Commissioner of Inland Revenue v Zentrum Holdings Ltd CA215/05 [2006] NZCA 534; [2007] 1 NZLR 145; (2006) 22 NZTC 19,912 (23 May 2006)

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IN THE COURT OF APPEAL OF NEW ZEALAND

_CA215/05

BETWEEN COMMISSIONER OF INLAND REVENUE

Appellant

AND ZENTRUM HOLDINGS LIMITED AND NGAHEMI PROPERTIES LIMITED AS THE ZENTRUM HOLDINGS GROUP Respondents

Hearing: 20 March 2006

Court: William Young P, Hammond, Chambers, O'Regan and Robertson JJ Counsel: R J Ellis and M Deligiannis for Appellant

G D Clews and T S M Spencer for Respondents

Judgment: 23 May 2006

_{JUDGMENT OF THE COURT}

A The appeal is allowed. The case is remitted to the High Court to be

_{determined in accordance with this judgment.}

B Zentrum is to pay the Commissioner costs of $6,000 together with usual

_{disbursements.}

COMMISSIONER OF INLAND REVENUE V ZENTRUM HOLDINGS LIMITED AND NGAHEMI PROPERTIES LIMITED AS THE ZENTRUM HOLDINGS GROUP CA CA215/05 [23 May 2006]

REASONS

_{(Given by William Young P)}

Introduction

[1] Zentrum Holdings Ltd (Zentrum) was successful before the Taxation Review Authority (the Authority) in its challenge to certain income tax assessments. The Commissioner of Inland Revenue has appealed to the High Court and seeks, in that Court, to uphold the correctness of the assessments on a ground which had not previously been relied on. The issue in this appeal is whether it is open to the High Court to permit the Commissioner to do so.

[2] Two decisions of this Court are apparently against the Commissioner. They are Commissioner of Inland Revenue v V H Farnsworth Ltd [1984] 1 NZLR 428 and FB Duvall Ltd v Commissioner of Inland Revenue [2000] NZCA 54; (2000) 19 NZTC 15,658. But they were decided by reference to the Inland Revenue Department Act 1974 and the Commissioner maintains that they are no longer applicable given the new dispute resolution procedure under the Tax Administration Act 1994 (the 1994 Act) which governs the present case.

Factual background

[3] The case concerns transactions (or apparent transactions) involving Zentrum, Mr John Brown who is a director of, and the majority shareholder in, Zentrum and Marketing Management Holdings Ltd (Marketing) which is also associated with Mr Brown. These transactions had the effect (or apparent effect) of mopping up tax losses associated with Marketing in a way which diminished the taxable income of Zentrum.

Procedural history

[4] The Commissioner began his investigation in June 1999. He suspected that the transactions amounted to tax avoidance for the purposes of the anti-avoidance provisions of the Income Tax Act 1994 (s BB for the 1997 year and s BG1 for subsequent years). On 31 July 2001 he issued a Notice of Proposed Assessment (NOPA). Zentrum issued a Notice of Response (NOR) on 28 September 2001. In March 2003, a second NOPA was issued by the Commissioner, which was replied to by way of a second NOR issued on 31 May 2003. A tax assessment was issued on

31 March 2003 (ie, between the second NOPA and the second NOR). In that assessment, the Commissioner disallowed the deductions of the interest paid by Zentrum to Marketing (which was the mechanism by which Marketing’s tax losses were mopped up and Zentrum’s taxable income was diminished). Throughout this process, the Commissioner relied on the general anti-avoidance provisions in the Income Tax Act 1994, ie he contended that the transactions involved illegitimate tax avoidance.

[5] Zentrum filed a challenge to the assessment in the Authority on

30 May 2003.

[6] Before the Authority, the Commissioner defended his assessment on the basis that the transactions involved illegitimate tax avoidance.

