Peterson v Commissioner of Inland Revenue [2003] NZCA 23; (2003) 21 NZTC 18,069 (19 February 2003)

Last Updated: 18 December 2011

IN THE COURT OF APPEAL OF NEW ZEALAND

CA122/02

	BETWEEN	RICHARD DALE PETERSON
		Appellant

	AND	THE COMMISSIONER OF INLAND REVENUE
		Respondent

Hearing:	2 and 3 December 2002
Coram:	Gault P Keith J Anderson J
Appearances:	C R Carruthers QC and B M Brown for Appellant J H Coleman and R J Wallace for Respondent
Judgment:	19 February 2003

JUDGMENT OF THE COURT DELIVERED BY GAULT P

[1] This is the second of two appeals relating to the taxation implications for the appellant of investments in special partnerships established to participate in the production and exploitation of motion picture films. Both appeals were argued together. They raise essentially the same issues. Contemporaneously with the delivery of this judgment we are delivering judgment in the other case (CA50/02). The judgments should be read together. It is unnecessary in this judgment to repeat much of what is said in the companion judgment.
[2] The present case relates to the film “Utu”. The taxpayer with some 113 others, through a special partnership formed with the name BAS – Utu, invested in the production of the film. Utu Productions Ltd (the production company) produced the film pursuant to a Production Deed dated 20 March 1982. According to that deed “The Equity Participants”, who were the partners, appointed the production company to produce the film and carry out post production, marketing and exploitation functions. The Equity Participants were to manage and operate the project exercising control and management functions through an Executive Committee of which the taxpayer was a member. The total budgeted expenditure for the project was specified as $3.1 million. This was to be contributed by the Equity Participants in their agreed shares but it was provided that:

... no Equity Participant shall be obliged to contribute any amount towards the Project Capital unless a Loan Contribution equal to or in excess of 50% of such amount to be contributed has been credited to the Equity Participant’s Trust Account from the Lender under the Deed of Loan.

[3] The Deed of Loan showed the Equity Participants as borrowers and Utu Funding Ltd as lender. The lender agreed to lend a maximum of $1.55 million to be drawn down in instalments for the purpose of investment by the borrowers as equity capital for the Utu project. The loan and interest thereon was repayable on demand but “in full satisfaction of the right to require repayment” the borrowers assigned to the lender rights of participation in net proceeds of exploitation of the film to be applied to interest and loan repayments. Except for these rights the lender was to have no recourse against the borrowers in respect of the loan and interest.
[4] There was extensive documentation dealing with various aspects of the project which has been described in more detail in the decision of the Taxation Review Authority (TRA) which is reported as Case U32 (2000) 19 NZTC 9302. For the purpose of this judgment a brief summary only is necessary. To satisfy the condition for the availability of the investors contributions, Mr Blakeney who, according to the TRA “had complete control over payments into and out of Utu Funding Ltd and Utu Production Ltd”, constructed fictitious loans in favour of Utu Funding Ltd from the New Zealand Film Commission and from a Hong Kong company Glitteron Films Ltd. In the case of the Film Commission loan moneys went in a circle back to the Commission (although the Commission subsequently provided some funding for the film). This Glitteron fictitious funding, and other false expenditure, was included within the $3.1 million the investors believed went into the project and gave rise to an ongoing debt obligation to Utu Funding Ltd to be repaid from the proceeds of exploitation of the film. In fact, they believe that a total of $207,992 from the proceeds of exploitation was subsequently applied in such repayment.
[5] The total amount which the Commissioner, after investigation, determined had not been applied to the project yet was said to be owed by the investors to Utu Funding Ltd and by Utu Funding Ltd to Glitteron Films Ltd (also in terms of a “non-recourse” loan) was $1.54 million. The finding of the TRA was as follows (9.33)

In fact, as Mr Nash’s investigations so ably disclose, the money was passing in a circle from Utu Funding to Wilkinson Wilberfoss to Utu Productions and back to Utu Funding. It is not necessary that I traverse Mr Nash’s evidence in detail suffice to say it is set out at para 8 beginning at p 38 and demonstrates beyond any doubt that this happened on 13 separate occasions. Mr Nash concludes that of the $1,182,000 allegedly lent by Glitteron, $980,000 went round in this fictitious circle. When one adds the other expenses fraudulently claimed by Mr Blakeney: Todd Motors $127,293; Fuji Films Ltd $9,200 and an item of $10,000. The total adds to the full $1,152,010 allegedly advanced by Glitteron.

