Commissioner of Inland Revenue v Gulf Harbour Development Ltd

[2004] NZCA 263

IN THE COURT OF APPEAL OF NEW ZEALAND

CA135/03

BETWEENCOMMISSIONER OF INLAND REVENUE

Appellant

ANDGULF HARBOUR DEVELOPMENT LIMITED

Respondent

Hearing:3 and 4 May 2004

Coram:McGrath J
Chambers J
O'Regan J

Appearances:  B A Corbett and K D Parkash for Appellant

L McKay and K F Quinn for Respondent

Judgment:5 November 2004 

JUDGMENT OF THE COURT DELIVERED BY CHAMBERS J

The issue on this appeal

[1] Baragwanath J, in the judgment under appeal (now reported at [2004] 2 NZLR 768), defined the issue before him in the following way:

[1]  One member of a group of companies sells to the public redeemable preference shares in another member that operates a golf club and related facilities.  The rights attached to each share and passing to the purchaser include membership of the club.  The issue in this proceeding is whether such sales are to be treated for the purpose of the Goods and Services Tax Act 1985 (the GST Act) as the supply to purchasers of financial services.

[2]  The primary question is whether, as [Gulf Harbour Development Ltd] submits and the Commissioner denies, what was supplied is simply an “equity security”, defined by s 3(2) as meaning:

… any interest in or right to a share in the capital of a body corporate.

If so, the supply is of a “financial service” as defined in s 3(2) which by the operation of ss 6(3)(d) and 14(1) is exempt from goods and services tax (GST). 

[3]  The Commissioner acknowledged that a redeemable preference share is in law “an equity security” and therefore its supply, viewed by itself, is of a “financial service”.  But he contended that, on a proper application to the agreed facts of the legislation truly construed, the supply was not simply of a financial service.  The supply is, he said, to be viewed as in substance of membership in the club, and cannot be regarded as a “financial service”.  In so far as the supply of the share may be characterised as an “equity security” that was a merely ancillary addition to the essential transaction and cannot affect the construction of the supply, as non-financial and thus non-exempt.

[2]        That remains the issue on this appeal.  Baragwanath J determined the issue in favour of the taxpayer, Gulf Harbour Development Limited (Gulf Development).  His Honour held that the supply in this case was a “financial service” and as such exempt from GST. 

[3]        The Commissioner of Inland Revenue disagrees.  He has appealed to this court, seeking a ruling that what was supplied in substance was membership in the golf club, which supply should attract GST.

The alleged errors in the High Court judgment

[4]        Mrs Corbett, for the Commissioner, submitted that Baragwanath J was wrong in his approach to the case.  She submitted that His Honour had asked the wrong question, which had led him into error so far as the answer was concerned.  She also contended that the judge had wrongly evaluated the two arguments the Commissioner had advanced. 

[5]        Mrs Corbett repeated in this court the two key submissions she had advanced in the High Court.  Her primary submission was and remains that the supplies made in this case were the supply of memberships to the golf club.  The equity security element was ancillary to or incidental to the supply of membership to the country club.  Baragwanath J had come to the opposite conclusion.  He held that what was supplied was a share, an incident of which was the right to belong to and make use of the golf club. 

[6]        Mrs Corbett’s alternative argument was that there were two supplies in this transaction.  One of the supplies was the supply of an equity security and the other membership to the golf club.  She submitted that the two supplies should be apportioned under s 10(18) of the GST Act between the taxable supply of club membership and the exempt supply of an equity security.  She submitted that the apportionment should be $1 for the supply of the equity security and the remainder for the taxable supply of club membership.  The judge rejected the suggestion that there were two supplies. 

[7]        We consider those issues in turn. 

What was being supplied

[8]        In order to understand this first issue, we must set out first some background facts, which we have taken from Baragwanath J’s judgment, there being no dispute concerning his summary.  Gulf Harbour Holdings Limited (Gulf Holdings) holds shares in three subsidiaries.  The first is Gulf Harbour Country Club Limited (CCL) which owns the country club and related development including a golf course near the eastern end of the Whangaparaoa Peninsula north of Auckland.  The 1,830,983 ordinary shares in CCL held by Gulf Holdings carry voting and dividend rights.  There were also 2,100 redeemable preference or “membership shares” in CCL.  They were allotted to Gulf Holdings’ other two subsidiaries, Gulf Harbour Country Club Holdings Limited (Club Holdings) and Gulf Development. 

[9]        Club Holdings acquired its membership shares in consideration of its paying the costs of construction of the golf course and facilities and transferring them to CCL.  Club Holdings then onsold those membership shares in CCL to members of the public.  It is on those sales that the Commissioner claims GST. 