[7] The Authority (Judge Willy) concluded that the transactions took advantage of tax losses lawfully available to the parties and that the favourable tax outcome was merely an incidental consequence of the structure. Accordingly the transactions did not amount to illegitimate tax avoidance and he overturned the Commissioner’s assessment, see (2005) 22 NZTC 12,001.

[8] The Commissioner appealed to the High Court against the Authority’s decision.

[9] In the course of preparing for the appeal, the Commissioner formed the view that the transactions were shams and gave notice that he wished to argue accordingly at the hearing of the appeal.

[10] In response, Zentrum brought an interlocutory application for an order limiting the Commissioner to the ground for assessment raised before the Authority. This application succeeded before Keane J who, in a judgment delivered on

16 September 2005 (reported at [2005] NZHC 490; (2005) 22 NZTC 19,510) held that the Commissioner will, on the hearing of the appeal, be confined to the grounds upon which he assessed Zentrum, ie that the relevant transactions amounted to illegitimate tax avoidance.

The judgment under appeal

[11] Keane J concluded that the course proposed by the Commissioner (ie taking a new argument on appeal) was precluded by Farnsworth and Duvall and that the same jurisdictional limitation applied under the 1994 Act.

Our approach to the appeal

[12] The parties chose to mount argument before us only on jurisdictional issues, although Zentrum sought to defend the decision of the Judge on a ground (the time bar point discussed below) which the Judge did not rely on. We were not asked to determine whether it would be appropriate in accordance with ordinary appellate principles for the High Court to permit the Commissioner to rely on a new argument on appeal.

[13] We propose to approach the appeal by addressing:

(a) The legislation under which Farnsworth was decided; (b) The Farnsworth principle;

(c) The scheme of the 1994 Act;

(d) The nature of the appeal from the Authority to the High Court; and

(e) The time bar point.

The legislation under which Farnsworth was decided

[14] When Farnsworth was decided, the right to challenge tax assessments and the associated procedures were addressed in part in the Income Tax Act 1976 and in part by the Inland Revenue Department Act 1974.

[15] Under the Income Tax Act 1976, a taxpayer who wished to challenge an assessment was required to give written notice of objection “stating shortly the grounds of his objection”, see s 29(1). If the objection was not completely allowed by the Commissioner, the taxpayer had the right to require the objection to be heard and determined by the Authority (see s 30) or, in some circumstances, by the High Court (see s 32).

[16] An objection came before the Authority or High Court by way of case stated, with the case being lodged by the Commissioner. The case as stated would set out the grounds (legal and factual) relied on by the Commissioner for the assessment and likewise the basis of the objection. What was referred to the Authority or Court for decision was the objection.

[17] Importantly, s 36 of the Inland Revenue Department Act 1974 materially provided:

On the hearing and determination of any objection, the objector shall be limited to the grounds stated in his objection, and ... the burden of proof shall be on the objector.

The Farnsworth principle

[18] In Farnsworth, the Commissioner had included in the assessable income of the taxpayer sums in respect of farming and forestry development expenditure which had previously been allowed as deductions for income tax purposes. In doing so he had relied on s 119E of the Land and Income Tax Act 1954 (the 1954 Act). The taxpayer objected to this assessment and the Commissioner was required under the

dispute resolution procedure then applicable to state a case for the opinion of the High Court. Before the High Court, the Commissioner sought to rely on s 91(ID) of the 1954 Act instead of s 119E. The High Court decided that the Commissioner was not permitted to take this course of action, a decision which was upheld by this Court on appeal.

[19] Richardson and Somers JJ, in separate judgments, held that proceedings before the High Court or the Authority were not in the nature of a general review of the assessed tax position. The questions arising for the determination of the Court or Authority were necessarily limited to those arising from the particular objection. Important to Richardson and Somers JJ’s approach was s 36 of the Inland Revenue Department Act 1974.

