Commissioner of Inland Revenue v John Curtis Developments Limited
[2014] NZHC 3034
•28 November 2014
IN THE HIGH COURT OF NEW ZEALAND WELLINGTON REGISTRY
CIV-2013-485-9686 [2014] NZHC 3034
BETWEEN COMMISSIONER OF INLAND
REVENUE Appellant
AND
JOHN CURTIS DEVELOPMENTS LIMITED
Respondent
Hearing: 30 June 2014 Counsel:
H W Ebersohn with S J Osborne for Appellant
G D Pearson with L Pelly for RespondentJudgment:
28 November 2014
JUDGMENT OF THE HON JUSTICE KÓS
[1] The taxpayer, a property developer, commenced development of a retail shopping centre north of Christchurch. Its original intent was to lease it up and retain it. Four years later the development was about 65 per cent complete. At that point the taxpayer sold the centre to an investor, AMP. Had that been all, the receipt from AMP would have been capital. Not taxable.
[2] But the agreement contained an “option”. It required the taxpayer to use best endeavours to lease and build the undeveloped part of the centre. The taxpayer received “development payments” from AMP as the new tenants started paying rent.
[3] Are these development payments capital or income? If the latter, they will be taxable.
[4] The Commissioner answered that question, revenue.
COMMISSIONER OF INLAND REVENUE v JOHN CURTIS DEVELOPMENTS LIMITED [2014] NZHC 3034 [28 November 2014]
[5] So the Commissioner assessed the development payments in the years 2006 to 2009 as assessable income.1 The tax involved is some $2,615,574. Shortfall penalties were also assessed, with a 50 per cent reduction.2 In effect, a further 10 per cent of the tax assessed. Notices of assessment were issued in April 2012.
[6] The taxpayer challenged the assessments before the Taxation Review
Authority.
[7] The Authority answered the question differently. She concluded that the payments were capital.
[8] The Commissioner now appeals to this Court.3
Issues for determination
[9] The principal issue for determination is this: did the agreement provide for a single supply of a capital asset (as the Authority found), or two distinct supplies – one capital (sale of the developed and undeveloped land) and the other revenue (letting and construction services on the undeveloped land)?4
[10] There are also two preliminary questions: (1) whether certain parol evidence from the parties to the agreement is admissible,5 and (2) whether the Commissioner has shifted ground impermissibly in this case.6
[11] Depending on the result of the principal issue, there are also three subsidiary issues: (1) whether the supply of letting and construction services under the development option is income or capital,7 (2) whether the development payments are
business income,8 and (3) whether shortfall penalties should be imposed?9
1 Receipts in earlier years had become time-barred.
2 Tax Administration Act 1994, ss 141B and 141FB.
3 Taxation Review Authorities Act 1994, s 26.
4 Discussed at [67] to [99] below.
5 Discussed at [53] to [57] below.
6 Discussed at [58] to [66] below.
7 Discussed at [100] to [101] below.
8 Discussed at [102] to [104] below.
9 Discussed at [105] to [108] below.
Background
A retail centre is developed
[12] In 1988 the taxpayer purchased a large block of land at Northwood, a northern suburb of Christchurch. In May 2000 it began construction of a large format “open air” retail shopping centre on the site. The centre is composed of adjacent units. Some are large consumer goods stores. Others are smaller units containing service businesses, food outlets and the like. Each unit opens on to a carparking area. There are no internal corridors between the storefronts. It is known as “Northwood Supa Centa”.
[13] By October 2003 65 per cent of the units planned for the shopping centre had been completed. That same month, AMP approached the taxpayer with a proposal to purchase the centre.
[14] Mr Ian Calderwood is a director of the taxpayer. He gave evidence that it was always the taxpayer’s intention to complete the centre and lease it out. But around the time of AMP’s offer, one of the taxpayer’s shareholders wanted to cash up its investment. The remaining investors decided the best way to raise funds to buy out the departing shareholder was for the taxpayer to sell the centre to AMP.
The agreement
[15] On 12 December 2003, the taxpayer signed an agreement for sale and purchase with AMP. Clause 2.1 provides for the sale of “the Development”. The Development is defined in cl 1.1 as:
the retail centre situated on the Property (including the Future Development Sites), known as the Northwood Supa Centa as shown indicatively on the Plan
Clause 1.1 defines “Future Development Sites” as:10
those sites shaded on the Plan which are to be constructed and completed in accordance with clause 15
10 Herein, the “FDS”.
[16] The purchase price to be paid for the Development, as set out in cl 4.1, is made up of two parts:
(a) $28.4 million (zero rated for GST), for 19,468 square metres of developed land and the completed, tenanted units on that land; plus
(b)$2.9 million (plus GST) “being payment for the land included in the FDS”, a figure based on valuing the footprint of the FDS (9,687 square metres) at $300 per square metre.
