Alex Harvey Industries Ltd v Commissioner of Inland Revenue [2001] NZCA 356; (2001) 20 NZTC 17,286; (2001) 15 PRNZ 361 (30 July 2001)

Last Updated: 12 December 2011

IN THE COURT OF APPEAL OF NEW ZEALAND

CA 36/01

	BETWEEN	ALEX HARVEY INDUSTRIES LTD
		Appellant

	AND	COMMISSIONER OF INLAND REVENUE
		Respondent

Hearing:	24 July 2001
Coram:	Gault J Thomas J Keith J
Appearances:	L McKay and R G Simpson for Appellant T Arnold QC and A Beck for Respondent
Judgment:	30 July 2001

JUDGMENT OF THE COURT DELIVERED BY THOMAS J

The question in issue

[1] The question in issue in this appeal is whether the Judge at first instance exercised her discretion properly in refusing the appellant’s application to separate the trial and resolve five questions as preliminary issues pursuant to r 418 of the High Court Rules.

Background facts

[2] Alex Harvey Industries Ltd (AHI), the appellant, entered into the three transactions in issue in the 1986 and 1987 income years. For convenience, these transactions have been referred to as the NZIMD1, NZIMD2 and SIFL transactions.
[3] Each of the transactions consist of a complex series of separate transactions involving different parties. But they share certain common features which were listed by AHI’s counsel, Mr McKay, as follows; money was borrowed by AHI from an unrelated third party; interest was payable by AHI to the lender; in each case AHI on-lent the proceeds of the borrowing to AHI Group Ltd, its immediate parent; interest was payable to AHI by AHI Group Ltd on those on-lendings; and the rate of interest payable by AHI Group Ltd was in each case at a margin over AHI’s own interest cost to the third party lender. The same transactions took place between AHI Group Ltd and its parent, Carter Holt Harvey Ltd.
[4] As a consequence of on-lending at a margin over its own borrowing costs, AHI derived assessable interest income at levels greater than the amount of interest deductions taken by it in respect of the NZIMD2 and SIFL transactions. Through an omission to set the on-lending margin at a level sufficient to cover fees incurred in the establishment of the transaction in the NZIMD1 transaction, AHI’s deductions exceeded its assessable income by just over $104,000.
[5] Mr McKay frankly acknowledged that the transactions were “circular”. He accepted that they invited the Commissioner of Inland Revenue to claim that they were “artificial and something of a pretence”.
[6] The Commissioner took just that view. He ruled that the three transactions constituted arrangements for the purpose of s 99(1) of the Income Tax Act 1976 and that each was void as against the Commissioner in terms of s 99(2), having for its purpose or effect tax avoidance.
[7] As a result, the Commissioner adjusted the assessable income of AHI. He disallowed, in the case of the NZIMD1 and NZIMD2 transactions, in whole, and in the case of the SIFL transaction, in part, the interest deductions claimed by AHI on account of its interest payments to third party lenders. The Commissioner did not, however, and this is AHI’s complaint, deduct the tax costs arising from or under those arrangements by way of an offset against the alleged tax advantage.
[8] AHI made an application under r 418 seeking the resolution of five separate questions as preliminary issues. The questions are as follows:

Does section 99(3) limit the power of adjustment conferred upon the Commissioner by that section to that sufficient to “counteract any tax advantage” derived by the relevant taxpayer from any arrangement that is void in accordance with subsection 99(2) of the Act?

When quantifying the tax advantage obtained by the appellant from or under each of the three arrangements ..., must the Commissioner deduct the tax costs arising from or under those arrangements, by way of offset against any tax advantage?

In relation to the NZIMD1 transaction, what was the tax advantage (if any) obtained by the appellant from or under that arrangement for each of the income years in question?

In relation to the NZIMD2 transaction, what was the tax advantage (if any) obtained by the appellant from or under that arrangement for each of the income years in question?

In relation to the SIFL note issuance transaction, what was the tax advantage (if any) obtained by the appellant from or under that arrangement for each of the income years in question?

[9] The first two of these questions are questions of law. Mr McKay described the second question as the key issue to be determined by the Court. The remaining three questions are questions of fact relating to the quantum of the tax advantage obtained by AHI. Mr McKay is confident that the answers to these three factual questions are capable of being resolved by agreement between counsel and, if not, says that they can be determined by the Court largely as a matter of formal proof.

