NRS Media Holdings Limited v Commissioner of Inland Revenue [2018] NZCA 472; [2019] 2 NZLR 19 (1 November 2018)

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IN THE COURT OF APPEAL OF NEW ZEALAND I TE KŌTI PĪRA O AOTEAROA

CA728/2017 [2018] NZCA 472

	BETWEEN	NRS MEDIA HOLDINGS LIMITED Appellant
	AND	COMMISSIONER OF INLAND REVENUE Respondent

Hearing:	12 June 2018 (further submissions received 6 July 2018)
Court:	Brown, Clifford and Williams JJ
Counsel:	G J Harley and R L Goss for Appellant H W Ebersohn and J B Y Y Cheng for Respondent
Judgment:	1 November 2018 at 3.30 pm

JUDGMENT OF THE COURT

1. The appeal is allowed.
2. The appellant is entitled to deductions totalling $1,706,568.23 and $1,963,472.31 in the 2011 and 2012 years respectively.

100. The respondent must pay the appellant costs for a standard appeal on a band A basis and usual disbursements.

4. Any order for costs in the High Court is quashed. Costs in the High Court are to be determined by that Court in accordance with this judgment.

____________________________________________________________________

REASONS OF THE COURT

(Given by Clifford J)

Introduction

• [1] In its tax returns for the 2011 and 2012 years, NRS Media Holdings Ltd (NRS) claimed deductions for expenditure it said it had incurred in deriving exempt foreign dividends. The Commissioner of Inland Revenue (the Commissioner) disallowed those deductions. She said the expenditure in question did not have the necessary nexus with those dividends. NRS took challenge proceedings in the High Court, where Clark J upheld the Commissioner’s determination.^[1] NRS now appeals.

Statutory context: issues

• [2] NRS claimed its deductions in reliance on s DB 55 of the Income Tax Act 2007 (the 2007 ITA) which, at the time, provided:

DB 55 Expenditure incurred in deriving exempt dividend

Deduction

(1) A company that derives a dividend that is exempt income of the company under section CW 9 (Dividend derived from foreign company) is allowed a deduction of the amount of the expenditure incurred by the company in deriving the dividend.

...

Link with subpart DA

(3) This section overrides the exempt income limitation. The general permission must still be satisfied and the other general limitations still apply.

• [3] The Commissioner based her decision, that NRS’ expenditure did not have a sufficient relationship to the dividends paid to it by its subsidiaries, on the words used in s DB 55(1) compared to the words used in s DA 1 (the general permission for the deduction of expenditure). That section reads:

DA 1 General permission

Nexus with income

(1) A person is allowed a deduction for an amount of expenditure or loss, including an amount of depreciation loss, to the extent to which the expenditure or loss is—

(a) incurred by them in deriving—

(i) their assessable income; or

(ii) their excluded income; or

(iii) a combination of their assessable income and excluded income; or

(b) incurred by them in the course of carrying on a business for the purpose of deriving—

(i) their assessable income; or

(ii) their excluded income; or

(iii) a combination of their assessable income and excluded income.

General permission

(2) Subsection (1) is called the general permission.

• [4] The Commissioner reasoned that the words “in deriving” found in s DA 1(1)(a) describes a closer nexus between the relevant expenditure and the income derived than do the words “in the course of carrying on a business for the purpose of deriving” found in s DA 1(1)(b). The same “closer” nexus was therefore required under s DB 55(1) given the use in that section of the same phrase “in deriving”.
• [5] NRS says there is no real distinction between the nexus with income described in the two subsections. Certainly, any difference is not sufficient to interpret s DB 55 in the way the Commissioner did. The Commissioner and NRS both say the interpretation they argue for is supported by legislative history.
• [6] The Commissioner also based her conclusion on the proposition that the expenses for which NRS sought deductions were of a capital nature: therefore, any deductions were necessarily prohibited by the capital limitation found in s DA 2(1) of the 2007 ITA (which is not overridden by s DB 55). The High Court did not need to consider that argument, because it upheld the Commissioner’s interpretation of s DB 55. On appeal, the Commissioner supports the High Court’s decision on the alternate basis of the applicability of the capital limitation.
• [7] We first consider whether the High Court was correct in upholding the Commissioner’s categorisation of the nexus required between expenditure and income for deductibility under s DB 55. We then consider the Commissioner’s alternative argument about the applicability of the capital limitation.

The facts

• [8] NRS was the sole or majority shareholder of a number of subsidiaries (the subsidiaries). Two were incorporated in the United Kingdom, one was incorporated in Australia, and another was incorporated in Canada. Those subsidiaries derived income by facilitating the purchase of media time by their client advertisers. Central to that business was software developed and licensed to them by a sister company of NRS, Persuaders Concepts (NZ) Ltd (Persuaders). For its part as parent company, NRS set the strategic plan for its group as a whole, and for each of its subsidiaries.^[2] In turn, it approved and monitored the business plans and the business activities of its subsidiaries as they operated within those strategic plans. It was in undertaking those activities that NRS incurred the expenses in question.
• [9] NRS categorised those expenses as comprising “payroll and consultants”, “marketing and travel”, “rent and occupancy”, and “overheads”. They totalled $1,706,568.23 in the 2011 year, and $1,963,472.31 in the 2012 year. In those years, NRS derived exempt foreign dividend income of $1,989,357.00 and $1,892,295.00 respectively.
• [10] NRS described the overall objective of its activities as being:

(a) to maximise the financial return to the shareholders of NRS through increased dividends from the NRS subsidiaries, for the benefit of NRS; and

(b) to enable NRS and its Board to discharge their obligations as parent company, from a legal governance perspective.