[17] AMP became the registered proprietor of all of the land, and all the units on it, on 16 February 2004.
The development option
[18] The agreement does not just transfer land. It also contains additional provisions dealing with development of the FDS.
[19] Clause 15 contains the “Development Option”. It is described in cl 1.1 as an option to develop and construct the FDS, “details of which are set out in the Sixth Schedule”. This option is granted to the taxpayer. The agreement acknowledges that the taxpayer has paid the sum of one dollar to AMP to obtain the option.
[20] The “option” is not a conventional one. It is both option and obligation – a point that assumes some importance in this appeal. The taxpayer is required under the agreement to use “best endeavours” to develop the FDS in accordance with the sixth schedule to the agreement:
15.3 Vendor’s covenants
The Vendor covenants with the Purchaser that it will use its best endeavours to develop the Future Development Sites in the manner provided for in the Sixth Schedule.
[21] Clause 1.1 says that the “Option Period” runs for three years from the date of settlement. The sixth schedule provides that, during that time, the taxpayer is entitled to be paid a “Development Payment”, for constructing buildings on the FDS,
according to a formula. The formula is based on the net rental paid by tenants moving into the newly constructed buildings. It is the tax status of these development payments that is in dispute.
[22] There are three ways in which the taxpayer might develop each site in the
FDS and be entitled to receive a development payment:
(a) First, the taxpayer is entitled to procure unconditional agreements to lease a site. However AMP has to approve the tenant and terms of the lease in advance. A broad discretion is given to AMP. If it approves, the taxpayer is entitled to develop the site by constructing the building the tenant has agreed to lease. The taxpayer is entitled to receive a development payment upon fulfilment of three conditions: delivery of a signed lease to AMP, the tenant occupying the site and the
commencement of rental payments.11
(b)Secondly, the taxpayer may also develop a site without having secured a tenant. But it is not entitled to a development payment until the same conditions are met. And until that point the taxpayer has to meet operating expenses other than rates, and any holding costs.12
(c) Thirdly, AMP can procure an unconditional agreement to lease a site itself. The taxpayer then has to approve the terms and conditions of the lease, but consent is not to be unreasonably withheld or delayed. Once the lease is approved, the taxpayer is obliged to construct the buildings required for the lessee, and to receive a development payment as in (a) above.13
[23] All development costs are to be borne by the taxpayer. Its recompense comes from the development payments. AMP has to approve construction plans, but cannot
withhold approval for plans of equal or better specifications to those supposedly
11 Sixth schedule, cl 1.1 and 1.2.
12 Clause 1.4.
13 Clause 1.3.
attached to the agreement.14 The taxpayer is obliged to enter into a construction contract with AMP prior to the commencement of construction on the FDS: cl 3.1.15
Development continues
[24] Between 2004 and 2009, the taxpayer found tenants and procured unconditional agreements to lease. Mr Calderwood gave evidence that there was essentially no change to the construction planned for the FDS, or arrangements with construction contractors, after the sale to AMP. Prospective tenants would review the plans for their unit and request any changes they needed. The only difference was that AMP had to approve the tenants and their amended plans for the units.
[25] A “project control group” (PCG) was provided for in the agreement. It oversaw construction. It comprised Mr Calderwood, two representatives from AMP and a representative of the head contractor. Mr Calderwood said that because title in the land had passed to AMP, the taxpayer could no longer obtain bank loans. There was no security available. The taxpayer therefore turned to AMP for loans (at commercial interest rates) to fund the development work. PCG meetings occurred only rarely, when funding arrangements had to be discussed. For instance, to confirm construction milestones to release further loan tranches.
[26] In all the taxpayer procured tenants for a further 23 units. It constructed those units. Ultimately, the option period lasted for five years rather than three. The taxpayer constructed and took the lease on the final (24th) unit in late 2008 to complete development of the FDS. Total development payments made by AMP to the taxpayer were $26.6 million.
Disputed assessments
[27] The taxpayer filed income tax returns stating that the income from both the purchase price and the development payments were capital receipts. The
14 Clause 3.3. In fact these specifications appear to have been omitted altogether from the signed agreement.
15 Clause 3.1. In fact no such contract was ever entered. The work was simply done generally in accordance with the sixth schedule.
Commissioner began investigating those returns in September 2006. The investigation concerned whether those receipts were capital or revenue.