[20] Richardson J said at 434:

If the Commissioner is free to adopt a fresh basis for his treatment of the item under objection after the taxpayer has become committed to a contest on a different ground s 36 precludes the taxpayer from responding. He cannot call evidence on the new point. He cannot present argument. Yet he carries the burden of proof both under s 36 itself and under s 19 of the 1954

Act. Parliament can never have intended leaving a taxpayer so vulnerable and it cannot reasonably be predicated that it may simply have overlooked

the point. I consider it is implicit in the statutory scheme affecting objections

that the Commissioner cannot shift his ground and thereby short-circuit the objection process.

The judgment of Somers J proceeded on very much the same basis.

[21] Cooke J took a different view. In his opinion, there was nothing in the legislation to deny the High Court its normal discretion to allow a party to change or supplement its contentions, such discretion to be exercised pursuant to “normal” principles. On the facts, however, Cooke J would not have permitted the Commissioner to raise s 91(ID).

[22] Duvall concerned a GST dispute and the point at which the Commissioner wished to change his ground was between the determination of the objection proceedings in the Authority in favour of the Commissioner and the determination of a subsequent appeal by the taxpayer to the High Court. In the latter respect, the case is more closely comparable than Farnsworth to the present situation. However,

it is right to note that the change of ground in Duvall was dramatic. Whereas the dispute before the Authority was as to output tax, the taxpayer, who in the end was successful as to output tax, wound up with the cancellation of input tax credits (which had not previously been in issue).

[23] The taxpayer’s further appeal to this Court was allowed. Richardson P for the Court concluded:

[25] On the appeal to the High Court the Commissioner was necessarily confined to the stance he had taken and which had been upheld by the TRA, namely that Duvall was liable for output tax having made supplies to subsidiaries for which it received the administration charges. The attempt to assert the opposite, namely that no supplies of services were made by Duvall, was outside the Commissioner’s actual assessments of output tax.

[26] Further, the High Court was not hearing and determining objections to the assessments. Rather it was hearing an appeal on questions of law or fact arising for its determination in terms of the case stated by the TRA. That case stated ultimately confined the High Court to determining whether the Commissioner was correct in determining that the administration charges were taxable supplies and therefore subject to GST ... .

[24] Union Steamship Co of New Zealand Ltd v Commissioner of Inland Revenue (1996) 17 NZTC 12,629 (CA) is another case where the Farnsworth principle was applied. We note in passing that a different but related issue as to whether the Commissioner can amend an assessment once a challenge to it is underway was addressed in BASF New Zealand Ltd v Commissioner of Inland Revenue (1995)

17 NZTC 12,136 (HC) and Dandelion Investments Ltd v Commissioner of Inland

Revenue [2000] NZCA 38; [2000] 2 NZLR 548 (CA).

The new dispute resolution procedure provided for in Parts 4A and 8A of the

Tax Administration Act 1994

[25] The current legislative scheme is expressed in reasonably dense language and it is most easily explained by reference to the way in which the relevant dispute between the Commissioner and Zentrum proceeded.

[26] The formal process started with a NOPA issued under s 89B. This section relevantly provides:

89B Commissioner may issue notices of proposed adjustment

(1) The Commissioner may issue one or more notices of proposed adjustment in respect of a tax return or an assessment.

...

(4) The Commissioner may not issue a notice of proposed adjustment— (a) If the proposed adjustment is already the subject of a

challenge; or

(b) After the expiry of the time bar that, under— (i) Sections 108 and 108B; or

(ii) Sections 108A and 108B,—

applies to the assessment.

We will return later in this judgment to discuss the time bar issue. We note in passing that s 89B(4)(a) appears to be a statutory reflection of the BASF principle.

[27] The contents of such a NOPA are provided for by s 89F:

89F Content of notice of proposed adjustment

(1) A notice of proposed adjustment must—

(a) contain sufficient detail of the matters described in subsections (2) and (3) to identify the issues arising between the Commissioner and the disputant; and

(b) be in the prescribed form.