• [11] The NRS subsidiaries were self-sufficient, with their own accounting, sales and management teams, and did not require support or services to be provided by NRS to operate on a day-to-day basis.

The correct interpretation of s DB 55

Judgment under appeal

• [12] The High Court first concluded, as had the Commissioner’s adjudication report, that for the claimed expenditure to be deductible under s DB 55, NRS needed to show that expenditure was:^[3]

(a) directly linked to its exempt foreign dividend income in a positive way;

(b) factually and causally directed to the production of the dividend income; and

(c) incurred in the course of producing the dividend income.

• [13] That conclusion was influenced by the following observations of the Taxation Review Committee in recommending the amendment that introduced the two limbs of s 111 of the Land and Income Tax Act 1954 (now s DA 1 of the 2007 ITA) in October 1967:^[4]

The suggested new wording of the section introduces two standards by which the deductibility of an expenditure or loss would be tested. The first is a general standard which could apply to any item of expense or loss “incurred in gaining or producing the assessable income” and to all taxpayers whether in business or employment. The second is applicable only to expense or loss “necessarily incurred in carrying on a business for the purpose of gaining or producing such (assessable) income”. The latter test is not [as] restrictive as the first one as the expenditure or loss would not have to be directly related to the income derived from the business. It would be sufficient if it were a necessary expense or loss in the carrying on of the business.

• [14] The explanation “the latter test is not [as] restrictive as the first one as the expenditure or loss would not have to be directly related to the income derived from the business” was — as we understood the argument — the basis for the requirement of direct linkage.
• [15] Referring to Europa Oil (NZ) Ltd v Commissioner of Inland Revenue^[5] and Thornton Estates Ltd v Commissioner of Inland Revenue^[6] the Judge reasoned:^[7]

[32] It is plain that the authorities recognise a distinction between the first and second limbs of the General Permission. Given the materially similar terms of s DB 55(1) to the first limb of the General Permission there is no basis for placing a different construction on each. Contrary to NRS’ submission, the similarity between the provisions does not mean the same interpretative approach applies to the General Permission as a whole. That is because s DB 55 does not contain any equivalent of the second limb of the General Permission.

[33] Section DA 1(1)(b), the second limb of the General Permission, allows deductions for expenditure incurred in the course of carrying on a business for the purpose of deriving an income. The deductions allowed under s DB 55 are available only in respect of those expenses incurred in deriving dividends. It follows that even if expenditure is incurred “in the course of carrying on a business” for the purpose of deriving a dividend (second limb), the expenditure will not be deductible unless the taxpayer establishes the expenditure was incurred in the actual course of deriving the dividend (first limb).

• [16] That meant, the Judge said, that NRS must establish its expenditure was factually and causally directed at deriving a foreign dividend.^[8]
• [17] The expenditure giving rise to the deductions claimed by NRS had not met that test. It was:^[9]

... insufficiently related to the derivation of foreign dividends. The derivation of foreign dividends was one step removed from the purpose of the expenditure, which was to increase the value of the subsidiaries. ...

• [18] The Judge summarised the evidence of Mr Gold, a director and majority shareholder of NRS, as being that NRS’ expenditure provided services to the subsidiaries to “maximise the value” and “profitability” of each subsidiary.^[10] The factual and causal effect of that expenditure “was to improve the value and profitability of the subsidiaries.”^[11] That was the first consequence of NRS’ expenditure. A further possible consequence was receipt of dividends. As she put it:

[50] I accept the purpose of NRS was “stewardship” of its investors directed at an increasing dividend stream derived from the share capital invested in the subsidiaries. But the purpose of the expenditure is irrelevant to the question whether expenditure is incurred in deriving the dividend.^[[12]] Deriving dividends was an ancillary consequence of the increasing profitability and value of the subsidiaries. Expenditure on maximising value and profitability of the [company’s] returning dividends is not deductible under s DB 55. Such expenditure may fall within the broader category of expenditure incurred “in the course of carrying on a business for the purpose of deriving income” (the second limb of the General Provision) but it does not fall within the more restricted scope of s DB 55.

• [19] For NRS, Mr Harley submitted that distinction was neither called for by the words of the legislation nor supported by case law. Mr Harley based that submission on a number of cases, including Commissioner of Inland Revenue v Banks^[13] and Buckley & Young Ltd v Commissioner of Inland Revenue.^[14]

The cases

• [20] Both the requisite nexus for deductibility and the relationship between the first and second limbs have been discussed in a number of cases. Given the parties’ reliance upon these cases, it is necessary to discuss these in some detail.
• [21] In Banks this Court considered the deductibility of home office expenses. At the time, s 111 of the Land and Income Tax Act provided the general authority for deductions in calculating assessable income. It read:

Expenditure or loss incurred in production of assessable income

In calculating the assessable income of any taxpayer, any expenditure or loss to the extent to which it—

(a) Is incurred in gaining or producing the assessable income for any income year; or

(b) Is necessarily incurred in carrying on a business for the purpose of gaining or producing the assessable income for any income year—

may, except as otherwise provided in this Act, be deducted from the total income derived by the taxpayer in the income year in which the expenditure or loss is incurred.