[28] Various Revenue investigators were involved. In November 2006 a Revenue investigator met with the taxpayer’s accountants. In mid-2007 a Revenue investigator was given a copy of the agreement for sale and purchase. Further enquiries of the taxpayer were made. In April 2008, the investigator concluded that receipts from both the purchase price and development payments were income receipts under s CB 11 of the Income Tax Act 2004 because they were derived from
significant expenditure on land development.16
[29] The taxpayer rejected that assertion, pointing out that s CB 11 of the 2004
Act had been amended with retrospective effect, covering the tax years in question. The amendment made s CB 11 subject to the “investment exception” in s CB 21 for income from selling land developed for the purposes of deriving rental income. Sections CB 13 and CB 23 of the 2007 Act had the same effect. Those sections meant none of the receipts were taxable.
[30] Further discussions took place. They left the Commissioner unconvinced. She issued a Notice of Proposed Adjustment (NOPA) on 4 March 2009 – proposing to tax both the purchase price proceeds and development payments. On 1 May 2009 the taxpayer issued a Notice of Response (NOR).
[31] At this point, the file was reassigned to Mr Vallabh, another IRD investigator. Mr Vallabh came to the view that the previous investigator had misunderstood the nature of the transactions and incorrectly applied the “investment exception” provisions in the Acts. On 17 August 2009, the March 2009 NOPA was withdrawn.
[32] Attempts at settlement failed. On 28 January 2011 the Commissioner issued a second NOPA assessing the development payments only as taxable income.
[33] On 24 March 2011 the taxpayer issued further NOR. It asserted that the agreement was for the sale of the completed shopping centre. The development
16 And s CB13 of the Income Tax Act 2007 for the later tax years.
option was simply a condition subsequent that the taxpayer had to comply with before AMP would pay the remainder of the purchase price.
[34] In a letter of 3 November 2011, the Commissioner issued a Statement of Position (SOP). Consistent with the January 2011 NOPA it asserted there were two supplies from the taxpayer to AMP:
(a) The sale of the partially completed shopping centre, including all the developed units and the undeveloped FDS land. This was the sale of a capital asset and therefore receipts were not taxable as income.
(b)Services to AMP in constructing and supplying tenanted buildings on what was now AMP’s land. The receipts, the development payments, were income and therefore taxable.
[35] On 23 December 2011 the taxpayer issued its SOP. It maintained the position advanced in its March 2011 NOR.
[36] The Commissioner’s internal Adjudication Unit confirmed the
Commissioner’s position on 27 February 2012.
[37] On 29 February 2012 the Commissioner reassessed the taxpayer’s income for
the 2006-2009 tax years as follows:
Tax Year Income as assessed Tax shortfall Shortfall penalty (including
50 per cent reduction)
2006 $3,975,697 $1,311,980.01 $131,198 2007 $2,766,150 $912,829.50 $91,282.95 2008 $386,094.00 $127,411.02 $12,741.10 2009 $877,845.00 $263,353.50 $26,335.35 Subtotals $3,615,574.03 $261,557.40 Total adjustment: $2,877,131.43
[38] The dispute proceeded to the Taxation Review Authority for determination.
The Authority’s decision
[39] The Taxation Review Authority delivered her decision on 23 October 2013.17
[40] The Authority considered three issues:
(a) Did the taxpayer enter into two agreements when the centre was sold to AMP? Those agreements being:
(i) a contract to sell all the land and existing buildings; and
(ii) a contract to construct and lease buildings on the FDS.
(b)Was the construction and leasing of buildings on the FDS a business or an undertaking or a scheme for profit and therefore taxable?18
(c) Is the taxpayer liable for shortfall penalties?19
Two agreements?
[41] The Authority held that that the agreement was a single, unitary contract for sale and purchase of the completed centre. The FDS development option was not severable from the agreement for sale and purchase. It was merely a “mechanism… for delivery of the completed Centre”.
[42] First, the Authority rejected the Commissioner’s submission that cl 4 – the pricing provision summarised in [16] – made it clear that the purchase price for “the Development” was paid in consideration for the completed buildings, and land, only. The thrust of the submission was that “the Development” part of the agreement did not include the development of the FDS and could be severed from it. The Authority held that cl 4 could not be looked at in isolation. Clause 2.1 and the recitals to the
agreement said the taxpayer agreed to sell the development:
17 Case 6/2013 [2013] NZTRA 06, (2013) 26 NZTC 2-005.
18 Under ss CB 1 and CB 2 of the Income Tax Act 2004 and ss CB 12 and CB 3 of the Income Tax
Act 2007.
19 Under s 141B of the Tax Administration Act 1994.
…for the Purchase Price set out in cl 4.1 and otherwise on the terms and conditions contained in this Agreement. (emphasis added)
[43] The Authority emphasised that this phrase brought the development of the FDS within the definition of “the Development”. The inference drawn by the Authority was that the agreement could not be for two different types of supply when what was being sold and purchased under the agreement was one indivisible item: the Development.
