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High Court of New Zealand Decisions |
Last Updated: 2 October 2018
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IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY
I TE KŌTI MATUA O AOTEAROA TĀMAKI MAKAURAU ROHE
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CIV 2018-404-0774
[2018] NZHC 2539 |
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UNDER
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the Income Tax Acts 1994, 2004 and 2007 and the Tax Administration Act
1994
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IN THE MATTER
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of an appeal from a decision of the Taxation Review Authority
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BETWEEN
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BOON GUNN HONG
Appellant
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AND
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COMMISSIONER OF INLAND REVENUE
Respondent
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Hearing:
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25 and 26 September 2018
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Appearances:
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B G Hong in person
M Deligiannis and L K Worthing for the respondent
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Judgment:
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27 September 2018
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JUDGMENT OF JAGOSE J
This judgment was delivered by me on 27 September 2018 at 4:00 p.m. pursuant to r 11.5 of the High Court Rules 1985.
Registrar/Deputy Registrar
..........................................
Parties/Solicitors:
Mr B G Hong
Ms M Deligiannis, Crown Law Office, Wellington
HONG v COMMISSIONER OF INLAND REVENUE [2018] NZHC 2539 [27 September 2018]
Introduction
[1] In his 2011 income tax return Mr Hong, a solicitor, claimed deductions in respect of loans he had written off as bad debts of $50,000 and $122,280 respectively. The loans were to two of his legal practice’s clients, facing financial difficulties, out of a fund he had created for that purpose.
[2] The Commissioner of Inland Revenue disallowed and reversed the deductions, issuing an amended assessment and further imposing shortfall penalties on the basis Mr Hong had failed to take reasonable care. On 29 March 2018, the Taxation Review Authority upheld the Commissioner’s findings.
[3] Mr Hong now appeals the Authority’s decision pursuant to s 26A of the Taxation Review Authorities Act 1994. He seeks orders quashing the decision, and declarations he is entitled to make the deductions and is not liable for any shortfall penalties in the circumstances.
[4] Mr Hong argues on appeal (as he did before the Authority):
(a) his deductions fall within s DB 31 of the Income Tax Act 2007, the exception carved out from the general principle bad debts are not deductible; and
(b) the Commissioner was not justified in imposing shortfall penalties under s 141A of the Tax Administration Act 1994.
[5] The appeal operates by way of a full rehearing,1 but I must still undertake my own assessment of the merits of the Authority’s decision. I may not interfere with its decision unless Mr Hong persuades me a different conclusion should be reached.2
1 High Court Rules 2016, r 20.18.
Analysis
[6] The Authority’s decision is comprehensive, well-reasoned, and to my mind, generally beyond reproach. I do not propose to rehearse its reasons in great depth, but only so far as is required to make the point I see no reason to depart from its findings.
Do the deductions fall within s DB 31 of the Income Tax Act?
—the legislative scheme
[7] As the Authority recognised, the operative provision in respect of the deductibility of bad debts is s DB 31 which stipulates, except to the extent expressly provided, deductions for bad debt will be denied. Section DB 31(1) overrides the general permission afforded by s DA 1 with the effect, when a deduction is denied under the former, it is unnecessary to consider the latter.3
[8] Section DB 31 relevantly provides:
DB 31 Bad debts
No deduction (with exception)
(1) A person is denied a deduction in an income year for a bad debt, except to the extent to which—
(a) the debt is a debt—
(i) written off as bad in the income year:
(ii) for which the debtor is released from making all remaining payments under the Insolvency Act 2006 excluding Part 5, subparts 1 and 2 of that Act, or under the Companies Act 1993, or under the laws of a country or territory other than New Zealand, and the person is required to calculate a base price adjustment by section EW 29 (When calculation of base price adjustment required) for the debt for the income year:
....
(b) in the case of the bad debts described in subsections (2) to (5), the requirements of the relevant subsection are met.
3 Income Tax Act 2007, s DB 31(6).
[9] The only relevant subsection on the present facts is subsection (3), which provides:
Deduction: financial arrangement debt: dealers and holders
(3) A person is allowed a deduction, quantified in subsection (3B), for an amount of a bad debt owing under a financial arrangement to which the financial arrangement rules apply, if—
(a) the person carries on a business for the purpose of deriving assessable income; and
(b) the business includes dealing in or holding financial arrangements that are the same as, or similar to, the financial arrangement; and
(c) a requirement of subsection (1)(a) is met for the bad debt; and
...
[10] Thus, to deduct the bad debts presently at issue, Mr Hong needed to establish:
(a) under subsection (1)(a), either:
(i) the relevant debts were written off as bad between 1 April 2010 and 31 March 2011, being the income year in which the deductions were claimed; or
(ii) the debtors were released from making all remaining payments by law, the relevant law here being the Insolvency Act 2006; and
(b) under subsection (3)(a), he carried on business for the purpose of deriving accessible income; and
(c) under subsection (3)(b), that business included dealing in or holding financial arrangements that were the same as, or similar to, the financial arrangement for which the deductions are claimed.
—application
[11] The Authority explained in detail why Mr Hong failed to establish any of those requirements. I see no reason to depart from its findings.