• [22] As can be seen, whereas s DA 1(1)(a) now uses the words “incurred by them in deriving their assessable income” s 111(a) used the words “as incurred in gaining or producing the assessable income”. It was not suggested to us that there was any material difference between those wordings.
• [23] Richardson J reasoned that there were two features of s 111, and its place in the scheme of the deduction provisions, of particular importance. It is the first of those that is relevant here. That is, “the expenditure must meet the statutory standards in relation to the assessable income of the taxpayer claiming the deduction”.^[15] The deduction was “available only where expenditure [had] the necessary relationship, both with the taxpayer concerned and the gaining or producing of his assessable income”.^[16] A relationship with the taxpayer was not, in itself, sufficient, as the prohibition of a deduction for capital expenditure (s 112(1)(a)) and private and domestic expenditure (s 112(1)(i)) made clear. There must be the statutory nexus between the particular expenditure and the assessable income of the taxpayer claiming the deduction.^[17] It is with the proper categorisation of that “statutory nexus” that we are concerned.
• [24] Speaking generally Richardson J said:^[18]

The language of s 111 is deceptively simple. The width and generality of the statutory language has posed problems for Courts and tribunals faced with applying the provisions in a practical way. There has been an understandable unwillingness in the cases to attempt to establish hard and fast rules to cover all situations in an area of the law which, so far as possible, should reflect commercial realities. There are constant reminders in the judgments that each case of this kind depends on its own facts and the dividing line between deductibility and non-deductibility is blurred. It will often be helpful, in determining and applying the statutory criteria, to consider the analysis and exposition of the statutory provisions in the decisions of the Courts and review tribunals and the considerations regarded as particularly significant in individual cases. However, this is not an area of the law where it is possible to devise a judicial formula which, as a substitute for the statutory language, could be applied in all cases and, in the end, a decision in a particular case must be reached on the application of the statutory language to its particular circumstances. The focus of the inquiry necessarily shifts, depending on the circumstances of the particular case.

• [25] Richardson J went on to state that it did not advance the argument in the case before the Court to emphasise the character of the expenditure for which deduction is sought.^[19] It all depended, the Judge reasoned, on the relationship between the particular premises or asset in respect of which the payment was made and the income earning process.^[20] So, further analysis of the relationship between expenditure and income earning activities was required.^[21]
• [26] In an important passage of the judgment, Richardson J referred to relevant Australian authorities in the following terms:^[22]

In the Australian cases under the counterpart of s 111(1) there has been considerable stress on the character of an outgoing in the sense of its being incidental and relevant to the gaining or producing of the assessable income. Statements to that effect emphasise the relationship that must exist between the advantage gained or sought to be gained by the expenditure and the income earning process. They do not, and cannot, specify in concrete terms the kind and degree of connection between the expenditure and the gaining or producing of assessable income required in individual cases for the expenditure to qualify for deduction. As was observed in Lunney v Federal Commissioner of Taxation:

“Examination of these cases, however, readily shows that the expression ‘incidental and relevant’ was not used in an attempt to formulate an exclusive and exhaustive test for ascertaining the extent of the operation of the section; the words were merely used in stating an attribute without which an item of expenditure cannot be regarded as deductible under the section.”

Putting it positively, Dixon J said in Amalgamated Zinc (de Bavay’s) Ltd v Federal Commissioner of Taxation and we respectfully agree:

“The expression ‘in gaining or producing’ has the force of ‘in the course of gaining or producing’ and looks rather to the scope of the operations or activities and the relevance thereto of the expenditure than to purpose in itself.”

As is clear, Richardson J was endorsing the Australian approach.

• [27] In our view, two further passages from the judgment in Banks capture well the approach mandated:^[23]

It then becomes a matter of degree, and so a question of fact, to determine whether there is a sufficient relationship between the expenditure and what it provided, or sought to provide, on the one hand, and the income earning process, on the other, to fall within the words of the section.

...

As we see it, the essential question for consideration in this respect is whether part of the premises — whether set up as a workshop or surgery or study (cf Caffrey v Federal Commissioner of Taxation), or whether simply used for income related activities — has a sufficient connection with the taxpayer’s income earning process to justify the conclusion that expenditure referable to that part of the premises is incurred in the course of gaining or producing the assessable income.

• [28] Richardson J took a similar approach in Banks when considering the taxpayer’s claim for interest deductibility under s 112(1)(g), which permitted a deduction for interest “payable on capital employed in the production of the assessable income”. He said:^[24]

Having regard, too, to the statutory language “in the production of the assessable income” in s 112(1)(g) and “in the gaining or producing of the assessable income” in s 111(a), an inquiry under the former provision will ordinarily involve essentially the same considerations in determining whether or not there is a sufficient connection between the expenditure of interest and the income earning activities involving the use of the property, for the interest to qualify for deduction.