[44] Secondly, the Authority said it was important that cl 4.3 provided for an adjustment to “the purchase price for the land included in the [FDS]” in the event that all 9,687 square metres of the FDS “is not able to be developed as large format retailing”.20 In that event, under cl 4.4 the taxpayer vendor would be obliged to reimburse AMP the difference between the purchase price paid under cl 4.1(b) ($300 per square metre multiplied by 9,687 square metres) and the “recalculated” price “based on the actual developable area” ($300 per square metre multiplied by say
8000 square metres). Any reimbursement would first be deducted from development payments payable to the taxpayer, and then by direct payment. The Authority said:21
In my view these provisions clearly envisage the completion of the Development and are consistent with the disputant’s position that the Agreement provided for the sale and purchase of the completed Centre.
[45] Thirdly, the Authority held that the development option was not in fact an option that could be exercised.22 Under cl 15.3 the taxpayer was obliged to use best endeavours to develop the FDS. There was no choice to be made.
[46] Fourthly, if the taxpayer failed to develop all of the proposed FDS units, it would be in breach of the obligation to use best endeavours to develop the site.23
The Authority emphasised that the taxpayer could develop a site without securing a tenant in advance under cl 1.4 of the sixth schedule. And that where AMP found a tenant, under cl 1.3 of the sixth schedule the taxpayer was compelled to construct the unit. Therefore the obligation to construct the remaining FDS units was not
conditional.
20 At [31].
21 At [31].
[47] Finally, the reference in cls 3.1 and 3.2 of the sixth schedule, to the requirement that the parties enter into a construction contract before construction of units (which was not in fact observed) did not mean that the development option had the nature of a separate construction contract. The obligations under the agreement were “not a construction contract in the usual sense.24 Payment was not made for a building but a tenanted unit. The taxpayer was responsible for all development costs.
Income or capital?
[48] Having concluded that the agreement was for a single indivisible supply of a completed shopping centre, the Authority concluded that what was supplied was a capital asset. Further, that all amounts paid to the taxpayer under the agreement, including those for construction and leasing of buildings on the FDS, were capital in
nature.25 Receipts that are capital in nature are specifically excluded from business
income under s CB 1(2) of the Income Tax Act 2007.
[49] The Authority also rejected the alternative submission of the Commissioner, that the payments were taxable under s CB 3 of the Income Tax Act 2007 as derived from an undertaking entered into for the purpose of making a profit. The Commissioner had conceded that s CB 3 did not apply to capital gains.
[50] Therefore the FDS development payments were not taxable.
Shortfall penalties?
[51] The FDS development payments were not taxable. No shortfall penalties were payable.
24 At [46].
25 At [50] and [53].
[52] Two preliminary points need to be considered briefly. One concerns the admissibility of certain evidence as to the taxpayer’s plans. The other concerns an argument that the Commissioner has shifted her ground impermissibly from her SOP.
Parol evidence
[53] In evidence before the Taxation Review Authority, Mr Calderwood and Mr Pocock (from AMP) expressed their views as to the intentions of the parties during pre-contractual negotiations. They also expressed their views as to the meaning and intent of the various provisions of the agreement.
[54] The Authority said:26
That evidence is all of a subjective nature and taking into account the above principles, I do not consider it to be relevant in determining the intended meaning of the Agreement. Accordingly, I do not place any weight on this evidence and have not considered it further in this decision.
[55] I agree with that approach. Subjective declarations of intent are not relevant to the objective interpretation of contracts.27
[56] Despite the taxpayer’s submissions to the contrary, I am satisfied that the statements excluded by the Authority are not simply evidence of the background facts as known by the parties at the time,28 or of subsequent conduct capable of
providing objective guidance as to intended meaning.29
[57] For example, Mr Calderwood said:
[T]he project was completed as always intended. AMP was to have delivered the completed facility with tenants in each unit…
26 At [21].
27 Vector Gas Ltd v Bay of Plenty Energy Ltd [2010] NZSC 5, [2010] 2 NZLR 444 at [14]. See now the recent decision of the Supreme Court in Firm P1 Ltd v Zurich Australian Assurance Ltd
[2014] NZSC 147 at [60] – [63], affirming the importance of an objective analysis of contract obligation, and of not reaching excessively into the factual matrix. It is a matrix, not a microscope.
AMP did not contract with any one, and in particular did not contract with John Curtis, for the construction of the remaining part of the Northwood Supa Centa. What AMP did was purchase a shopping centre development which delivered some 32,000 square metres of tenanted retail space.
None of this is of any help to me in interpreting the agreement.
Has the Commissioner shifted ground impermissibly?
[58] The taxpayer submits that the Commissioner’s ground in the Taxation Review Authority departed from her SOP of 3 November 2011. The taxpayer says that in the SOP the Commissioner relied on there being two separate contracts, rather than a single contract to complete the whole development. The taxpayer says that the Commissioner’s position changed in her pleadings. She now contends that even if there is only one contract, there are two supplies, and the receipts for the supply of tenancy and construction services are revenue, not capital.
