XXX v Commissioner of Inland Revenue [2014] NZTRA 6 (4 June 2014)

Last Updated: 30 June 2014

BEFORE THE TAXATION REVIEW AUTHORITY

TRA 022/12

[2014] NZTRA 06

IN THE MATTER OF the Income Tax Act 2007 and the

Tax Administration Act 1994

BETWEEN XXX

Disputant

AND THE COMMISSIONER OF INLAND REVENUE

Defendant

Hearing: 28 April 2014

Appearances: M Keating for the Disputant

H Ebersohn and C Kern for the Defendant

Decision: 4 June 2014

RESERVED DECISION OF JUDGE AA SINCLAIR AS TAXATION REVIEW AUTHORITY
[On Application for Discovery by Defendant]

Introduction

[1] The Commissioner filed an application for discovery orders which came before the Authority on 28 April 2014. The Commissioner sought discovery of the following documents:

1.1 A copy of the disputant’s diary for the 2006 through 2008 income years.

1.2 All documents/material that evidence or explain what funds the disputant or her family used to fund her losses and to support her and her family’s life-styles during the 2006 to 2008 income years, including:

1.2.1 Financial statements of the disputant’s associated entities along with supporting ledgers, journals and trial balances;

1.2.2 Trustee resolutions and minutes of Trustee meetings for any family trust;

1.2.3 Trust accounts for any family trust;

1.2.4 Documents outlining the flow of funds from the disputant’s associated entities to herself or vice-versa;

1.2.5 All mortgage or loan statements; credit card statements; records of assets held by the disputant, her partner or her family trusts; bank statements; financial statements of associated entities from 1 April 2005[1] until 31 March 2008; and

1.2.6 Documents evidencing any inheritance, gifts or other funds received by the disputant, her partner or any family trust from 1 April 2005 until 31 March 2008.

1.3 All documents relevant to the deductions claimed by the disputant in each income year; including all invoices, bank statements, correspondence and contractual documents, including accounting journals, spreadsheets or trial balances.

[2] Subsequent to the hearing the parties reached agreement for informal discovery of the documents referred to in orders 1.1 and 1.3.[2] The remaining issue for determination relates to discovery of the documents identified in order 1.2.
[3] The disputant opposes this application on the grounds that:

• (a) the evidence sought is not relevant to matters in these proceedings; and
• (b) the information is excluded by virtue of s 138G of the Tax Administration Act 1994 (TAA).

[4] Affidavits were filed and lengthy submissions given at the hearing covering all the categories of documents sought. My decision focuses simply on the evidence and submissions (which I summarise briefly) relating to the discovery of the documents in order 1.2.

Background to Application

[5] This dispute involves a claim for deductions. The disputant failed to file income tax returns for the 2006, 2007 and 2008 income tax periods. In June 2009, the Commissioner issued default assessments, based on annualised sales from goods and services tax returns filed for the periods in dispute, allowing for deductions based on the NZ Business Benchmarking Survey results for 2007. This benchmark indicated overhead, as a percentage of income, for the disputant’s professional group at 30%.
[6] The disputant subsequently filed tax returns for the 2006, 2007 and 2008 income years and issued a Notice of Proposed Adjustment. She claimed expenses exceeding income in 2 of the 3 years in dispute. The expenses claimed represented 139%, 99% and 113% of income for those respective years.
[7] In her Statement of Position[3] the disputant stated:

Since the taxpayer is handling [description of work] and will not be paid until the end of the [matter] her taxable income for the 2006, 2007 and 2008 is not greater than her expenses resulting in taxable losses...the taxpayer has funded the losses by loans from the X Family Trust.

Arising from this statement the Commissioner seeks discovery of the documents detailed in order 1.2

Relevance of Documents?