[10]     Gulf Development acquired its membership shares in consideration for having on-lent to CCL the funds required for the development of the facility. 

[11]     The reason Gulf Development was the plaintiff (and now the respondent) is that it was nominated pursuant to s 55(3) of the GST Act as the representative member on behalf of the group. 

[12]     We now set out from Baragwanath J’s judgment the relevant features of CCL’s constitution:

[9]  CCL has elected pursuant to s 27 of the Companies Act 1993 to adopt a constitution.  It distinguishes between “Membership share” and “Ordinary share”.

[10]  The former is defined as meaning “an individual membership share”, a “corporate membership share” or a “restricted membership share”.  The latter is defined as meaning “a share other than a membership share …”.  Article 3.1 provides:

“… any Share may be issued upon the basis that such Share:

(a)    confers preferential rights to distributions of capital or income;

(b)    confers special, limited or conditional voting rights;

(c)    does not confer voting rights; or

(d)    is redeemable in accordance with terms of issue that are incorporated in this Constitution.”

[11]  The rights, obligations and restrictions attached to membership shares are stipulated in appendix 2 of the constitution.  Such shares are of three classes:

(a)Individual membership shares may be held only by a natural person who has attained the age of 20 years, is ordinarily resident in New Zealand, does not already hold a membership share, and whose share has been approved by the board of CCL.  The rights attaching to such shares are defined as entitling the holder personally to use the club facilities, to invite a guest on any day in which the holder is using the club facilities also to do so, and, subject to the absolute discretion of the board, to nominate up to four family members to become social members.  Such a share does not entitle the holder to attend or vote at any company meeting except on a proposal affecting the rights, privileges, limitations or conditions attached to the holder’s shares; on a proposal to liquidate the company; on a proposal on liquidation as to the division and vesting of assts to the extent that the proposal relates to the entitlements of holders of individual membership shares.  It does not entitle the holder to participate in any distribution save:

(i)by redemption on 31 May 2073 by payment of $1 in cash whereupon all rights attaching the share will cease; and

(ii)in the event of liquidation prior to redemption in accordance with a stipulated formula which recognises the duration and amount of the investments of preferential shareholders and gives them priority over ordinary shareholders;

(b)Restricted membership shares can be held only by natural persons over the age of 20 not ordinarily resident in New  Zealand who do not already hold a membership share and whose application had been approved by the board.  Such restricted membership rights are analogous to but more limited than those of holders of individual membership shares; and

(c)Corporate membership shares may be held only by a non‑natural legal person whose application has been approved by the board.  The holder is entitled to appoint a “nominated representative” to personally use the club facilities, to invite up to four guests, and to apply for up to four family members to become social members.

[12]  “Social members” and “junior members” are family members nominated by shareholders and certain others.  They have certain rights to use club facilities.

[13]  The constitution of CCL empowers the board to issue “club rules” relating to the operation and use of the club facilities.  It further empowers the board to levy annual subscription fees for the purposes of:

·meeting the costs of managing, operating and maintaining the club and club facilities;

·covering prospective repairs and renovations; and

·meeting any shortfall.

[14]  The constitution also provides for the imposition of penalties for breach of obligations attaching to members’ shares or of the club rules.  The board’s powers include suspending membership rights, imposing fines, and forfeiting shares. 

[13]     Mrs Corbett did not dispute that the shares were “equity securities” as defined in s 3 of the GST Act.  But, she submitted, that was not the issue.  She submitted that the judge had gone wrong because he had focused on whether the shares fell within the definition of “equity security”.  The crucial question, Mrs Corbett submitted, was the identification of the supply or supplies.  She submitted that what was really being sold here was memberships to the country club.  The equity security element was ancillary to or incidental to that supply.  She pointed to the prospectus, which referred to the “opportunity to invest in membership of a high quality integrated Country Club facility situated at Gulf Harbour”.  She particularly relied on a decision of the English Court of Appeal in British Railways Board v Customs and Excise Commissioners [1977] 1 WLR 588, which Baragwanath J had distinguished, wrongly in her submission.

[14]     Mrs Corbett placed emphasis on the fact that the shares were marketed as memberships of the golf club and the fact that memberships were sold separately from shares in some cases.  That reinforced, she said, her submission that what was really being sold was memberships of the golf club.

[15]     We are unable to accept Mrs Corbett’s arguments, essentially for the reasons given by Baragwanath J and skilfully embellished by Mr McKay in his submissions for Gulf Harbour.  There was no error in Baragwanath J’s approach or focus.  Although Mrs Corbett disputed that her argument was effectively one of substance over form, we disagree: in our view that is exactly what her argument amounted to, and as such it is contrary to well established authority in this court. 