Sections 111 and 112 were considered again in 1978, by Richardson J in Buckley & Young Ltd v Commissioner of Inland Revenue.^[25] The case involved payments made by a company to a senior employee after an acrimonious retirement. As relevant, the company made annual payments of $6,000 on account of the employee’s covenant in restraint of trade, contributed to his superannuation scheme, provided him with a car and met his legal expenses. The issue for this Court was whether those payments were, for the company involved, of a capital or revenue nature. Nexus was not the issue. But, in describing the legislative scheme Richardson J again identified the features of nexus and apportionment found in s 111 as being of particular importance. Relevantly, he described the nexus in the following terms:^[26]

The first is that a deduction is available only where the expenditure has the necessary relationship both with the taxpayer concerned and with the gaining or producing of an assessable income or with the carrying on of a business for that purpose. The heart of the inquiry is the identification of the relationship between the advantage gained or sought to be gained by the expenditure and the income earning process. That in turn requires determining the true character of the payment. It then becomes a matter of degree and so a question of fact to determine whether there is a sufficient relationship between the expenditure and what it provided or sought to provide on the one hand, and the income earning process on the other, to fall within the words of the section (Commissioner of Inland Revenue v Banks).

• [29] It is of some significance, in our view, that Richardson J speaks in the alternative of “the gaining or producing of his assessable income” and “with the carrying of a business for that purpose” without distinction as regards nexus. It would appear the Judge saw no reason to distinguish between the approach called for on that issue as regards the two provisions.
• [30] As can been seen, thus far there is little if any support for the approach the Commissioner took to deductibility, as summarised at [12] above. There is simply no reflection, in the authorities, of the concepts of “directly linked in a positive way” and “factually and causally directed”. Nor is it suggested that there is any great distinction between the tests for nexus under either of subs (1)(a) or (b) of s DA 1. Rather, what is required is the application of the statutory language — here “the amount of the expenditure incurred by the company in deriving the dividend” — to the particular circumstances.
• [31] In his oral submissions, Mr Harley drew our attention to like approaches to the required nexus for deductibility found in a number of earlier decisions. Reference to one of those will suffice to support the general conclusion we have just reached.
• [32] In Ronpibon Tin No Liability v Federal Commissioner of Taxation the High Court of Australia commented on the phrase “incurred in gaining or producing the assessable income” as it then appeared in both limbs of s 51(1) of the Income Tax Assessment Act 1936 (Cth) in the following way:^[27]

For expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income it must be incidental and relevant to that end. The words “incurred in gaining or producing the assessable income” mean in the course of gaining or producing such income. Their operation has been explained in cases decided under the provisions of the previous enactments: see particularly Amalgamated Zinc (de Bavay’s) Ltd v Federal Commissioner of Taxation and W Nevill & Co Ltd v Federal Commissioner of Taxation.

Notwithstanding the differences in other respects in the present provision, the expression “incurred in gaining or producing the assessable income” has been left unchanged and bears the same meaning. In brief substance, to come within the initial part of the sub-section it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, would be expected to produce assessable income.

• [33] In our view, the phrase “whatever is productive of the assessable income” is a helpful way both of characterising the factual inquiry that the application of the statutory language requires and of describing the nexus that is the focus of that inquiry.
• [34] In our view, Europa Oil (NZ) Ltd and Thornton Estates Ltd do not provide support for the Commissioner’s stance.
• [35] As reported, Europa Oil (NZ) Ltd contains this Court’s discussion of the then recently enacted s 111 of the Land and Income Tax Act. It would appear that the factual issue related to the availability of deductions for the cost of stock-in-trade. The report provides little detail beyond that. The new s 111 governed three of the tax years involved. Each of the Judges wrestled with the difference between the old and the new. McCarthy P wrote:^[28]

The reasons for the changes are by no means certain. McMullin J [the High Court Judge] has pointed to some, and it has also been suggested that one special purpose of limb (b) may have been to include expenditure such was the subject of the Privy Council’s judgment in Ward & Co Ltd v Commissioner of Taxes, which, though it may have been incurred for the purpose of protecting or advancing the taxpayer’s business, cannot be shown to have been expended in producing assessable income. I think this may well be so, but I do not feel sufficiently convinced of any explanation other than the new section was intended to relieve taxpayers somewhat from the rigorous test which the courts had found it necessary to impose because of the earlier wording.

• [36] Richardson J acknowledged that the language of the new s 111(b) would likely “widen the field of deductibility”, at least for taxpayers who were “carrying on a business”.^[29] Other than comparing the wording of the two sections he proffered little further explanation.
• [37] Beattie J also saw the amendment as having an expansionary purpose. He wrote:^[30]

I consider that the new section enlarges the scope of deductible expenditure. As I shall later discuss, under s 111(a) there is no qualifying adverb and under s 111(b) the qualification has changed.

• [38] But, again, beyond that Beattie J also offered no further explanation.
• [39] As can be seen, the comments in Europa Oil (NZ) Ltd reflect the general proposition that the second limb of s 111 may not be as restrictive as the first. Beyond that, they do not materially assist. In our view, the case does not support the nexus characterisation adopted by the Commissioner and the High Court.
• [40] Nor does Thornton Estates Ltd add much, if anything, to that analysis. The case concerned the accrual rules, and the timing of the availability of deductions for the cost of land and its subsequent development. That the relevant expenses were deductible was not challenged by the Commissioner: the question was timing. In the course of extended submissions, and having correctly summarised the general principles found in Banks and Buckley & Young Ltd, the taxpayer’s lawyer paraphrased the nexus requirement under s 104(a) of the Income Tax Act 1976 (the 1976 ITA) by the phrase “factually and causally relevant to the production of the taxpayers’ assessable income”. The Judge noted:^[31]

The Commissioner did not make any submissions in relation to s 104, and it seems to me those made by Mr Martin are correct. ...