[12] First, Mr Hong has not shown, according to his own accounting procedures,4 the loans had been written off in the 2011 income year.5 Instead:
(a) except for Mr Hong’s assertion his office administrator, Ms Chan, had entered the write-offs in the spreadsheet during the 2011 income year, there was no evidence of that entry or its timing;
(b) Ms Chan – who was said to make all computer entries for inclusion in the spreadsheet – was not called by Mr Hong. Mr Hong had to call her to obtain direct evidence of his assertion, and her evidence could explain or elucidate the entry and timing of the write-offs in the spreadsheet, but her absence was unexplained (beyond Mr Hong’s preference she remain at work than become involved in the litigation). An inference is therefore available what she may have said in evidence would not have assisted Mr Hong;6
(c) the database of financial transactions apparently compiled during the 2011 income year, from which the spreadsheet was in part derived, omitted any reference to the write-offs;
(d) Mr Hong’s 2011 return was completed in conjunction with those for 2006-2010 and 2012, after the Commissioner initiated an audit of Mr Hong’s compliance, given the absence of his returns for those years;
(e) on 24 September 2012, Mr Hong advised the Commissioner “[his] staff had entered all the transaction details for [him] to complete the returns over this weekend”, and sought an extension of time to 1 October 2012 to complete the returns; and
(f) Mr Hong himself said he had included the bad debts in the 2011 return, ultimately filed in October 2012, “as more or less it was then that I turned my mind to this”.
4 Case W3 (2003) 21 NZTC 11,014 at 11,030.
6 Perry Corp v Ithaca (Custodians) Ltd [2004] 1 NZLR 731 (CA) at [153].
[13] Mr Hong complained the Commissioner unlawfully raised, and in any event the Authority wrongly accepted, the investigator’s evidence the spreadsheet was created at 10:30am on 20 September 2012, based on the investigator’s observation of the spreadsheet’s metadata recording its “Content created” at that time and date. The observation was not included in the Commissioner’s statement of position. Mr Hong notes the same time and date is specified for each of the 2006-2012 spreadsheets incorporated with his belated returns, and says it would be impossible for him to have created all seven documents contemporaneously. Certainly that coincidence suggests the 20 September 2012 spreadsheets are copies of earlier created documents.
[14] Be that as it may, nothing in particular turns on the date the spreadsheet was created. Even if it existed during the 2011 income year, there is no evidence the write- off of the bad debts was recorded in it at that time. The Authority’s finding of the spreadsheet’s “true creation date” is distinct to its conclusion Mr Hong failed to establish the bad debts were written off during the 2011 income year. In any event, Mr Hong misapprehended the scope of the amended s 138G(1) of the Tax Administration Act, which omitted the subsection’s former exclusion of “facts and evidence” not disclosed in statements of position. The Commissioner was entitled to tender the evidence.
[15] Next, the Authority did not err in finding Mr Hong’s debtors – both natural persons – had not been released at law from making any further payments, relevantly by dint of being discharged from bankruptcy under s 304 of the Insolvency Act. Specifically, one debtor was only released from bankruptcy in 2013, after the 2011 income year; and the other had not been adjudicated bankrupt at all.
[16] Plainly, whether there had been any ‘release’ was alternative to the Authority’s finding on the timing of the bad debts’ write-off. Mr Hong is wrong in arguing the Authority incorrectly combined the two heads of s DB 31(1)(a).
[17] I do not accept the $50,000 loan to Bill Chan, Sai Kwong is to be construed as being made to his company, Far South Investment Society Co Limited. The loan documentation, prepared on Mr Hong’s behalf, is determinedly expressed in personal terms on account of Mr Chan’s “overspent funds renovating my restaurant”. That
documentation also directs payment 90 per cent to Mr Chan’s company “to clear rent and other creditors owed”; and 10 per cent to himself, but “I undertake to pay back the loan as quickly as I can”. And, even if it was to the company, there was no evidence the company had been released from its obligations to pay.
[18] Further, Mr Hong was not carrying on, even in part, a lending business for the purpose of deriving accessible income:7
(a) the fund from which the loans had been advanced was set up with the dual objective of, first, assisting Mr Hong’s clients in financial difficulty according to his assessment of their qualification for such assistance; and second, increasing the amount available for a final distribution upon Mr Hong’s death to his charity of choice, World Wildlife Fund. None of that objectively suggests business activities;8
(b) the lending activity was not carried on in an organised and coherent manner, or with sufficient continuity and extent.9 Mr Hong’s primary business was providing legal services, and the lending was a side project to which he gave minimal time and energy. Until Mr Chan sought a further loan, Mr Hong had ‘forgotten’ he had lent money to Mr Chan at all. The evidence was clear Mr Hong did not undertake due diligence on his lending, or monitor the balances of his loan account. Neither did he take any formal security or derive any significant income from the lending; and
(c) Mr Hong went to lengths to impress he lent out of benevolence and in reliance on conscience; his fund was called the “Benevolence on the Conscience Loan Fund”. His only hope of financial return was if grateful clients elected to reimburse him (whether at all, or with interest, or even including a ‘bonus’). His lending was “at least as