[8] It is not in contention that the primary issue in this dispute is the deductibility of the items of expenditure claimed by the disputant. The Commissioner says that whether the disputant has satisfied her onus of proof will in part turn on her credibility, assessed in the context of the background facts. The Commissioner submits that a key background fact will be whether it is credible that the disputant had virtually no net income in the years in dispute given that she claims to be successful in her chosen career.
[9] The Commissioner further submits that the documents sought are relevant as such evidence has a tendency to disprove that all the deductions claimed are genuine business expenses.[4] As well, the Commissioner submits that she is entitled to respond to the disputant’s statement that her net income is temporarily low and that she has effectively lived off loans from her family trust.
[10] The Commissioner contends that the disputant was aware of the unusual nature of her returns and that the level of net income was low for her profession, and has thought to justify her position by noting a temporary loss of income which she has been able to fund from a family trust. The Commissioner submits that the disputant cannot justify her returns and then not discover the documents relevant to that justification.
[11] The Commissioner also sought to rely in support of this application, on evidence relating to the disputant’s income in prior tax years. The prior financial years are not the subject of this claim and are not otherwise raised in the Statements of Position. I do not consider that income earned in those years is relevant to the present application. Furthermore I agree with the disputant that under s138G of the TAA (discussed below) the evidence cannot simply be introduced in support of an interlocutory application.
[12] The disputant submits that as the matter in dispute relates exclusively to the extent of deductibility of the specific categories of expenditure identified, discovery is warranted only in respect of documents relevant to that matter. Neither party in her Statement of Position identifies the disputant’s source of funds as a legal issue in dispute. In these circumstances the disputant contends that the discovery sought is not relevant.
[13] It is settled law that a deduction may be allowed in respect to expenditure incurred, although there has been no actual disbursement if, in the relevant income year, the taxpayer is “definitely committed” to that expenditure.[5] The disputant submits therefore that how or whether the taxpayer is in a position to pay that expenditure, immediately or in the future, let alone the source of the funds to make the payment, is simply not relevant to determining the proper deductibility of that expense.
[14] As to this argument, the Commissioner submits that in assessing whether expenditure is private or business, how the expenditure was funded can be relevant. She contends that it is unreal to suggest that a person would spend all of their income on business expenditure. Further she contends that whether an expense is paid is relevant to whether a taxpayer was “definitively committed” to the expenditure. The Commissioner says that this was understood by the disputant when she explained how her losses were funded in her Statement of Position.

Applicability of Evidence Exclusion Rule?

[15] Section 138G(1) of the TAA (“the evidence exclusion rule”) provides:

(1) Unless subsection (2) applies, if the Commissioner issues a disclosure notice to a disputant, and the disputant challenges the disputable decision, the Commissioner and the disputant may raise in the challenge only-

(a) The facts and evidence, and the issues arising from them; and

(b) The propositions of law,-

that are disclosed in the Commissioner’s statement of position and in the disputant’s statement of position.

(2) A hearing authority may, on application by a party to a challenge to a disputable decision, allow the applicant to raise in the challenge new facts and evidence, and new propositions of law, and new issues, if satisfied that—

(a) The applicant could not, at the time of delivery of the applicant's statement of position, have, with due diligence, discovered those facts or evidence; or discerned those propositions of law or issues; and

(b) Having regard to the provisions of section 89A and the conduct of the parties, the hearing authority considers that the admission of those facts or evidence or the raising of those propositions of law or issues is necessary to avoid manifest injustice to the Commissioner or the disputant.

(3) For the purposes of subsection (1), a statement of position includes any additional information that the Commissioner and the disputant agree (under section 89M(13)) to add to the statement of position.

[16] The disputant accepts that the operation of the evidence exclusion rule does not preclude an order for discovery of relevant material.[6] Rather, the disputant submits that in this case the Commissioner has failed to establish that discovery of the documents identified in order 1.2 is either relevant or necessary to resolve the present challenge.
[17] The disputant submits that the scope of the evidence exclusion rule refers back to the requirements to be included in the parties’ respective Statements of Position. Subsections 89M(4) and (6) of the TAA provide that the Statement of Position of the respective party (the Commissioner or disputant) must, with sufficient detail to fairly inform the other party, give an outline of the facts and the evidence on which the party intends to rely; an outline of the issues that the party considers will arise; and specify the propositions of law on which the party intends to rely. The disputant contends that the parties must therefore not only identify the facts on which they will rely but specify the legal issues that will arise and the relevant propositions of law. In the present case the disputant says that neither party identified any legal issues or propositions of law relating to the question of how the disputant funded her expenditure or supported her family.
[18] The Commissioner contends that it is necessary under ss 89M(4)(b) and 89M(6)(b) that Statements of Position contain only an outline of the evidence. That outline does not require each document to be listed separately but is intended to ensure that parties cannot conduct a trial by ambush.[7] This can be significant for cross examination purposes. In Glenharrow Holdings Ltd v CIR Master Venning (as he then was) observed:[8]