The judgment in the Court below

[10] The application, which was opposed by the Commissioner, came before Potter J. The learned Judge shared the Commissioner’s concern about proceeding on the basis proposed by AHI and declined the application in an admirably succinct judgment. So much of her conclusions as are relevant read as follows:

...In my view there is little to be gained, and there is potential for delays and increased costs in the longer term, in attempting to put the cart before the horse, to determine as a preliminary issue the question the Court will need to address under s.99(3), if and when on the basis of the evidence and argument presented to it at a full hearing, it determines there is an arrangement, and that one of the purposes or effects of the arrangement is tax avoidance.

Attractive though it may seem, at least superficially, to obtain preliminary interpretation of s.99(3), to do so in a vacuum is unlikely to be helpful in the long run. Unless the interpretation of s.99(3) is made in relation to established facts, there is the real likelihood that when all the facts are before the Court, the interpretation and application of s.99(3) will again require to be considered by the Court on the basis of the facts as determined by the Court, and the determinations made on other relevant issues which precede the application of s.99(3). The interpretation and application of s.99(3) on the basis of the established facts is chronologically the final step in the process, and should be addressed by the Court in proper order.

Our decision

[11] In this Court, Mr McKay launched a lengthy attack on the learned Judge’s reasoning. He failed to persuade us, however, that Potter J exercised her discretion improperly. The decision which she reached was undoubtedly open to her.
[12] Mr McKay favoured the test enunciated in Fitzgerald v Beattie [1976] 1 NZLR 265, at 268, and adopted by the majority (Thomas J dissenting) in Neumegen v Neumegen and Co [1998] 3 NZLR 310 at 320, when deciding an appeal against the exercise of a discretion. The Court, it was said, will not disturb the order made in the discretion of the Judge at first instance unless it is satisfied that the Judge had proceeded on a wrong principle or had given undue weight to some factor or insufficient weight to another or is plainly wrong.
[13] But this Court has more recently indicated that it prefers the formulation in May v May [1982] 1 NZFLR 165, at 170, to that of the Court in Fitzgerald v Beattie. See Harris v McIntosh CA 279/98, 30 September 1999, at 4-5. That formulation reads:

... an appellant must show that the Judge acted on a wrong principle; or that he failed to take into account some relevant matter or that he took account of some irrelevant matter or that he was plainly wrong.

[14] The significant difference is that the latter test omits any reference to the Judge having given undue weight to some factor or insufficient weight to another. Weighing and balancing the various factors is an integral part of a Judge’s exercise of his or her discretion. This Court will not repeat that exercise unless the Judge has given such excessive weight to some factor or such patently inadequate weight to another as to be “plainly wrong”. The problem is that, if the phrases “undue weight” and “insufficient weight” have this meaning, they are tautologous and unnecessary. If, on the other hand, they do not have that meaning they suggest that the Court will be prepared to substitute its view for that of the Judge – which it will not do.
[15] We therefore reiterate that the formulation in May v May, as endorsed in Harris v McIntosh, is to be treated as the applicable test for examining on appeal the exercise of a discretion in the Court below.
[16] Relying upon the test in Fitzgerald v Beattie, however, much of Mr McKay’s submissions were directed at showing that Potter J gave undue weight to some factors and insufficient weight to others. It is true that in his oral submission Mr McKay decried the significance of these phrases and sought to rely on the contention that the Judge was plainly wrong. In fact, however, much of Mr McKay’s submission was an open attempt to persuade the Court to enter upon the exercise of remaking the decision reached by the learned Judge in the exercise of her discretion. But he could not point to a wrong principle and fell far short of demonstrating that Potter J was plainly wrong.
[17] Several features in our decision not to disturb the judgment of the Court below may be elaborated.
[18] In the first place, it became clear that Mr McKay perceived the strength of his argument to rest on the assertion that the Commissioner’s interpretation of s 99(3) was “fundamentally flawed”. Thus, he urged, the prospect of incurring unnecessary delay and additional costs should the questions be resolved as preliminary issues is to be balanced against the fact that the Commissioner’s position is completely untenable in law. For his part, the Solicitor-General was reluctant to enter upon the merits of the argument. We shared this reluctance, but explored the issue to a sufficient extent to ensure that there is no reason to depart from the established approach to an appeal of this kind.
[19] AHI’s argument that the Commissioner’s assessment under s 99(3) is fundamentally flawed is based on the express language of the subsection. The subsection reads:

(3) Where an arrangement is void in accordance with subsection (2) of this section, the assessable income ... of any person affected by that arrangement shall be adjusted in such manner as the Commissioner considers appropriate so as to counteract any tax advantage obtained by that person from or under that arrangement, and, without limiting the generality of the foregoing provisions of this subsection, the Commissioner may have regard to such income as, in his opinion, either-