(2) A notice of proposed adjustment issued by the Commissioner must—

(a) identify the adjustment or adjustments proposed to be made to the assessment; and

(b) provide a concise statement of the key facts and the law in sufficient detail to inform the disputant of the grounds for the Commissioner's proposed adjustment or adjustments; and

(c) state how the law applies to the facts.

[28] The Commissioner’s NOPA resulted in a NOR from Zentrum. This was required under s 89G which provides:

89G Issue of response notice

(1) To reject a proposed adjustment, the recipient of the notice of proposed adjustment must, within the response period for the notice, notify the issuer that the adjustment is rejected by issuing a response notice.

(2) A notice of response must state concisely—

(a) the facts or legal arguments in the notice of proposed adjustment that the issuer of the notice of response considers are wrong; and

(b) why the issuer of the notice of response considers those facts or legal arguments to be wrong; and

(c) any facts and legal arguments relied on by the issuer of the notice of response; and

(d) how the legal arguments apply to the facts; and

(e) the quantitative adjustments to any figure referred to in the notice of proposed adjustment that result from the facts and legal arguments relied on by the issuer of the notice of response.

[29] At the time relevant to these proceedings, the Commissioner had a discretion to issue a disclosure notice under s 89M. In this case there was no disclosure notice. For reasons which will become apparent, that is of critical importance here. It is therefore appropriate to set out the relevant statutory provisions:

89M Disclosure notices

(1) Unless subsection (2) applies, ... the Commissioner may issue a disclosure notice in respect of a notice of proposed adjustment to a disputant at the time or after the Commissioner ... issues the notice of proposed adjustment.

(2) The Commissioner may not issue a disclosure notice in respect of a notice of proposed adjustment if the Commissioner has already issued a notice of disputable decision that includes, or takes account of, the adjustment proposed in the notice of proposed adjustment.

(3) Unless the disputant has issued a notice of proposed adjustment, the

Commissioner must, when issuing a disclosure notice,—

(a) provide the disputant with the Commissioner's statement of position; and

(b) include in the disclosure notice—

(i) a reference to section 138G; and

(ii)a statement as to the effect of the evidence exclusion rule.

(4) The Commissioner's statement of position in the prescribed form must, with sufficient detail to fairly inform the disputant,—

(a) give an outline of the facts on which the Commissioner intends to rely; and

(b) give an outline of the evidence on which the Commissioner intends to rely; and

(c) give an outline of the issues that the Commissioner considers will arise; and

(d) specify the propositions of law on which the Commissioner intends to rely.

(5) If the Commissioner issues a disclosure notice to a disputant, the disputant must issue the Commissioner with the disputant's statement of position within the response period for the disclosure notice.

(6) A disputant's statement of position in the prescribed form must, with sufficient detail to fairly inform the Commissioner,—

(a) give an outline of the facts on which the disputant intends to rely; and

(b) give an outline of the evidence on which the disputant intends to rely; and

(c) give an outline of the issues that the disputant considers will arise; and

(d) specify the propositions of law on which the disputant intends to rely.

(7) If a disputant does not issue a disputant’s statement of position in the prescribed form within the response period for a disclosure notice the disputant is deemed to have accepted the Commissioner’s notice of proposed adjustment or the Commissioner’s statement of position, as the case may require.

...

A statement of position can be added to in certain circumstances (which are immaterial here).

[30] At the end of the process, the Commissioner makes a decision, which in this case was adverse to Zentrum, and in this way triggers a right of challenge under s 138B(1). This section relevantly provides:

138B When disputant entitled to challenge assessment

(1) A disputant is entitled to challenge an assessment by commencing proceedings in a hearing authority if—

(a) the assessment includes an adjustment proposed by the Commissioner which the disputant has rejected within the applicable response period; and

(b) where the assessment is an amended assessment, an adjustment proposed by the Commissioner that is included in the assessment—

(i) imposes a fresh liability (being a liability that was not included in an earlier assessment) in respect of a particular; or

(ii) increases an existing liability (being a liability that was included in an earlier assessment but to a lesser extent) in respect of a particular; and

(c) the disputant files the proceedings, in accordance with the Taxation Review Authority Regulations 1994 (or any regulations made in substitution for those regulations) or the High Court Rules, within the response period following the issue of the relevant notice of assessment.

