As a result of having a 30% interest between 2005 and 2009 in four companies which were resident in China, the taxpayer had the active business income of those companies of $4.6 million attributed to her in New Zealand under the New Zealand controlled foreign companies (CFC) regime. The New Zealand income tax payable by her on that income was reduced by the Chinese tax actually paid by those companies, but not by approximately $0.6 million of tax that the Chinese companies were spared from paying due to tax concessions granted to them under Chinese domestic law. Art. 23 of the China- New Zealand Double Taxation Agreement (the “DTA”) provided in relevant part:
2. In the case of New Zealand, double taxation shall be avoided as follows:
(a) … Chinese tax paid under the laws of the People’s Republic of China and consistently with this Agreement, whether directly or by deduction, in respect of income derived by a resident of New Zealand from sources in the People’s Republic of China (excluding, in the case of a dividend, tax paid in respect of the profits out of which the dividend is paid) shall be allowed as a credit against New Zealand tax payable in respect of that income; …
3. For the purposes of paragraph 2 (a), tax payable in the People’s Republic of China by a resident of New Zealand shall be deemed to include any amount which would have been payable as Chinese tax for any year but for an exemption from, or reduction of tax granted for that year or any part thereof under any of the following provisions of Chinese law … .
In finding that Art. 23 did not require the Commissioner to grant a foreign tax credit for the spared Chinese tax, Harrison J stated (at paras. 29-30, 33):
The phrase “in respect of” is amorphous and can lead to linguistic uncertainty and confusion. …
We are satisfied that the phrase “in respect of” is used synonymously with “on” in all three places in art 23(2)(a). Its meaning should be consistent throughout. Contrary to the Judge’s view, we are satisfied that art 23(2)(a) requires the tax to have been paid by a New Zealand resident on income derived by him or her in China, not by a third party CFC; that is the essential precondition to a credit in New Zealand. …
In our judgment art 23(2)(a) relieves solely against juridical double taxation. Mr Clews’s argument [for the taxpayer] requires us to disregard the legal nature of the relationship between Ms Lin and the Chinese CFCs to focus instead on the substantive source of “the income derived”. The fact that the ultimate source is income attributed to Ms Lin from the Chinese CFCs does not justify treating the two income streams, earned separately by the CFCs and Ms Lin, as one for revenue purposes, and ignoring the plain foundation of art 23(2)(a) on the source of “the income derived by a resident of New Zealand”, Ms Lin.