• [41] To the extent the Commissioner’s phrase “factually and causally directed” appears to come from Thornton Estates Ltd, we did not find the case to be of any great authority, nor the phrase itself to be relevant or helpful.

Legislative history

• [42] We now turn to the legislative history of s DB 55 because, as noted, both the Commissioner and NRS say the interpretation they argue for is supported by the legislative history. Notwithstanding the helpful submissions we received, both in writing and orally, by the end of the hearing the position on that matter was not as clear as we might have wished. We therefore requested a joint memorandum from counsel setting out, hopefully on an agreed basis, s DB 55’s legislative history and its role over time.
• [43] The memorandum we subsequently received was, as requested, agreed albeit with one exception. That exception was of some significance: the parties were unable to agree on the reason for the enactment of s DB 55. That has not helped our task. Moreover, the material is dense and now historical.
• [44] We also note that in her submissions the Commissioner relied in particular on correspondence from an individual taxpayer to the Select Committee as evidencing the type of expenditure Parliament had in mind when enacting s DB 55. We think that expands the net of legitimate interpretational material at least a step too far. Whatever may or may not have been the motivation of an individual taxpayer, or group of taxpayers, in seeking a particular amendment to the legislation does not, in our view, constitute relevant interpretational material, beyond the extent to which that material becomes part of the official Parliamentary record.
• [45] Subject to those reservations, we now set out our understanding of the legislative history of s DB 55. At the end of the day, and taken overall, our sense is that the deductions NRS claimed may not have been at the forefront of Parliament’s, or the Commissioner’s, minds when the section was introduced. That, of itself, is not determinative of the issues here.
• [46] Section DB 55 was originally introduced in 2004 as s DJ 11B of the Income Tax Act 1994. It was retrospectively repealed on 30 June 2014 by s 49(2) of the Taxation (Annual Rates, Employee Allowances, and Remedial Matters) Act 2014 (the 2014 Act). The repeal was effective as of 30 June 2009. However, the 2014 Act contained a savings provision: provided certain criteria were met, the repeal did not apply to tax returns filed before 22 November 2013, the date the Bill was introduced to Parliament. It is not disputed that NRS’ challenged returns fall within that savings provision.
• [47] Section DB 55 did an apparently curious thing. It allowed a deduction for expenses incurred in deriving exempt income. That is, s CW 9(1) of the 2007 ITA provides:

A dividend from a foreign company is exempt income if derived by a company that is resident in New Zealand.

• [48] Such an allowance is contrary to the scheme of the 2007 ITA. Section DA 2(3) provides:

(3) A person is denied a deduction for an amount of expenditure or loss to the extent to which it is incurred in deriving exempt income. This rule is called the exempt income limitation.

• [49] Section DB 55 had its origins in New Zealand’s international tax regime. That tax regime, designed to protect New Zealand’s tax base and remove distorting incentives for off-shore investment, was introduced by the Income Tax Amendment Act 1988 (No 5). Three regimes for taxing foreign-sourced income were established:

(a) the CFC regime;

(b) the foreign investment fund (FIF) regime; and

(c) the foreign dividend withholding payment (FDWP) regime.

• [50] The CFC regime was necessary to ensure that foreign-sourced income was taxed effectively. Before the CFC regime, New Zealand residents could avoid tax by accumulating income in companies resident offshore, but effectively controlled from New Zealand. The CFC regime now applies to all taxpayers who have an “income interest” of greater than 10 per cent in a foreign company that is effectively controlled by a New Zealand shareholder or group.^[32] The threshold for effective control is generally 50 per cent. Thus, each of NRS’ subsidiaries was a CFC.
• [51] When introduced, the CFC regime provided for full attribution of a CFC’s income to the New Zealand controlling shareholder — unless the CFC was resident in a grey list country (Australia, Canada, France, Germany, Japan, the United Kingdom and the United States). Given the incorporation of NRS’ subsidiaries in the United Kingdom, Canada and Australia, NRS was not required to attribute their income.
• [52] FDWP applied to dividends received by a New Zealand company from foreign companies, subject to a credit in the case of dividends from grey list companies. That credit worked on the basis that, for dividends from grey list countries, the foreign company would be presumed to have paid foreign tax equal to the New Zealand income tax payable. So, in effect, there would be no withholding payment to pay. Thus, just as NRS was not required to attribute its subsidiaries’ income, neither was it required to pay FDWP on dividends actually received from those subsidiaries.
• [53] That was not the case for all corporate taxpayers, including investment vehicles like unit trusts, for whom dividends from foreign companies were exempt income but nonetheless subject to FDWP. Notwithstanding the effective tax of the FDWP, s DA 2(3) precluded deductions for expenses incurred in deriving that exempt income. That mismatch was, counsel advised, addressed by taxpayers structuring such dividends as bonus issues. As we understand it, in that way liability to pay FDWP did not arise. In 2003, however, changes were proposed which would treat such bonus issues as dividends and therefore as exempt income. So, the mismatch — the objective significance of which was not explained to us — would exist again. In response, s DJ 11B was introduced “to allow a deduction for expenditure incurred by a company deriving dividends that are exempt under section CB 10(1) ...”.^[33]
• [54] New Zealand’s international tax regime was changed again in 2009. The introduction of the active/passive distinction and its application in the attribution of CFC income resulted in the abolition of FDWP. Our understanding is that NRS’ grey list subsidiaries were not affected by that repeal, as FDWP had not applied to them. How the CFC provisions applied going forward to NRS and its subsidiaries, however, was not explained. What was agreed was that “no deductions [were] allowed to the shareholder ... in relation to [the] active income” of a CFC.
• [55] What is reasonably clear is that with those changes in 2009 the rationale for s DB 55 no longer existed. That is, the abolition of FDWP, and the nexus for deductibility provided by the attribution of CFC income, eliminated the mismatch that the section had been intended to address. That fact was, however, overlooked, as was subsequently explained in the Officials’ Report to the Finance and Expenditure Select Committee considering the Taxation (Annual Rates, Employee Allowances, and Remedial Matters) Bill 2014, which proposed the repeal of s DB 55:^[34]