[59] The taxpayer’s submission is misconceived.
[60] SOPs are not pleadings in the strict sense. The taxpayer relies on the Supreme Court’s observations in Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue:30
[154] There is therefore limited scope for the introduction of new points as the disputes process proceeds through the judicial system. NOPAs, NORs and SOPs are the equivalent of ordinary civil pleadings in the taxation field. Indeed, because of the requirement to specify the legal basis upon which a party takes its stance, NOPAs, NORs and SOPs require a more precise legal articulation of a party's case than is conventional with ordinary civil pleadings.
[61] But that overlooks subsequent qualification of those observations by the Supreme Court. The Commissioner applied for recall of the Ben Nevis decision on the grounds that paras [152]-[155] relied erroneously upon Commissioner of Inland
Revenue v V H Farnsworth Ltd.31 The decision of the Court of Appeal in
30 Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2
NZLR 289.
31 Commissioner of Inland Revenue v V H Farnsworth Ltd [1984] 1 NZLR 428 (CA).
Commissioner of Inland Revenue v Zentrum Holdings Limited32 had held Farnsworth to have no application to disputes under Part 4A of the Tax Administration Act 1994. On recall in Ben Nevis the Supreme Court said:33
Inadvertently therefore this Court has created uncertainty as to whether Zentrum is a correct statement of the law. The reasons given in paragraphs [152] — [155] should not be regarded as representing this Court's view of the correctness or otherwise of either the Farnsworth or the Zentrum cases in the light of Part 4A.
[62] Zentrum remains binding authority on this court. In Zentrum, the Court of Appeal held that the challenge process is a challenge to the assessment. Neither the Commissioner nor the taxpayer are confined to positions taken in the pre-assessment process.34
[63] It is clear from the Court of Appeal’s decision in Vinelight Nominees Ltd v Commissioner of Inland Revenue that there is a distinction between SOPs and pleadings.35 What is required is that the Commissioner’s SOP must “give an outline” of the facts, and evidence and specify the propositions on which she relies, in sufficient “detail to fairly inform the disputant”.36 If the assessment is challenged, the pleadings may raise in the challenge “only the issues and the propositions of law that are disclosed in the Commissioner's and disputant's statements of position”.37
As noted by the Court of Appeal in Vinelight, the “outline” in the SOP might be couched in considerably broader terms than the pleadings. And the Commissioner’s pleadings might address matters not outlined in the Commissioner’s SOP, that were later outlined in the taxpayer’s SOP.38
[64] I am satisfied that the Commissioner’s SOP gave an outline fairly informing
the taxpayer of the substance of the facts and propositions relied upon by her.
32 Commissioner of Inland Revenue v Zentrum Holdings Limited [2007] 1 NZLR 145 (CA).
33 Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2009] NZSC 40 at [2].
34 At [33].
35 Vinelight Nominees Ltd v Commissioner of Inland Revenue [2013] NZCA 655, (2013) 26 NZTC
21-055 at [30].
36 Tax Administration Act 1994, s 89M(4).
37 Tax Administration Act 1994, s 138G(1). There are exceptions to subs (1) contained in subs (2) to avoid manifest injustice or whether the matters raised could not have been discerned earlier with due diligence.
38 Vinelight Nominees Ltd v Commissioner of Inland Revenue [2013] NZCA 655, (2013) 26 NZTC
21-055 at [30].
[65] The SOP makes clear that it is the agreement for sale and purchase that governs both the supply of land with finished units on it, and construction on the FDS. That is, a single document covers both. It is true that the Commissioner phrased the issue as whether the taxpayer “entered into two agreements”. Those agreements were described as “a contract to sell” and a “contract to construct and lease”. In context, the obvious and logical reading of this is as an assertion that the December 2003 agreement served both functions. As a matter of fact it was the only relevant agreement. There were no wholly separate agreements performing separate functions. There is no place in the law for arid literalism when clear meaning is conveyed despite form.
[66] Even if that were not so, the pleading would be permitted under s 138G(1) as a response to the assertion made in the taxpayer’s SOP that there was a single contract with a series of obligations, and that all payments made in respect of those obligations were capital in nature.
One supply or two?
[67] The Authority’s decision turned on her interpretation of the agreement. That was that performance of the agreement could only be satisfied by delivery of a finished shopping centre, and thus the agreement was for a single indivisible capital supply.