[16]     We refer first to the well known authority of Marac Life Assurance Limited v Commissioner of Inland Revenue [1986] 1 NZLR 694. In that case, Marac Assurance issued instruments termed Marac life bonds in consideration for payment by investors of the principal amounts of the bonds. The bonds were issued for various terms and carried “bonuses” equating with market interest rates for the relevant term. The bonds carried a number of other debt-suggestive features and were marketed with an emphasis upon those debt elements. They did, however, impose an element of mortality risk upon Marac, which was obliged to pay the “bonuses” calculated over the term of the instruments at the interest rate agreed if the holder of the bond died prior to the term expiry. On the evidence, that mortality risk represented a cost to Marac of 0.5% of the amount subscribed by each holder.

[17]     Under the tax rules at the time, if the bonds were regarded as contracts of life insurance rather than as contracts for the lending of money, a substantial net tax advantage to the holder arose in respect of the interest or “bonus” he or she received. 

[18]     The Commissioner contended that each contract was “essentially…for the investment of moneys with the added life insurance component being insufficient to justify labelling the contract as a policy of life insurance”: at 705.  The Commissioner “seemed to suggest that a single non-severable contract could not be categorised as life insurance if on a wider assessment the Court concluded that the bonds were primarily designed and entered into as an investment but one containing an incidental insurance content”: at 706.  We pause to note that the Commissioner’s argument in Marac was clearly very similar to his argument before us. 

[19]     The court’s response to the Commissioner’s argument is summed up in the following passage from the reasons given by Richardson J (at 705):

[The parties] are free to enter into whatever lawful financial arrangements will suit their purposes.  They cannot be treated as having entered into a different arrangement which would or might have achieved somewhat similar economic advantages and whether or not they ever had that alternative in contemplation.  If Marac life bonds are policies of life insurance that is the end of the enquiry. 

The true nature of a transaction can only be ascertained by careful consideration of the legal arrangement actually entered into and carried out: not on an assessment of the broad substance of the transaction measured by the results intended and achieved or of the overall economic consequences.  The nomenclature used by the parties is not decisive and what is crucial is the ascertainment of the legal rights and duties which are actually created by the transaction into which the parties entered. 

[20]     Based on that approach, all members of this court held that the Marac bonds represented contracts of life insurance and were not “money lent” giving rise to assessable interest income.  That was notwithstanding that, as earlier noted, only 0.5% of the amount paid by each investor was applied to the mortality risk undertaken by Marac on issuance of the bonds. 

[21]     The Marac approach has been applied by this court in the GST context: see Commissioner of Inland Revenue v New Zealand Refining Co Limited (1997) 18 NZTC 13,187 at 13,192 and Chatham Islands Enterprise Trust v Commissioner of Inland Revenue [1999] 2 NZLR 388 at [17] and [26].

[22]     We are satisfied that Marac principles apply in the present case and that they lead inextricably to the result contended for by Gulf Harbour and reached by Baragwanath J. 

[23]     There can be no dispute in this case that preference shares were sold and that they are equity securities for the purposes of the GST Act.  The Commissioner could not and did not dispute that.

[24]     It is also undeniable that the rights to membership arose exclusively from that equity security.  As Mr McKay submitted, no independent source or origin of those rights exists.  Membership rights are as inherent in these shares as a dividend right normally is. 

[25]     The Commissioner accepts that it is neither illegal nor contrary to the Companies Act for the shares to confer rights to membership.  No issue of sham has been made or could be made. 

[26]     How the offer was marketed and why people purchased the shares are irrelevant.  Everyone who buys a share in a company buys it to acquire the rights attaching to that share.  A share is in all cases a “vehicle” for acquisition of the rights attached to it.  The fact that in this case the rights attached to the shares were rights to membership in the country club does not alter what one is acquiring.  It may well be that, in marketing the shares, rather more emphasis was placed on “membership of the golf club” than on the “share” element.  That was the case in Marac as well.  Cooke J referred to the fact that Marac, in marketing the bonds, placed more emphasis “on the ‘secure tax-free yield’ in terms of percentage per annum than on the ‘insurance content’”.  But that did not matter, he said: “The true nature of the contract must be determined by reference to its fundamental features, not by the manner of its commercial marketing.” [1986] 1 NZLR 694 at 697.

