Zealand will have experienced the awkwardness that involves. The prospect of “working a room” alone can be daunting, especially if those whom one is trying to meet are accompanied. Anyone who has asked a companion whether involvement in such business-related activities is a “junket or a joy-ride or a holiday” will very probably have been disabused of that suggestion quickly.
Considering the matter on a broader scale, New Zealand has a small economy and outreach is critical to our long term economic prosperity. The tax system should encourage business activity or at least not impose costs where they need not be. Being geographically isolated, it is important that business people from New Zealand are able to travel in a cost effective manner, and with appropriate support. The loss of deductibility for companion travel costs adds unnecessarily to the costs of effective outreach.
Moreover, the CIR’s policy is tantamount to her saying that, unless a companion possesses the now required “special knowledge or skill”, his or her travel to be present at a business function in support of the taxpayer (or that person’s employer) is worthless in tax terms. That is because it is not sufficiently connected with the success of the business being represented to warrant tax recognition. The pertinent issue is whether in the context of business-related activity it is realistic to regard the involvement of a companion as fundamentally a matter of personal consumption in the Haenga sense. When a person and his or her companion are away from home, often in a foreign environment, and in circles which require convivial social interaction in pursuit of business outcomes, it is debatable whether the companion’s value is truly personal or whether the business person and his or her companion take on a team function in the interests of the business. That seems to have been the sense in which Judge Barber considered the role of Mrs G. It is very probably the better view of most such companionship on business travel.
At a policy level there are also some anomalies that emerge from the statement. It is not clear, for instance, how the approach to companion travel expenses fits alongside the deductibility of business related entertainment expenses which of course includes food and drink. Such expenses incurred in New Zealand are subject to a 50 per cent deduction but expenses incurred overseas are not. Is it required now that expenses related to meals consumed by a companion traveling on business should be wholly excluded from deduction, or does the statement deal only with the travel costs and nothing more? If it is the latter, then the deductibility for companion involvement in overseas business entertainment seems to be at odds with the assumptions underpinning the new travel cost rule. Similarly it is unclear how the treatment of companion travel costs equates with the fringe benefit tax regime. There seems to be an uneasy and inconsistent connection between these different tax rules.
In an effort to prevent taxpayer subsidised “junkets”, which clearly ought not to be permitted, Inland Revenue has failed to read and apply the authorities correctly and, as a result, has set the bar too high. It fundamentally undervalues the companion’s contribution to successful business by assuming that a companion’s social role is wholly related to supporting the business person with whom the companion is travelling, rather than supporting the achievement of business outcomes. Inland Revenue ought to rethink this matter urgently and, if it does not, it can expect its position to be tested.
* Article author Mr Geoffrey Clews practices from Old South British Chambers as specialist tax and trusts counsel in Auckland. He acknowledges the assistance of his associate Andrew Tringham in the preparation of this article.
 TIB vol 26:1 (February 2014).
 “Deduction for Wife’s Expenses – Professional People Attending Overseas Conferences” Public Information Bulletin 74 (June 1973) at 10, and part of the item “Overseas Travel Expenses Claims” TIB vol 7:2 (August 1995).
 Commissioner of Inland Revenue v Haenga  1 NZLR 119 (CA).
 Case K75 (1988) 10 NZTC 602 (TRA) at 611.
 At 613.
 At 614.