When a New Zealand company receives a dividend from a foreign company, the dividend is exempt from income tax. Section DB 55 allows deductions despite the fact that the dividends are exempt from income tax.

The rationale for this, is that before 2009, the dividends were subject to a special levy, known as “foreign dividend payment” or [FDWP] which was equivalent to income tax.

In 2009 there was a major reform of New Zealand’s international tax rules. This reform was designed to reduce tax barriers on New Zealand businesses that expand offshore. It did this by exempting most types of income that businesses earned through foreign subsidiaries. As part of this reform all tax on foreign dividends paid to New Zealand companies, including [FDWP] was removed.

In the course of implementing the 2009 reforms, the need to repeal section DB 55 was overlooked. We are now seeking to repeal it as part of the current bill.

Maintaining section DB 55 in the absence of [FDWP] would be contrary to general tax principles of not allowing deductions which relate to exempt income (now that the dividends are truly exempt). It would effectively be a tax concession or subsidy.

...

• [56] Thus, and as that Report makes clear, in claiming deductions for expenses incurred in deriving exempt dividend income, NRS was the unintended beneficiary of a legislative oversight. In our view, however, that does not advance the Commissioner’s argument.
• [57] We therefore conclude that here the legislative history does not support the Commissioner’s interpretation of s DB 55. Rather, taking account of the plain words of the section, the statutory context and the recorded legislative intent, we think the ambit of the deductibility provided by s DB 55 is to be decided in accordance with the general principles that we have already explained.

Nexus

• [58] The question then becomes whether the nexus between NRS’ expenditure and the deriving of the exempt dividend income has the necessary characteristics to support deductibility.
• [59] As a holding company, NRS’ business was, as its witnesses described, to promote the interests of its shareholder investors by maximising the value of their investment. That is basic company law. At the same time, there can be little doubt that the activities NRS engaged in for that overall purpose bore the necessary nexus with the deriving of the dividends paid to it by its subsidiaries.
• [60] Mr Gold’s evidence summarises the position well:
  103. [NRS] was the group company shareholder, and its functions were as described above, reflecting the four major cost types. Those costs and functions were directed at building and managing the respective businesses of the foreign companies, to make them profitable. [NRS] was not itself running those foreign companies — each had their own highly skilled and competent management teams, to run their businesses (CEO, CFO, marketing and sales functions and administration). [NRS’] costs were incurred in respect of the function of providing group stewardship including financial control, leadership and development. It would never have derived the dividends without these functions, and the costs incurred in providing them.
  104. [NRS] was not a passive investor of its share capital. Quite the reverse. The Corporate Office team were totally active in every sense, in driving the highest possible dividend returns, from the ongoing stewardship of all the company’s capital and intellectual property.
  105. In fact, the payment of Corporate Office costs was reliant on dividend streams from the subsidiaries. From the practical perspective, it had to incur the Corporate Office costs that are in issue here, in order to derive those dividends.
• [61] In our view, those comments illustrate why the necessary nexus did exist between the expenditure and the exempt dividend income derived to make that expenditure deductible.

Were NRS’ expenses of a capital nature?

• [62] We therefore turn to the matter not addressed in the High Court: that is, the significance here of the capital limitation.
• [63] Section DA 2 of the 2007 ITA contains what are described as the general limitations. These are overriding principles of non-deductibility. The first of those reads as follows:

Capital limitation

(1) A person is denied a deduction for an amount of expenditure or loss to the extent to which it is of a capital nature. This rule is called the capital limitation.

• [64] As subs (3) of s DB 55 makes clear, in allowing deductions incurred in deriving exempt dividend income, the legislature did not override the capital limitation or the other general limitations. The subsection provides:

Link with subpart DA.

(3) This section overrides the exempt income limitation. The general permission must still be satisfied and the other general limitations still apply.

• [65] So, notwithstanding our conclusion that the necessary nexus between the expenses incurred and the exempt dividend income derived exists, if those expenses are properly categorised as being of a capital nature, then they will not be deductible.