...

This section makes it clear that the nature of the challenge is an attack on the assessment itself rather than a consideration of the taxpayer’s NOR. On this basis the current scheme differs from that considered in Farnsworth.

[31] The key issue in respect of this part of the case is whether the Commissioner and taxpayer, at the hearing of a challenge, are restricted to contentions advanced earlier in the dispute resolution process.

[32] Mr Clews’ argument for Zentrum was along these lines. Since the Commissioner did not issue a NOPA alleging sham, s 89C means that it would not have been open to the Commissioner to assess on grounds of sham. Further, where the Commissioner has issued a NOPA prior to assessment, the taxpayer’s right of challenge is confined to the assessment and its grounds (as notified in the NOPA). So Zentrum was confined to challenging the disallowance for illegitimate tax avoidance of the interest deductions. Once the assessment was under challenge, s 89B(4)(a) deprived the Commissioner of any entitlement to issue a further

assessment. Underpinning this line of argument is the contention that in this context an assessment must be treated as including its grounds. On this logic, an attempt to defend an existing assessment on grounds which go beyond those relied on when it was issued involves the issue of a further assessment.

[33] The general structure of the disputes process is not as conducive to this line of argument as the structure of the scheme which was addressed in Farnsworth. Section 36 of the Inland Revenue Department Act 1974 has no direct counterpart in the 1994 Act. Further, as just noted, the challenge process involves a challenge to the assessment rather than a reconsideration of the taxpayer’s objection. If the Commissioner and taxpayer were to be confined to the positions each had adopted in either the pre-assessment process or up to the time when the challenge proceedings were lodged, one would expect this to be the subject of direct legislative provision.

[34] The only statutory provision which is directly on point is 138G which provides:

138G Effect of disclosure notice: exclusion of evidence

(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.}

...

[35] As noted, no disclosure notice was given in this case. Accordingly, the evidence exclusion rule provided for by s 138G did not apply. The existence of specific evidence exclusion rule which applies only in specified circumstances rather suggests that outside those circumstances there is no comparable implied and absolute rule confining the parties to the positions formally taken in their NOPAs and NORs. Further – and perhaps more importantly – the existence of the discretion provided for by s 138G(2) to waive the evidence exclusion rule where a disclosure notice has been given is flatly inconsistent with the existence of such an implied and absolute rule.

[36] Faced with s 138G, Mr Clews submitted that the parties are confined to their pre-assessment positions in all cases save that where a disclosure notice has been given, the Authority or High Court has a limited discretion to permit expansion of grounds of assessment or challenge. On this basis the giving of a disclosure notice makes the subsequent procedures more, rather than less, flexible. The perversity of this result makes it clear to us that the approach contended for by Mr Clews was not intended by Parliament.

[37] We are accordingly satisfied that the Farnsworth principle has no application under the new disputes process.

The nature of the appeal from the Authority to the High Court

[38] Appeals from determinations of the Authority under Part 8A of the 1994 Act are dealt with in s 26A of the Taxation Review Authorities Act 1994. Such appeals fall to be determined under Part 10 of the High Court Rules, see Commissioner of Inland Revenue v Dick (2000) 19 NZTC 15,849 (HC) at [14]-[16] per Glazebrook J. Accordingly such appeals are by way of rehearing, see r 718.

[39] It follows that points which could have been argued before the Authority are able to be advanced on appeal in the High Court, subject of course to the application of the usual appellate principles as to the circumstances in which new arguments may be advanced on appeal.