(a) That person would have, or might be expected to have, or would in all likelihood have, derived if that arrangement had not been made or entered into; or
(b) That person would have derived if he had been entitled to the benefit of all income, or of such part thereof as the Commissioner considers proper, derived by any other person or persons as a result of that arrangement.
[20] Mr McKay contends that the Commissioner’s power to adjust or reconstruct the taxpayer’s assessable income is limited to counteracting any tax advantage obtained by the taxpayer whose assessment is in issue from or under that arrangement. He described the subsection as “taxpayer specific”. In this case, AHI is a separate taxpayer, and it is that company’s assessment which is in issue. In order to quantify the tax advantage to AHI the Commissioner must take into account any tax costs or disadvantages arising under the arrangement as a whole. It was, Mr McKay argued, then a matter of arithmetic to determine that no tax advantage was obtained by AHI in respect of the NZIMD2 and SIFL arrangements. In respect of both transactions AHI derived a greater sum of assessable income from the arrangement than it claimed by way of deductions from the arrangement. A “net tax disadvantage” accordingly arose to AHI. With reference to the NZIMD1 arrangement, AHI obtained a tax advantage of $104,167 representing the excess of the deductions claimed by it over the level of assessable interest income derived from the arrangement. Mr McKay urged that, to disallow the appellant over $100 million in deductions but to leave as assessable income the sum of $101 million which would not have arisen but for the arrangements, cannot be a correct application of the Commissioner’s power of reconstruction under s 99(3).
[21] Notwithstanding his reluctance to enter upon this question, the Solicitor-General sought to broadly outline the Commissioner’s position. The Commissioner takes the view that the deductions were “manufactured deductions” reflecting an attempt to change the cost of capital into tax deductible interest payments. He has chosen to reassess AHI as it was the company in which the arrangement to manufacture the deductions originated, and it was that company into which, following the “circular” transactions which are part of the arrangement, the deductions entered the corporate group. Thus, he claimed, it is that company which gets the advantage of the manufactured deductions. It is immaterial, the Solicitor-General argued, that these deductions might be passed on to others within the group. The Commissioner is not obliged to trace the internal transactions of the group to ascertain which company in the group has the ultimate tax advantage in the terms insisted upon by Mr McKay.
[22] Another way of making this point, as we understand it, is to begin with the fact that an arrangement is void under subs (2) for income tax purposes if it has the “purpose or effect” of tax avoidance. Arguably, tax avoidance was the “purpose” of each arrangement initiated by AHI, and the “effect” of the arrangement was complete when the deductions entered the group through that company. The arrangement became void at either point. It is that arrangement which is the “arrangement” for the purposes of readjustment and reconstruction under subs (3), and it is inappropriate to look at the fate of the deductions at a later point in time.
[23] Mr McKay is undoubtedly correct to stress that in the express terms of the subsection, the adjustment must be directed to counteracting the tax advantage obtained by AHI. Assuming that the subsection applies and that the Commissioner must rely on s 99(3) to assess the tax payable on AHI’s assessable income, the Commissioner will need to meet the argument that the tax advantage is not the difference between the total interest and fee deductions paid by AHI to, say, NZIMD2 over the 1987 to 1989 years and the assessable income derived by AHI from the loan to AHI Group Ltd over the same period. It would seem that the answer can only lie in a close examination of the arrangements as a whole, and for that reason the Commissioner should have the opportunity to establish the arrangements, and to seek to confirm his perception of those arrangements, in evidence. We do not regard the “model” statement of facts proffered by Mr McKay as an adequate basis for what will obviously be a difficult question of law.
[24] While the Commissioner may face some difficulties with the express wording of s 99(3), therefore, we are not presently persuaded that the issue is as straight-forward as Mr McKay would have it. Certainly, we are not inclined to accept that AHI’s legal contention is so strong as to warrant a departure from the established principles governing an application under r 418.
[25] It is to be emphasised, in the second place, that AHI wishes to pursue the preliminary questions on the basis of what are essentially “hypothetical” facts. For the purpose of determining the preliminary questions, AHI is prepared to assume each and every fact agreed to or asserted by the Commissioner in his Points of Objection Notice relating to ss 99(1) and (2), including the details of each arrangement and the nature of the tax avoidance purpose or effect of each arrangement. Thus, Mr McKay argued, the Commissioner could not improve his position by insisting upon a trial. But AHI makes this concession for the purpose of the preliminary hearing only. The company does not concede that the transactions constitute tax avoidance. It is in this sense that the facts are hypothetical.