Submissions

• [66] The Commissioner’s argument here is that the subsidiaries were capital assets of NRS and therefore expenditure in respect of improving the value of such assets is capital in nature. It did not matter, the Commissioner argued, that the expenditure was recurrent nor of a category that could, in other circumstances, be considered to be in respect of revenue. Whether the expenditure is capital or revenue is determined by the nature of the asset acquired or improved by the expenditure. The Court of Appeal has called this the “identifiable asset test”.^[35] The asset improved by the expenditure here was, the Commissioner argued, NRS’ subsidiaries. Those assets “were part of the business structure of [NRS] that is held on capital account”.
• [67] That was, NRS responded, a rerun of arguments designed to limit interest deductibility unsuccessfully advanced in a series of decisions culminating in this Court’s decision in Commissioner of Inland Revenue v Brierley.^[36] Those cases concern the extent of the deductibility of interest provided for by s 106(1)(h) of the 1976 ITA. The question was whether deductibility could be declined to the extent that the capital in respect of which the interest was being paid itself increased in value in a non‑assessable way. Mr Harley pointed to the following extract from the decision of Richardson J in Brierley in support of his argument:^[37]

The legislature must be taken to have well understood that capital employed in income earning activities may in the course of those activities change in value and that the owner may derive capital returns in variety of forms. On a narrower view it might be said that such an asset is always employed in the production of both assessable income and prospective capital benefits. However it would be contrary to both past practice and to the principle that income is a flow reflecting the fruit of the tree to treat the existence of actual or prospective capital appreciation or actual or prospective capital returns as providing a basis for the apportionment of interest expenses. It would also be inconsistent with the scheme of the legislation, and in particular the specific and limited provisions for clawback of interest, to refuse deduction for an assumed capital element of interest under s 106(1)(h).

• [68] By analogy, Mr Harley argued that the fact that NRS’ activities might have increased the value of its subsidiaries did not disentitle NRS to the deduction allowed by s DB 55.
• [69] We can see that argument: but the distinction here is the Commissioner’s reliance on the general capital limitation. Given that Parliament explicitly retained the general limitation on the deductibility of expenditure of a capital nature when providing for deductibility with respect to exempt dividend income, it clearly provided a different scheme from the one Mr Harley based his argument on.
• [70] It is therefore necessary to address this aspect of the Commissioner’s argument in terms of first principles and by considering NRS’ expenditure from a practical and business point of view.

The law

• [71] The approach in New Zealand is now settled, as this Court’s decision in Easy Park Ltd v Commissioner of Inland Revenue shows.^[38] The governing approach is summarised by the observations of Lord Pearce in BP Australia Ltd v Commissioner of Taxation of the Commonwealth of Australia, adopted by this Court in Commissioner of Inland Revenue v Thomas Borthwick & Sons (Australasia) Ltd:^[39]

The solution to the problem is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other. One consideration may point so clearly that it dominates other and vaguer indications in the contrary direction. It is a commonsense appreciation of all the guiding features which must provide the ultimate answer. Although the categories of capital and income expenditure are distinct and easily ascertainable in obvious cases that lie far from the boundary, the line of distinction is often hard to draw in borderline cases; and conflicting considerations may produce a situation where the answer turns on questions of emphasis and degree. That answer:

“depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process”:

per Dixon J in Hallstroms Pty Ltd v Federal Commissioner of Taxation. As each new case comes to be argued felicitous phrases from earlier judgments are used in argument by one side and the other. But those phrases are not the deciding factor, nor are they of unlimited application. They merely crystallise particular factors which may incline the scale in a particular case after a balance of all the considerations has been taken.

• [72] The courts have also identified a number of relevant, but not determinative, indicators. These include the “enduring benefit test”,^[40] the “fixed or circulating capital test”,^[41] and whether the expenditure was recurrent. Ultimately, however, the focus must be on what the expenditure was calculated to effect from a practical and business point of view.
• [73] With that in mind, it is necessary to briefly summarise the nature of NRS’ business. As noted above, NRS is the parent company of subsidiaries incorporated in foreign jurisdictions. The subsidiaries provide and maintain systems that facilitate sales of radio and television advertising space by the subsidiaries’ clients. The intellectual property in the systems has, at all material times, been held by Persuaders. The High Court summarised:^[42]

The function of the Head Office was to manage NRS’ share capital invested in the subsidiaries. NRS managed the subsidiaries by establishing and managing strategic and business plans; executing projects to increase profitability; reviewing financial performance; receiving reports from the subsidiaries; regularly visiting each subsidiary; and reporting to the Board on a monthly basis.

• [74] NRS took issue with that synopsis on appeal — it claimed “each subsidiary had its own independent Board of Directors, Chief Executive, Chief Financial Officer and operating staff”. This is reflected in Mr Gold’s evidence, as set out above at [60].
• [75] The Commissioner relies on selected pieces of evidence to support her argument, including:

(a) the agreement between NRS and Persuaders, which noted that the funding of the head office was to ensure the “ongoing development and successful management of the [group]”;

(b) Mr Gold’s brief of evidence, which noted that oversight of the subsidiaries included expansion into new markets, new product development, and existing product improvement and business development”; and

(c) the expenditure included the establishment of business plans, making of surplus profits that were not only paid out as dividends but reinvested within the group, and the development and improvement of products.