I accept Mr Mathieson’s submission that the discovery process is a more general process that may disclose documents relevant to the facts and evidence and issues arising from them already stated in the statements of position. Put another way, discovery may result in the disclosure of a document which could add weight or force to the Plaintiff’s cross-examination of a defence witness. To make an order for discovery in those circumstances should not be seen as offending, or as contrary to, the purposes of s 138G.

The Commissioner submits that the discovery sought in this application is within the outline of evidence in the disputant’s Statement of Position and cannot therefore be excluded under the evidence exclusion rule.

[19] The Commissioner says that the fact that a document may add weight or force in response to the other party’s case, first recognised in the High Court in Commissioner of Inland Revenue v Delphi Fishing Co Ltd,[9] was confirmed by the Supreme Court in Penny v Commissioner of Inland Revenue.[10] That case concerned a dispute as to whether a restructuring of Mr Penny’s business affairs constituted a tax avoidance arrangement. In Mr Penny’s Statement of Position it was stated that Mr Penny had restructured his affairs through a family trust to provide a greater degree of asset protection and not to avoid tax. The Commissioner was able to rely on evidence about loans made by Mr Penny’s family trust to Mr Penny even though these loans were not mentioned in the Statements of Position. The Commissioner was allowed to rely on this evidence to show that as Mr Penny had received the funds in the form of loans he had compromised the asset protection (thereby questioning whether such a commercial purpose ever existed). The Supreme Court noted:

[30] It is said [by Mr Penny] that no reliance was placed upon them [the loans] as forming part of the arrangement until after the discovery process.

[31] It seems to us, however, that this last point fatally undermines the argument for Mr Penny since it is undisputed that until discovery was made the Commissioner did not learn that the loans were an accounting reconstruction of what actually occurred, namely that Mr Penny had drawn on company funds by signing its cheques made payable to himself. Furthermore, even if that had not been so, the Commissioner would have been entitled to refer to the loans in response to the statement in Mr Penny’s SOP that he had been advised that a restructure of his assets would provide a greater degree of asset protection for his family. To the extent that the money immediately found its way back to Mr Penny, that protection could be at risk of his bankruptcy if he were ever to be faced with an uninsured negligence claim not covered by ACC. The Commissioner was therefore able to rely upon the making of the loans...

[20] The Commissioner says that that the disputant has sought to explain her low net income in terms of a temporary lack of funds due to a large matter in which she is involved and explained her ability to fund her losses by loans from her family trust. The Commissioner contends that the disputant has therefore put in issue how she has funded her losses. It now forms part of the outline of the case and she (the Commissioner) is entitled to reply to it. Accordingly the Commissioner says that she is only responding to this issue in seeking discovery of all documents/material which evidence or explain what funds the disputant or her family used to fund her losses and to support her and her family’s lifestyle.
[21] The disputant acknowledges that the Commissioner is entitled to rely upon facts contained in the disputant’s Statement of Position when the evidence exclusion rule is applied.[11] However, the disputant says that the statement in her Statement of Position was not contested by the Commissioner, either in her own Statement of Position or subsequently, and the existence or reliance by the disputant on those loans from the X Family Trust was never identified as “an issue arising” from that evidence that was in dispute between the parties. As such, the disputant contends that the existence or otherwise of the loans and/or other sources of finance available to the disputant is simply not relevant to the legal issue being the deductibility of expenditure.
[22] The disputant also refers to the decision in Penny v Commissioner of Inland Revenue[12] (discussed above) and submits that implicit in both the Court of Appeal and Supreme Court is the understanding that the existence of the loans (whether as a step in the arrangement or not) had both been raised in the taxpayer’s evidence and was relevant to the issues in dispute, namely whether the restructure constituted tax avoidance. By contrast, the disputant contends that in the present case the source of the disputant’s funding for the years in question is simply not relevant to the sole issue in dispute and was not identified as a legal issue or proposition of law raised by either party in their Statements of Position. Accordingly, the disputant submits that while both Penny and the present case coincidentally refer to the possibility of new evidence being introduced to establish loans entered into by the taxpayers, they arise in very different factual contexts and in respect of entirely different types of disputes. As such, the disputant submits that the reasoning in Penny can be distinguished in this instance.
[23] The disputant submits that no reasonable person reading the parties’ Statements of Position would think that either party had made an issue of her source of funds.[13] Documents, and therefore legal arguments about the source of that funding, are therefore precluded from being raised by the Commissioner by virtue of s 138G.