Questions of construction and characterisation
[68] Commercial transactions in this country are taxed on the basis of the legal rights and obligations in fact entered into. The deal done, not the deal that might have been done. In Wattie v Commissioner of Inland Revenue, Blanchard J put it thus:39
The character of a receipt is not determined by reference to other ways in which the deal could have been, but was not, done. A genuine transaction may be structured in a particular way which is beneficial in taxation terms to a party: Regent Oil Co Ltd v Strick (Inspector of Taxes) [1966] AC 295. The
39 Wattie v Commissioner of Inland Revenue (1997) 18 NZTC 13,297 (CA), at 13,302 (upheld on appeal: [1999] 1 NZLR 529 (PC)).
Commissioner must accept the contractual consequences of a genuine transaction unless he can apply s 99.
[69] Ordinary principles of contractual interpretation apply in ascertaining the content of those legal rights and obligations. The fact that revenue obligations are also involved does not compel some shapeless resort to notions of “broad substance”.40 The contract underlying the transaction must be construed in the ordinary way.
[70] That approach governs the question whether the contract contains a single indivisible supply (here, said by the taxpayer to be of a completed shopping mall) or multiple and divisible supplies (here, said by the Commissioner to be land and buildings in the first instance, and letting and construction services of the undeveloped land in the second instance). This question will be examined further shortly.
[71] Having identified the obligations in that way, a substantive and not formalistic approach is to be taken to the nature of a payment made under that transaction. In Commissioner of Inland Revenue v Wattie, Lord Nolan, speaking for the Privy Council, held that:41
It is well settled that in considering whether a particular item of receipt or expenditure is of a capital or revenue nature the approach to be adopted should be that described by Dixon J in Hallstroms Pty Ltd v FCT (1946) 72
CLR 634 (HCA), at p 648, where he said that the answer to the question:
... 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.
That approach was adopted by their Lordships’ Board in BP Australia Ltd v C of T of the Commonwealth of Australia [1966] AC 224 and has been followed in many other cases of high authority. The passage from the Board’s judgment in the BP Australia Ltd case at p 264 in which the approach of Dixon J is adopted was described by Richardson J in CIR v Thomas Borthwick & Sons (Australasia) Ltd (1992) 14 NZTC 9,101; (1992)
16 TRNZ 777 (CA), at p 9,103; p 779, as exemplifying the “governing approach” in New Zealand. Dixon J was speaking in terms of expenditure
40 Marac Life Assurance Ltd v Commissioner of Inland Revenue [1986] 1 NZLR 694 (CA) at 705 –
706 per Richardson J. See also Buckley & Young Ltd v Commissioner of Inland Revenue [1978]
2 NZLR 485 (CA) at 489.
41 Commissioner of Inland Revenue v Wattie [1999] 1 NZLR 529 (PC) at 536.
but it is familiar law that within the context of the same business, similar principles will apply to payments and to receipts. This appears from the general discussion of the earlier cases by Lord Macmillan in Van den Berghs Ltd v Clark [1935] AC 431 (HL), 438 to 441, and from the Borthwick case itself, which was concerned with the character of a receipt.
[72] That approach then governs the question whether a supply is of a capital or income nature.
[73] There is a qualification to these two approaches where a contract includes two supplies, and the secondary supply is incidental or ancillary to a primary supply that is capital in nature. In such circumstances, the incidental supply may be treated as capital also. As the Court of Appeal held in Buckley & Young Ltd v Commissioner of Inland Revenue:42
The proper conclusion may be that the payment secures one advantage and the other provision is merely ancillary or incidental, not affecting the character of the payment.
A single contract may contain multiple supplies: some capital receipts and others income
[74] As noted a moment ago, a single transaction in a single contract may nonetheless contain two or more supplies for tax purposes. Whether it does or not is first a matter of construction under contract law and, secondly, a matter of characterisation under revenue law. Some receipts may be capital, whereas others are income. Whether that is so or not is to be assessed in accordance with the
principles stated in Wattie.43
[75] A simple example given by Mr Ebersohn was of the sale of a furniture store business, including stock in trade. The amount received for the furniture must be treated as on revenue account and returned; the amount paid for goodwill, on the other hand, is capital.
[76] In Buckley & Young Ltd v Commissioner of Inland Revenue the 56 year old managing director of a chemical importing firm agreed to retire early, following a
42 Buckley & Young Ltd v Commissioner of Inland Revenue [1978] 2 NZLR 485 (CA) at 489.
43 See [71] above.
disagreement.44 He was paid $6,000 per year until he turned 60 (when he would be entitled to superannuation). The firm also agreed to pay $800 per year towards his superannuation fund and give him the use of a car, both until he turned 60. In return, he agreed to retire, sell his shares and enter restraint of trade and confidentiality agreements. The firm said the payments were expenditure incurred in being rid of an unsatisfactory employee, revenue in character and therefore deductible. The Commissioner assessed the whole of the payments as capital in nature, essentially to gain restraint of trade and privacy protections.