7 Grieve v Commissioner of Inland Revenue [1984] 1 NZLR 101 at 110.
8 Compare Case 5/2011 (2011) 25 NZTC 1-005 at [57]-[58].
9 Grieve v Commissioner of Inland Revenue, above n 7, at 106.
consistent” with charitable giving or, at most, a passive investment, either way not satisfying subsection (3)(a).10
[19] So far as the subject loans are concerned, the last may well have been Mr Hong’s approach to their recovery, but the Chan loan is expressed as being “[r]epayable on demand with interest at 10% on repayment”, and the Tololi loan also is “[r]epayable on demand with fair interest ... on repayment”. Even if Mr Hong’s ‘benevolent’ lending could be viewed as part of his legal services business, these loans do not appear the same as or similar to their ‘conscience’ character. Mr Hong has recourse to demand, as an alternative to awaiting his clients’ action. It also is notable the $300,000 Tololi loan (of which only $122,000 is claimed to be written off, with no explanation as to whether the balance has been or remains to be reimbursed, with or without interest or ‘bonus’) includes Mr Hong’s recourse to such surplus funds as Mr Tololi or his group of companies may leave with him. That is a separate distinguishing feature from any ‘conscience’ loan.
[20] Last, there is no sufficient connection between Mr Hong’s legal services business, and the financial arrangements he seeks to deduct as bad debts. That the two loans at issue happen to be to his clients is not enough. The two services do not naturally or easily co-exist. Mr Hong lending money to his clients raises significant issues under the Lawyers and Conveyancers Act (Lawyers: Conduct and Client Care) Rules 2008 – specifically, in addressing conflicting interests – about which there is no indication Mr Hong is aware or has addressed. It is also significant Mr Hong did not use his legal business bank account for the lending activities, and seeks to account for the write-offs as “Extraordinary losses”.
Was the Commissioner justified in imposing shortfall penalties?
[21] Section 141A of the Tax Administration Act governs the imposition of shortfall penalties for not taking reasonable care. Subsection (1) provides:
A taxpayer is liable to pay a shortfall penalty if the taxpayer does not take reasonable care in taking a taxpayer’s tax position (referred to as not taking
reasonable care) and the taking of that tax position by that taxpayer results in a tax shortfall.
‘Reasonable care’ is not defined in the Act. However, the section provides the safe harbour a person will have taken reasonable care if that person:
(a) under subsection (3), takes an acceptable tax position; or
(b) under subsection (2B), relies on an action or advice of a tax advisor engaged by the taxpayer.
[22] I take no issue with the Authority’s finding Mr Hong failed to take reasonable care – which is to say, a reasonable person in his circumstances would have foreseen the tax shortfall as a reasonable possibility.11 In particular, Mr Hong failed to do what a reasonable person in his circumstances would have done:
(a) taken sufficient steps to understand relevant taxpayer obligations, commensurate with the complexity and exceptionality of the tax position to be taken;
(b) kept adequate books and records to substantiate the making, repayment, and enforcement of the loans, and the reasons for assessing the debts had gone bad and for deciding to write them off; and
(c) filed returns and paid tax on time (Mr Hong did not file income returns for the entire income period 2006 to late 2012, and made no provisional tax payments after May 2008).
However, I think the Authority goes too far in saying a reasonable person “would have sought advice from a tax advisor” (and, inferentially, relied on it). That leaves no margin between the ‘reasonable’ person and the safe harbour. I prefer the Commissioner’s alternative as I have expressed it at (a) above.12
11 Case 3/2013 (2013) 26 NZTC 2-002 at [38] citing Case W4 (2003) 21 NZTC 11,034 at [60] and
Case Y21 (2008) 23 NZTC 13,227 at [74].
12 See also Case W3 (2003) 21 NZTC 11,014 at [113], and Case 9/2016 (2016) 27 NZTC 3-031 at
[45]-[46].
[23] The legislation provides another safe harbour: a taxpayer who takes an acceptable tax position will have taken reasonable care.13 But the position taken by Mr Hong was also objectively unacceptable: that is, it could not on rational grounds be argued to be right.14 There is no rational ground to assert a deduction in an income year for a bad debt, without evidence either the debt was written off as bad in the income year or the debtor was released from making remaining payments.
[24] Mr Hong fell well short of the standard of care expected of taxpayers generally, as set out in s 15B of the Tax Administration Act, and in those circumstances, I see no error in the Authority upholding the (reduced) penalty imposed by the Commission.
Result
[25] The appeal is dismissed.
Costs
[26] As the successful party, my preliminary view is the Commissioner is entitled to costs on a 2B basis. If that is not accepted by any party, and costs cannot otherwise be agreed between them, costs are reserved for determination on short memoranda of no more than five pages – annexing a single-page table setting out any contended allowable steps, time allocation, and daily recovery rate – to be filed and served by:
(a) the Commissioner within ten working days of the date of this judgment;
(b) Mr Hong within five working days of service of the Commissioner’s memorandum; and
(c) the Commissioner strictly in reply within five working days of service of Mr Hong’s memorandum.
Jagose J
13 Tax Administration Act 1994, s 141A(3).
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