Discussion

[24] It is not in contention that the High Court Rules concerning discovery apply in proceedings before a Taxation Review Authority.[14] High Court Rule 8.5(1) provides that a Judge must make a discovery order for a proceeding unless he or she considers that the proceedings can be justly disposed of without any discovery. McGechan on Procedure[15] notes that the presumption is that discovery remains the norm, and that the onus will be on any party resisting to make out that the proceeding can be disposed of without any discovery.
[25] The disputant submits that the specific power under which discovery can be ordered by this Authority is set out in Regulation 12 of the Taxation Review Authorities Regulations 1998 which states:

12 Interlocutory applications

...

(5) An applicant for an order directing a party to supply further information to the applicant must satisfy the Authority that the order is justified in the circumstances and in light of the purposes of Part 4 of the Tax Administration Act 1994.

(6) Subclause 5 is subject to section 138G of the Tax Administration Act 1994.

The disputant contends that those Regulations require the Authority to both consider the need for further discovery in light of the information already exchanged under the pre-litigation disputes procedure and to make any application for discovery subject to the evidence exclusion rule under s 138G.

[26] Furthermore the disputant submits that both in terms of Reg 12(5) and under the applicable discovery rules, the onus of proving that further discovery is required falls on the Commissioner. In Radio Works Ltd v Commissioner of Inland Revenue[16] Abbot AJ stated:

[34] Although, in principle, it must be for the person seeking general discovery to show that the threshold has been met, that threshold is a low one which will be assumed in standard track proceedings. However, where the party opposing general discovery raises matters (such as prior provision of documents and exchange of information) which call that assumption into question, the party seeking general discovery will have the onus of showing that discovery is appropriate notwithstanding the matters raised. In the present case, it is for the Commissioner, therefore, to show that general discovery is appropriate notwithstanding the prior exchange of documents under the disputes procedure, and the potential inadmissibility of any further documents by reason of s 138G.

[27] In this case the parties have agreed to informal discovery of other categories of documents and the Commissioner seeks an order for discovery of the documents identified in order 1.2. The onus is on the Commissioner to meet the threshold test under High Court Rule 8.5(1). It is accepted that this threshold is a low one. While there may possibly be instances where as a consequence of the level of prior disclosure pursuant to s 17 of the TAA or otherwise, the onus may shift to the party seeking discovery, I do not consider that is the case here. The discovery sought arises from a statement made in the disputant’s Statement of Position and the level of prior discovery is therefore not a relevant issue.
[28] In Case Y23[17] Judge Barber considered the application of reg 12(5). He held that the Regulation had no application in the circumstances of that case for the following reasons:

[62] ... Regulation 12 is concerned with interlocutory applications. General discovery under the DCR [District Court Rules] is not an interlocutory application.....Secondly, reg 12(5) is not concerned with general discovery but particular discovery (which is obtained by way of interlocutory application). Furthermore, reg 12(5) provides that, if an applicant seeks further information, the Authority must be satisfied it is justified in the circumstances and in light of the purposes of Part IV of the TAA. Part IV of the TAA contains provisions that relate to secrecy. Usually where secrecy is an issue, before the Commissioner can disclose information it must be for the purposes of carrying into effect the Revenue Acts: s 81 of the TAA. However, there is no secrecy issue in the current matter. The general discovery sought is merely between the Defendant and the Disputant.