[77] The Court of Appeal concluded that payments made to obtain restrictive covenants were capital investment, but payments made to secure the partner’s retirement were expenditure incurred in deriving income. The payments therefore had a “dual character”:45
The payments have a dual character, being referable both to the retirement and to the restrictive covenants. Accordingly they are deductible in so far as they are referable to securing E’s retirement from the company and are not deductible to the extent they are referable to the restrictive covenants.
[78] But it was impossible to apportion. There was no evidence to enable a finding that a defined part of the payments was attributable to the one purpose rather than the other. This was a matter of fact, not of logical attribution after the event. In the absence of adequate evidence the taxpayer had not met its onus of showing the
Commissioner’s assessment was wrong, let alone by how much.46
Does this agreement contain two distinct supplies?
[79] I have concluded that the agreement in this case contains two distinct and separately identifiable supplies.
[80] In Buckley & Young the Court of Appeal held that where “distinct and separately identifiable advantages” may be gained in return for payment of a
particular amount, the first step in deciding the character of the amount is “to
44 Buckley & Young Ltd v Commissioner of Inland Revenue [1978] 2 NZLR 485 (CA).
45 At 496.
46 At 499.
determine the true nature of the legal arrangements pursuant to which the payments
were made and the benefits provided.”47
[81] I do not accept that the agreement, properly construed, provides simply for the sale and purchase of a completed retail development. Non-supply of such a completed development would not be a breach of obligation by the taxpayer. Failure initially to settle the sale of the incomplete development would be. Thereafter it is inattention to a distinct obligation to use best endeavours to develop the FDS under the development option that would be a breach. But not non-completion of the development.
[82] First, I accept that “the Development” is defined to include the FDS as well as the land and existing buildings. And I accept that cl 2.1 says that the whole Development is sold for the Purchase Price and otherwise on the terms and conditions of the agreement (including the development payments). But those provisions do not provide a clear pointer to the agreement containing a single indivisible supply: a completed shopping centre. The fact that parties use a broad label to describe what is being transacted does not necessarily characterise the whole of the transaction from a taxation perspective. In Mr Ebersohn’s example of the sale
of a furniture store, that description rather conceals what is being supplied.48 At one
level, a shop. At the relevant level, a range of items comprising a going concern;
some revenue account, and some capital.
[83] In my view a far better indication of character of the development payments made under the agreement is their functional and temporal separation under the agreement from the land purchase payment. The agreement divided the consideration paid into two distinct sums: the purchase price in cl 4.1 and the development payments under the sixth schedule. Each is clearly attributable to a different type of performance: the transfer of land, and the letting and construction of buildings on land already transferred. The purchase price stated in cl 4.1, and
payable on settlement, includes nothing for the FDS apart from the undeveloped
47 At 489.
48 See at [75] above.
land. Any future letting and construction on that land is paid for under the sixth schedule.
[84] Secondly, I do not find the Authority’s analysis of cls 4.3 and 4.4 of the agreement persuasive. Indeed I cannot take the same view of them as the Authority did. The adjustment provision in cl 4.3 applies in the event that the full 9,687 square metres of the FDS is “not able to be developed”. This sort of adjustment clause operates where there has been a mismeasurement. Or where resource consent cannot be obtained to develop all of the FDS. In that case the taxpayer vendor must refund part of the original purchase price under cl 4.1. It is not a financial penalty for non- completion of the development. It is a refund to adjust a false assumption underlying the purchase price. It would not operate where the taxpayer had not developed the whole of the FDS land for retailing, but only where it could not do so. Otherwise AMP would be obtaining developable land for free. The fact that the refund may be achieved by credit against development payments owing is neither here nor there.
[85] The adjustment clause does not demonstrate that the taxpayer was compelled to deliver a completed shopping centre on pain of financial penalties affecting the sum received for supply of the land.
[86] Thirdly and most fundamentally, I cannot agree with the Authority’s conclusion that the taxpayer would be in breach of the agreement if it failed to complete development of the FDS sites.49 Under cl 15.3 the taxpayer is only obliged to use best endeavours to “develop the Future Development Sites in the manner provided for in the Sixth Schedule”. The taxpayer is “entitled” to procure tenants for the FDS, but not compelled to do so.50 The taxpayer might use best endeavours to find tenants, but find none. Due, perhaps, to a market downturn. Similarly, AMP might not find tenants either. It could not then compel the taxpayer to begin construction.51 In neither case would a completed shopping centre result. In neither
case would there be a breach of the agreement.
49 Above at [46].
50 Sixth schedule, cl 1.1.
51 Sixth schedule, cl 1.3.
[87] It might be argued that the taxpayer would yet be required to exercise its discretion to develop part of the FDS without securing a tenant. Clause 1.4 of the schedule permits this. But I do not consider clause 15.3 requires it In Kingdon Development Ltd v SaiteysMcMahon Property Ltd Venning J held that a best endeavours clause required the following:52
The test of whether a party has used its best endeavours is an objective one. A party is required to apply itself conscientiously to the task of satisfying the condition to a level expected if the party was prudently protecting its own interests.