• [76] In our view, however, that does not properly reflect the nature of NRS’ business. NRS’ business operations were, fundamentally, the oversight of its subsidiaries. As Mr Gold explained at one point in his brief of evidence, the real value in the media business operated by NRS and NRS’ subsidiaries was in the intellectual property of their business systems. From a practical and business point of view, NRS’ expenditure was calculated to simply facilitate the operations of the subsidiaries rather than to improve the capital of the subsidiaries. In this respect, the expenses for which NRS claimed deductions represent recurrent and regular business expenses — payroll and consultants, marketing and travel, rent and occupancy, and overheads. These are all manifestly revenue expenses. In our view, NRS ought to be entitled to a deduction for these expenses.

Result

• [77] The appeal is allowed.
• [78] The appellant is entitled to deductions totalling $1,706,568.23 and $1,963,472.31 in the 2011 and 2012 years respectively.
• [79] The respondent must pay the appellant costs for a standard appeal on a band A basis and usual disbursements.
• [80] Any order for costs in the High Court is quashed. Costs in the High Court are to be determined by that Court in accordance with this judgment.

Solicitors:
Chapman Tripp, Wellington for Appellant
Crown Law Office, Wellington for Respondent

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^[1] NRS Media Holdings Ltd v Commissioner of Inland Revenue [2017] NZHC 2978.

^[2] As we return to, NRS maintains that it did not manage the subsidiaries.

^[3] NRS Media Holdings Ltd v Commissioner of Inland Revenue, above n 1, at [10] and [33].

^[4] Taxation in New Zealand — Report of the Taxation Review Committee (Taxation Review Committee, October 1967) at [478].

^[5] Europa Oil (NZ) Ltd v Commissioner of Inland Revenue [1974] 2 NZLR 737 (CA).

^[6] Thornton Estates Ltd v Commissioner of Inland Revenue (1995) 17 NZTC 12,230 (HC).

^[7] NRS Media Holdings Ltd v Commissioner of Inland Revenue, above n 1.

^[8] At [33].

^[9] At [46].

^[10] At [47].

^[11] At [48].

^[12] In this appeal, the Commissioner accepted the Judge erred in saying the purpose of the expenditure was irrelevant. As we discuss from [24] onwards, purpose can be relevant, and even determinative, in deciding whether the required nexus for deductibility exists between expenditure and derived income.

^[13] Commissioner of Inland Revenue v Banks [1978] 2 NZLR 472 (CA).

^[14] Buckley & Young Ltd v Commissioner of Inland Revenue [1978] NZCA 22; [1978] 2 NZLR 485 (CA).

^[15] Commissioner of Inland Revenue v Banks, above n 13, at 476.

^[16] At 476. The second feature, not relevant here, was the contemplation in the statutory language of apportionment.

^[17] At 476.

^[18] At 477.

^[19] At 477.

^[20] At 477.

^[21] At 477.

^[22] At 478 (citations omitted).

^[23] At 478 and 482 (citations omitted and emphasis added).

^[24] At 483 (emphasis added).

^[25] Buckley & Young Ltd v Commissioner of Inland Revenue, above n 14.

^[26] At 487 (emphasis added and citations omitted).

^[27] Ronpibon Tin No Liability v Federal Commissioner of Taxation [1949] HCA 15; (1949) 78 CLR 47 at 56–57 (citations omitted).

^[28] Europa Oil (NZ) Ltd v Commissioner of Inland Revenue, above n 5, at 739 (citations omitted).

^[29] At 740.

^[30] At 741.

^[31] Thornton Estates Ltd v Commissioner of Inland Revenue, above n 6, at 12,235.

^[32] Income Tax Act, s CQ2 and subpt EX.

^[33] Taxation (Annual Rates, Venture Capital and Miscellaneous Provisions) Bill 2004 (110-2) (select committee report) at 19.

^[34] Inland Revenue Taxation (Annual Rates, Employee Allowances, and Remedial Matters) Bill Officials’ Report to the Finance and Expenditure Committee on Submissions on the Bill (March 2014) at 256.

^[35] The Commissioner cited Commissioner of Inland Revenue v McKenzies (NZ) Ltd [1988] 2 NZLR 736 (CA) in support.

^[36] Commissioner of Inland Revenue v Brierley [1990] 3 NZLR 303 (CA); Pacific Rendezvous Ltd v Commissioner of Inland Revenue [1986] 2 NZLR 567 (CA); and Eggers v Commissioner of Inland Revenue [1988] 2 NZLR 365 (CA).

^[37] At 310–311.

^[38] Easy Park Ltd v Commissioner of Inland Revenue [2018] NZCA 296, (2018) 28 NZTC 23-066.

^[39] BP Australia Ltd v Commissioner of Taxation of the Commonwealth of Australia [1966] AC 224 (PC) at 264–265 (footnotes omitted); and Commissioner of Inland Revenue v Thomas Borthwick & Sons (Australasia) Ltd (1992) 14 NZTC 9,101 (CA) at 9,103.

^[40] Commissioner of Inland Revenue v Trustpower Ltd [2015] NZCA 253, [2015] 3 NZLR 658 at [62].

^[41] Commissioner of Inland Revenue v Inglis [1993] 2 NZLR 29 (CA).

^[42] NRS Media Holdings Ltd v Commissioner of Inland Revenue, above n 1, at [6].