Judge Barber went on to observe that reg 12(5) refers not to orders for “information”, which would be expected if it referred to general discovery, but to orders for “further information”. While this decision was decided under the old discovery regime there is no reason why these principles do not still apply. The present application is for tailored discovery. It is not one for particular discovery under Rule 8.19. However even if reg 12(5) does apply, I consider that discovery of the documents sought is justified for the reasons set out below.

[29] The issue for determination in this dispute is the deductibility of the various categories of expenditure identified by the disputant. The disputant contends that the source of the disputant’s funds in the years in question is simply not relevant to this issue. The disputant has sought to explain her low net income and the funding of her losses by loans from her family trust. I agree with the Commissioner that in making that statement, the disputant has immediately put in issue how she funded her losses in the years in dispute. I accept the Commissioner’s submission that the discovery sought is relevant to the legal issue (being the deductibility of expenditure) for the following reasons:

• (a) for the purpose of assessing the credibility of the disputant;
• (b) the documents sought have a tendency to disprove that all the deductions claimed are genuine business expenses;
• (c) it is necessary for the Commissioner to be able to respond to the disputant’s statement that her net income is temporarily low and that she has effectively lived off loans from her family trust.

[30] The disputant has sought to provide an explanation to justify her returns. I agree with the Commissioner’s further submission that the disputant cannot expect to be able to do this and then not discover the documents relevant to that justification.
[31] The disputant submits that no reasonable person reading the parties’ Statements of Position would think that either party had made an issue of the disputant’s source of funds. In particular, she says that neither party identified any legal issue or proposition of law in their Statement of Position about the disputant’s source of funds. I do not consider that it is necessary for the matter to be identified as a separate legal issue or proposition of law. In my view the disputant in her Statement of Position, clearly raised the issue of the source of her funds in the context of her claim for deductibility of expenditure when she sought to explain how she funded her losses. That explanation/statement now forms part of the disputant’s case and the Commissioner is entitled to reply to it. In these circumstances I am satisfied that the documents sought in order 1.2 are clearly within the outline of evidence in the disputant’s Statement of Position and cannot be excluded under the evidence exclusion rule. The discovery sought is relevant for the reasons set out above.

Decision

[32] An order is made for discovery of the documents identified in order 1.2 of the Commissioner’s application.

Judge AA Sinclair
Taxation Review Authority

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[1] In the application the year in 1.2.5 and1.2.6 is incorrectly stated as being from 1 April 2003.
[2] Recorded in the Minute of the Taxation Review Authority following the directions hearing held on 8 May 2014.

[3] The Investigator’s first affidavit in support of application related to discovery, Exhibit “D” page 4.
[4] S 7(3) of the Evidence Act 2006
[5] King v Commissioner of Inland Revenue (1973) 1 NZTC 61,000, 61,107
[6] This is clearly established in Commissioner of Inland Revenue v Dick and Anor (2001) 20 NZTC 17,396 (HC). See also Case Y14 (2008) 23 NZTC 13,137 and Case Y23 (2008) 23 NZTC 13,248.
These cases were decided under the old Rules on discovery replaced on 1 February 2012 by the High Court Amendment Rules (No 2) 2011 but are still applicable.

[7] Case Y14 supra,[39] and Case Y23 supra [43]
[8] Glenharrow Holdings Ltd v CIR (2002) 20 NZTC 17,729, [23]
[9] Commissioner of Inland Revenue v Delphi Fishing Co Ltd (2004) 21 NZTC 18,525 (HC)
[10] Penny v Commissioner of Inland Revenue [2011] NZSC 95; [2012] 1 NZLR 433 (SC)
[11] Commissioner of Inland Revenue v Delphi Fishing Co Ltd above note 9.
[12] Above note 10.
[13] Vine Light Nominees Limited v Commissioner of Inland Revenue [2013] NZCA 655; (2013) 26 NZTC 21,055 (CA)
[14] Regulation 4 of the Taxation Review Authority Regulations 1998 and District Court Rules 2009
Rules 1.6 and 8.5 which invoke the High Court Rules on discovery
[15] McGechan on Procedure HR8.5.01(1)
[16] Radio Works Ltd v Commissioner of Inland Revenue (2009) 24 NZTC 23,691

[17] Above note 6.