The time bar point

[40] Section 108 of the 1994 Act currently relevantly provides:

108 Time bar for amendment of income tax assessment

(1) Except as specified in this section or in section 108B, if—

(a) a taxpayer furnishes an income tax return and an assessment has been made; and

(b) 4 years have passed from the end of the tax year in which the taxpayer provides the tax return,—

the Commissioner may not amend the assessment so as to increase the amount assessed.

...

(2) If the Commissioner is of the opinion that a tax return provided by a taxpayer—

(a) Is fraudulent or wilfully misleading; or

(b) Does not mention income which is of a particular nature or was derived from a particular source, and in respect of which a tax return is required to be provided,—

the Commissioner may amend the assessment at any time so as to increase its amount.

Although this section has been amended since the current dispute arose, the changes are not material for present purposes.

[41] Mr Clews sought to argue that the Commissioner, by seeking to justify the earlier assessment on a new ground, was seeking to impose a “fresh liability” and he further argued that such fresh liability involved an “increase” in the “amount assessed”.

[42] There are passages in Farnsworth which can be read as providing some apparent support for this argument, see 429-430 per Cooke J and at 434-435 per Richardson J. The remarks in question, however, are too elliptical to be fairly regarded as deciding the point. Certainly Richardson J must have thought that as, in Simunovich Fisheries Ltd v Commissioner of Inland Revenue (2002) 20 NZTC

17,456 (CA), he considered the issue was open, see [59] – [61]. Indeed his summary of the taxpayer’s argument in Simunovich (at [60]) suggests that he saw the case for the application of the time bar in these circumstances as depending upon an analysis of the Commissioner’s actions as involving a withdrawal of the earlier assessment and its subsequent replacement by another assessment (which thus arguably involved an increase in the “amount assessed”).

[43] The technical timing argument left open by Richardson J in Simunovich does not appear to be potentially applicable here as logically the sham arguments the Commissioner wishes to advance are upstream of the illegitimate tax avoidance arguments which the Commissioner has, in any event, not abandoned.

[44] More importantly, Mr Clews’ argument is not consistent with the words of the section. The only amendment which is precluded is one which increases the “amount assessed”. If the legislature intended the prohibition to apply to any alteration to the basis of assessment, one might expect that to have been spelt out. In this context we prefer to construe the section in accordance with its plain and ordinary meaning; cf Dandelion Investments at [9].

[45] Finally on this aspect of the case, we note one issue which was mentioned in argument. The Commissioner contends that Zentrum is subject to penalties under s 141D of the 1994 Act on the basis that it adopted an abusive tax position. If its sham arguments are upheld, there might be scope for suggesting that Zentrum is susceptible to higher penalties for evasion under s 141E. On this basis it might be thought that the sham argument involves the potential for increasing the “amount assessed” against Zentrum.

[46] We do not regard this consideration as invoking the time bar. Whether it is right to treat penalties as part of the assessment for these purposes is not entirely

clear. Further, a conclusion that the transactions in question were shams would not necessarily be tantamount to a finding of evasion. But, more importantly, if it were the case that Zentrum was liable under s 141D, it would follow that it was not entitled to invoke the time bar in any event, see s 108(2).

Conclusions

[47] It follows from what we have said that the Farnsworth principle has no application to the disputes resolution procedure under the 1994 Act.

[48] Accordingly, it would have been open to the Commissioner to seek to defend the assessments before the Authority by reference to arguments that the key transactions were shams.

[49] Given that the appeal to the High Court is by way of rehearing, there is no jurisdictional bar to the Commissioner seeking to do the same in the High Court on appeal (by way of rehearing) from the Authority.

[50] The sham argument is not subject to the s 108 time bar.

Disposition

[51] The appeal is accordingly allowed and the case is remitted to the High Court to be determined in accordance with this judgment. Zentrum is to pay the Commissioner costs of $6,000 together with usual disbursements.

Solicitors:

Crown Law Office, Wellington for Appellant

Hunt Edward Worker, Orewa for Respondents