[27]     It is also irrelevant that there may have been other arrangements whereby rights to membership in the country club could have been conferred and under which GST would have been payable.  That was the very point being made in Marac.  It would have been possible for Marac to have issued to investors an instrument which was in form as well as substance a debt instrument.  But it did not.  And what this court said was that one ascertained “the true nature” of the transaction by a careful consideration of the legal arrangements actually entered into and carried out, not by an assessment of the broad substance of the transaction measured by the results intended and achieved or of the overall economic consequences.  It is that principle which the Commissioner’s argument fails to recognise in the present case, just as it did in Marac.  The Commissioner’s argument here, as in Marac, when stripped down to its essentials, involves an assessment of what is in “broad substance” being supplied.  The argument is at odds with what is legally being supplied. 

[28]     We have not overlooked Mrs Corbett’s argument that certain memberships were sold separately from the shares.  Mr McKay accepted that the fact that certain memberships were sold separately from the shares was something of a conceptual nonsense and that the legal basis on which that had been done did not appear to have been properly documented.  He said that the taxpayers had accepted that when memberships were sold separately, GST was payable and in fact had been paid.  As a matter of fact, there were very few of these memberships not tied to shares.  We cannot accept Mrs Corbett’s argument, however, that because memberships were sold separately in some cases, that meant that memberships were always seen as being separate from shares, with the consequence that the supply was in truth a membership supply or, alternatively, that there were two supplies.  The fact that there were separate supplies of memberships in particular cases does not affect one’s analysis in other cases where the documentation provided for the supply of shares incorporating membership rights.  The fact that membership rights could be severed from shares (although this seems somewhat doubtful, as Mr McKay conceded) does not mean that membership rights were actually severed from shares in all cases. 

[29]     We turn now to consider the British Railways case on which Mrs Corbett relied.  Mrs Corbett criticised the grounds on which Baragwanath J distinguished the case.  We do not think the case assists the Commissioner at all.  The English Court of Appeal did not adopt a “substance and reality” approach: indeed, Browne LJ expressly stated that such an approach might be “dangerous if it suggests that one can go behind a written contract”: at 596.  All judges emphasised that it was irrelevant what “the motive or intention of the person receiving the service” might be: at 592, per Lord Denning MR, 597, per Browne LJ, and 599, per Sir John Pennycuick.  The court found that the legal effect of buying the student rail card was a down payment on future rail travel.  Since the supply of rail transport was zero-rated for the purposes of the English Value Added Tax legislation, the supply of student rail cards must also be zero-rated. 

[30]     Like Baragwanath J, we consider that the English cases need to be approached with care, given the different legislative framework under which VAT is levied compared with GST in this country.  But there is one more case we feel we must discuss, given the fact it was discussed in some detail before us.  That case is Customs and Excise Commissioners v Zinn [1988] STC 57 (QBD).  The facts of the case can be briefly stated.  In order to raise funds to build and maintain the Royal Albert Hall in London, the corporation of the hall was empowered in 1866 by Royal Charter to grant subscribers to the funds permanent seats within the hall for the whole term for which the site of the hall was leased to the corporation.  The lease was for a term of 999 years from 1867.  The names of seat holders were entered in a register of members.  Registered holders were permitted to transfer their seats by the use of a prescribed form in consideration of payment to them of an unspecified sum of money.

[31]     Peter and Danielle Zinn were the holders of two of these licences.  They assigned these licences.  The Commissioners of Customs and Excise contended that the transaction was caught by the Value Added Tax Act 1983 because what was being transferred was “a right to attend performances at the Albert Hall”: at 58.  The Commissioners argued (at 58):

What the purchaser was paying for was the right to attend performances, and such rights of occupation of land as he might acquire were purely incidental.

[32]     The Zinns disputed that contention.  They said they were assigning a licence to occupy land, which was an exempt supply under the legislation. 

[33]     Nolan J found in the favour of the taxpayers for the following reasons (at 65):

The agreement, and the only agreement, between the taxpayers and their assignees was that set out in the transfer document.  Counsel for the Crown does not suggest that the transfer document is a sham.  Yet he urges that it should be judged as if the consideration there set out was not the true or real consideration for the money paid.  The true consideration, he says, was the right to attend performances.  But the taxpayers were under no obligation to provide the purchaser with performances, and no-one suggests they would or could do so.  Even the corporation is under no obligation to provide entertainment to its members, although no doubt it has a general obligation under the charter to make the Albert Hall available for performances.  What is critical in my view is the nature of the consideration provided by the supplier.  In law and in fact all that the taxpayers could and did supply in the present case was the licence to occupy. 