[26] There may be cases where facts are to be assumed for the purpose of hearing and determining a separate issue pursuant to r 418. But we do not think that this is such a case. In effect, the Court is being asked to give an opinion on the meaning of s 99(3) in the absence of a finding that the prerequisite to the operation of that subsection, that is, that the arrangements constituted tax avoidance, has occurred. It may well be, as counsel for AHI undertook to the Court that, if the Court’s interpretation of subs (3) accords with the interpretation pressed on the company’s behalf, AHI will end the litigation. It would no longer be economically feasible for it to contest the question whether the transactions constituted tax avoidance. But the fact remains that the interpretation of subs (3) would have been arrived at on a hypothetical basis in that no Court will have pronounced on the critical question under subs (2), which is a prerequisite to the operation of subs (3).
[27] In the third place, we take the view, as did Potter J in the Court below, that the determination of the scope and true meaning of subs (3) will benefit from having the facts relating to the transactions in question established at trial. Having heard witnesses, including apparently accounting and expert witnesses, the Court may well obtain a more complete appreciation of the facts than is possible from a written outline. This Court has repeatedly stressed the perils of trying to decide a complex question of law in advance of a hearing and a comprehensive determination of the facts. It is an exhortation which seemingly needs to be constantly reiterated. The relationship of the facts to the law is more often than not impenetrably close, and it is unlikely to promote justice in the individual case or serve the broader requirements of the law to seek to determine questions of law in the abstract. The greatest caution, if not reluctance, is required before the Court will be prepared to enter upon such an inquiry. See Sew Hoy & Sons Ltd (In Receivership and in Liquidation) v Coopers & Lybrand [1996] 1 NZLR 392, at 407.
[28] The wisdom of this reluctance on the part of the Court became apparent when discussion during oral argument focused on the wording of the questions posed by Mr McKay, especially the key question relating to the interpretation of s 99(3). It became evident that, while the terms of this question may reflect what AHI wishes to establish, the question as worded may not adequately encompass the Commissioner’s competing arguments. The precise issue to be resolved will no doubt emerge with greater precision from the evidence which is adduced at trial.
[29] A further factor which we regard as relevant in this regard relates to the ability of the Commissioner, subject always to the Court’s overall supervision of its processes, to press his claim in the manner which he considers most appropriate. The Solicitor-General left us in no doubt that the Commissioner wishes to proceed with the trial. As already noted, this is not a case where the taxpayer has conceded that the transactions in issue constitute tax avoidance. We therefore consider that the Commissioner should have the latitude to determine which issue is to be pursued first.
[30] Finally, we consider that Potter J was correct, and certainly not plainly wrong, in accepting that the risk of exacerbating the delay and costs of the proceeding outweighed any advantage in separating the issues. The Court must be concerned to avoid a multiplicity of appeals and a wasted use of resources. See Strathmore Group Ltd v Fraser [1992] 3 NZLR 385. In this case, the High Court’s decision on the preliminary questions would almost certainly be appealed to this Court. There is then a real likelihood that there would be an appeal to the Privy Council. If AHI were unsuccessful, the case would return to the High Court for the trial which had been deferred. It is then possible that there would be further appeals to this Court and to the Privy Council. In these circumstances, the risk of further delay and additional costs cannot be justified.
[31] We also consider in this connection that the Solicitor-General’s point relating to the procedural nature of this issue is not without merit. Whether the issue under subs (2) or the issue under subs (3) is to be heard separately is essentially a procedural question falling for decision in the Court which is to hear and determine the proceeding. Such a question cannot be divorced from case management. Cooke P has aptly made this point. See the Note to Levi Strauss & Co v Kimbyr Investments Ltd (1992) 5 PRNZ 577, at 580. The Note reads:

...although we are now dealing with an application for leave to appeal made directly to this Court and not with an appeal from Barker J, in accordance with the normal practice we attach considerable weight to the exercise of the Judge’s discretion. That factor is of special importance in a case concerned as this essentially is with a matter of case management in the Judge’s registry. (Emphasis added).

[32] For the above reasons we reject AHI’s claim that the decision of Potter J was plainly wrong. To the contrary, we consider that the decision was a correct exercise of her discretion.
[33] The appeal is dismissed. There will be costs to the Commissioner in this Court in the sum of $5,000, together with disbursements which, failing agreement, are to be fixed by the Registrar.

Solicitors
Bell Gully, Auckland for Appellant
Crown Law Office, Wellington for Respondent