[6] Pursuant to the Commissioner’s ruling relating to expenditure on films (IR52-3) the taxpayer claimed deductions from his assessable income for his proportionate share of the whole $3.1 million spread over the two income years 1982 and 1983. The Commissioner disallowed part of the claimed loss in each year on the grounds that it did not represent expenditure incurred by the partnership. He determined that the arrangements including the loans were a sham and were void as against the Commissioner under s99 Income Tax Act 1976.
[7] The TRA, after considering the extensive documentation and evidence, determined that the relationship between the Equity Participants and the production company was one of principal and agent and that the disallowed losses were never incurred. It was therefore unnecessary for the TRA to consider the matter in terms of s99. Clear findings were made, however, that neither the taxpayer nor the accountant who acted for the investors’ partnership and was a member of the Executive Committee knew of the falsification of expenditure.
[8] The appeal by the taxpayer to the High Court was heard by Hammond J who delivered his judgment on 14 June 2002. He accepted the argument advanced for the taxpayer that, on a proper construction of the Production Deed, the relationship between the Equity Participants and the production company was not one of principal and agent but was a fixed price contract. He therefore disagreed with the view of the TRA that the losses were limited to the actual expenditure on the film. On his view, the cost to the partnership was the full $3.1 million.
[9] The Judge went on to consider whether, in the alternative, the assessments should be upheld as adjustments made to counteract tax advantages obtained by or under a tax avoidance arrangement within s99. He had no difficulty concluding that there was such an arrangement. He said (para [65]):

However it is put, at the end of the day Mr Blakeney’s scheme as such was patently within s99. It was a scheme that worked in two directions – against the Commissioner, and also against the investors. Indeed, given the concessions made at the hearing before the TRA, and again as the case advanced on appeal, it is difficult to see how any other conclusion could have been come to. My understanding is that it is now common ground that the arrangement infringed s99.

[10] The Judge accepted the argument for the Commissioner that, although the taxpayer did not know of the tax avoidance dimension of the arrangement, his assessable income could be adjusted as a “person affected” by the arrangement. He relied expressly on a passage from the judgment of Blanchard J in this Court in BNZ Investments Ltd v CIR [2002] 1 NZLR 450, 497 which he quoted (not quite accurately) as follows:

The adjustment can be made against both a party to the arrangement and a person affected, who is not necessarily a party. But it can be made only where a tax advantage is obtained [from or] ‘under that arrangement’. (at para 175).

[11] Hammond J, therefore, upheld the Commissioner’s assessments on this ground.
[12] The taxpayer’s appeal to this Court was directed to the Judge’s finding that the assessments were justified as adjustments under s99. The issue is the same as in the appeal in CA50/02 heard at the same time.
[13] The Commissioner did not cross-appeal or seek to uphold the TRA reasoning and was content to have the matter determined under s99. That was somewhat surprising because, as in the other appeal, we consider the matter is capable of more straightforward analysis. To the extent that the $3.1 million cost to the partnership comprised the undertaking of liability for loans it was not incurred, or if incurred briefly, was extinguished. On the TRA findings, which were not disputed, the money passed in a circle back from the production company to Utu Funding Ltd. The loan was repaid. It did not need to be repaid again from the proceeds of exploitation in the film. Without that liability the partnership cannot include it as part of its costs. It cannot be capitalised by the partnership and included in the depreciation calculation from which the taxpayer’s proportionate share of loss derives.
[14] The application of s99 to the circumstances of this case is no different from the companion case relating to the film “The Lie of the Land”.
[15] Mr Carruthers QC, for the taxpayer, submitted that the only arrangement in which his client was a participant was the fixed price contract to purchase an asset for $3.1 million, and he was not affected by any other transaction from which he obtained a tax advantage. We do not accept that the matter can be viewed so narrowly. It was an essential part of the transaction in which the taxpayer participated that loan moneys amounting to at least 50% of the equity capital of the project was to come from the non-recourse loan. Assumption of liability for those loan moneys constituted part of the cost the partners agreed to pay. No such liability endured, if it was ever assumed. The depreciation calculation by the partnership is to be made not on what was agreed to be paid, but on the cost actually incurred. The arrangement to falsely inflate that cost was for the purpose of increasing the loss for tax purposes. The taxpayer, as a partner claiming a share of the partnership depreciation, was a person directly affected by that arrangement and obtained a tax advantage under it.
[16] It was submitted by counsel that Hammond J misconstrued the passage he quoted from the judgment of Blanchard J in the BNZ Investments case by failing to take into account its context and, in particular, the rest of the paragraph relied upon. For the reasons given in our judgment in CA50/02, we are satisfied the Judge was right and that Blanchard J is not to be understood as excluding from the Commissioner’s power of adjustment in s99(3) persons who have obtained a tax advantage in the belief that they have a debt that in fact has been repaid.
[17] We add a comment concerning the evidence that the partnership has actually paid from the proceeds of exploitation of the film $207,000 in accordance with the terms of the deed of loan. Taking into account the findings that the taxpayer and the accountant had no knowledge that the borrowings and expenses were fictitious, it is understandable that some payments were made before the deception was exposed by the inspector’s investigations. But the fact of those payments does not make the illusory loans real. Further, it is to be noted that the payments (or at least some of them) were made not to Utu Funding Ltd, the creditor – which was dissolved in 1993, but to Mr Blakeney. They cannot affect the decision in this case.
[18] The appeal must be, and is, dismissed.
[19] The Commissioner is entitled to costs which we fix at $5,000 together with disbursements approved, if necessary, by the Registrar.

Solicitors
Harkness & Peterson, Wellington, for Appellant
Crown Law Office, Wellington, for Respondent