[34]     Mr McKay submitted that that case was analogous to the present one.  Nolan J, Mr McKay submitted, correctly appreciated that any analysis must hinge on the legal effect of the parties’ agreement.  It was irrelevant in Zinn that the assignee was or may have been acquiring the licence so that he or she could attend performances at the Albert Hall: the ability to enjoy performances was, as the Zinns’ counsel successfully submitted, merely “consequential upon the assignment of the seats but not the subject of the assignment”: at 65.  So in the present case, Mr McKay submitted, the ability to play golf at Gulf Harbour was consequential upon the sale of the shares but was not the subject of the sale.  We agree with that analysis, and we accept that Zinn is consistent with the Marac line of authority in this country.  Mrs Corbett sought to distinguish Zinn on the basis that the assignor had no obligation to provide performances.  That is correct, but so too in the present case Club Holdings was not the supplier of the country club facilities. 

[35]     We think that Baragwanath J was correct in rejecting the Commissioner’s first argument.

The two supplies concept

[36]     Mrs Corbett’s second argument was that, if this court found that the transaction was the sale of the share, then the transaction involved two supplies: one being the supply of an equity security and the other being the supply of country club membership.  These supplies, she said, should be apportioned under s 10(18) of the GST Act.  In particular, Mrs Corbett relied on a decision of the VAT Tribunal in Court Barton Property PLC v The Commissioners [1985] VATTR 148. 

[37] Baragwanath J rejected this argument. He held there was no evidence to support the supply of more than the shares; the right to membership passed not as a discrete element but as an incident of share ownership: at [4].

[38]     Mr McKay supported Baragwanath J’s reasoning.  He urged caution in the application of English decisions generally, given that the VAT legislation is different in numerous respects from our GST legislation.  Quite apart from that, however, Mr McKay submitted that Court Barton was no longer good law, the modern English approach being exemplified by Zinn.  Even if Court Barton was not wrong, it was distinguishable on the facts. 

[39]     Once again, we prefer the reasoning of Baragwanath J and Mr McKay.  Mrs Corbett’s argument suffers from the same defect as her primary argument, in that it is effectively a “substance and reality” approach.  Her argument involves putting the contractual arrangement to one side and looking at what in substance Club Holdings and sister companies were supplying to those who acquired membership shares.

[40]     In actual fact, the argument falls down even on the facts, as Baragwanath J found.  The party which receives the payment is Club Holdings.  But Club Holdings is not the party which makes the membership services available.  That is CCL.  It is CCL which has the power to make rules relating to the operation and use of the club facilities.  It is CCL which has the power to levy annual subscription fees for the purposes of maintaining the club and club facilities.  The only thing Club Holdings provides is the share. 

[41]     We turn now to Court Barton.  Court Barton owned a number of cottages in Devon.  It had a capital of £100,000 divided into 50,000 preference shares and 50,000 ordinary shares.  Under the company articles, the holder of each ordinary share had the right to use one of the cottages which was thereby allocated to his or her ordinary share for a particular week of each year.  A VAT problem arose because the supply of shares was VAT exempt but the supply of holiday accommodation was not.  The VAT Tribunal held that there was in this case “ a multiple supply consisting of a share (exempt) and holiday accommodation (standard-rated) with the result that there must be an apportionment of the consideration between these two elements”: at 158.  The Tribunal considered that the correct approach was that set out in Commissioners of Customs and Excise v Automobile Association [1974] 1 WLR 1447, where, according to the Tribunal, “Lord Widgery had said that the question is to be resolved as a matter of substance and reality”. The Tribunal considered that it would be “unable to do this [i.e. resolve the question as a matter of substance and reality] if it [was] forced to make a blindfold approach”: at 156.

[42]     Court Barton could be distinguished on the ground that Court Barton was itself supplying the holiday accommodation, whereas here Club Holdings does not.  But we do not decide this matter on that narrow ground.  We consider that the approach in Court Barton is inconsistent with the decisions in this court in Marac, New Zealand Refining, and Chatham Islands Enterprise Trust.  This court has expressly repudiated a “substance and reality” test.  We also accept Mr McKay’s submissions that Court Barton does not appear to represent the current law in the United Kingdom.  As we have already noted, Lord Widgery’s view that the question of supply was “to be resolved as a matter of substance and reality” has been disavowed in later cases, including British Railways, where, as we have noted, Browne LJ termed the “substance and reality” test “dangerous if it suggests that one can go behind a written contract”.

Result

[43]     We dismiss the appeal. 

[44]     We order that the Commissioner pay Gulf Harbour costs in the sum of $12,000, plus reasonable disbursements, including travel and accommodation costs of Gulf Harbour’s counsel.  We certify for two counsel.  If disbursements cannot be agreed, they are to be fixed by the registrar. 

Solicitors:
Crown Law Office, Wellington, for Appellant
Kensington Swan, Auckland, for Respondent