I adopt that approach here.
[88] It would require the taxpayer conscientiously to develop the FDS site in the manner provided in the sixth schedule. It could not pursue its entitlement to procure tenants half-heartedly. As I said earlier, the option is a mixture of option and obligation. But it does not require the taxpayer, in the event that neither the taxpayer nor AMP have been able to find tenants, to develop a site, entirely at its own cost, with no payment unless and until a tenant eventually is secured. That would be a step altogether beyond the degree of conscientiousness required.
[89] Fourthly, the obvious but important point needs to be made that after settlement of the sale of the land, when the development option took practical effect, the land no longer belonged to the taxpayer. It belonged to AMP. The procurement of tenancies, and the construction of buildings by the taxpayer for those tenants to occupy, was all work now to be done on land belonging to AMP, not the taxpayer.
[90] Viewed through the lens of the taxpayer, the nature of that work necessarily took the form of services supplied to a third party. Not capital improvements to the taxpayer’s own land.
[91] Mr Pearson submitted that the taxpayer in fact supplied tenanted units as going concerns. Tenanting and construction services were an ancillary aspect of that
only. I do not accept that submission. The FDS explicitly were not treated as a
52 Kingdon Development Ltd v SaiteysMcMahon Property Ltd HC Auckland CIV-2007-404-3760,
17 October 2007 at [21].
going concern under the agreement. On 16 February 2004 the land, including the FDS, became AMP’s. Services provided after that date by the taxpayer could not form part of a going concern that had already been transferred to AMP. The nature of the taxpayer’s activities had changed, and fundamentally.
[92] I record there was extended submission on the fact that the Commissioner had accepted zero-rated development payment invoices in an audit some years earlier. That action was likely wrong, for the reasons Mr Ebersohn advanced in his submissions. But, more fundamentally, it is simply irrelevant to this appeal. The Commissioner could no more have relied on a correct GST assessment than the taxpayer may rely on an incorrect one. The Authority ignored it. So do I.
[93] Fifthly, cl 2.3 contemplates AMP having the right to cancel the development option independently of the principal agreement. It follows that the parties recognised it might be breached without the principal agreement being breached. That strongly suggests they are two severable supplies.
[94] Sixthly, Mr Pearson placed some emphasis on the fact that cl 3.1 of the sixth schedule provides for entry into a construction contract before any development of the FDS occurs. No such contract was in fact entered, although development of the FDS occurred nonetheless. Mr Pearson suggests this means construction services to AMP were not supplied. Nor were the requirements of the Construction Contracts Act 2002 triggered.
[95] I do not think this assists the taxpayer at all, however. The agreement thus suggests very much that the parties did have in mind the provision of construction services. They provided for a contract for them to be entered. The fact that they did not enter it does not mean that such services were no longer supplied. The terms of the development option were carried into effect without any other alteration (apart from timing). It is apparent the parties were satisfied simply that the short form structure established in the sixth schedule was adequate for their purposes.
[96] Finally, some recognition must be given to the fact that the parties themselves have attempted to distinguish the two supplies. Why else create the option? And if
the option is part obligation, why qualify that obligation with “best endeavours” only? The obligation to sell the developed land and FDS is unqualified, apart from the conditions expressed in cl 3. The obligation and qualification in cl 15.3 are quite different.
[97] In my view the taxpayer, having chosen by its agreement to separate the form and timing of these distinct obligations to supply, cannot now re-amalgamate them because it better suits its taxation objectives. It cannot have it both ways.
Conclusions
[98] In summary:
(a) consideration in the agreement is clearly divided into two sums, paid for distinct obligations;
(b)payment of the purchase price in cl 4.1 is not affected by non- performance of the development option;
(c) the two obligations are different in character, certainty and timing;
(d)it would not be a breach of the agreement for the taxpayer not to develop all of the FDS development sites, unless it failed to use best endeavours only;
(e) the taxpayer having sold its land to AMP, the nature of the work done under the development option took the form of services supplied to a third party, rather than capital improvements to the taxpayer’s own land;
(f) the development option may be cancelled by AMP separately from the principal agreement for sale and purchase of land;
(g)the parties sought in the agreement to distinguish the two obligations, or supplies;
(h)the absence of the formal construction contract anticipated in the sixth schedule does not alter the reality that letting and construction services were then supplied; and
(i)the agreement, properly construed, does not provide simply for the sale and purchase of a completed retail development.
[99] I conclude therefore that the agreement contains two separate supplies:
(a) The supply of land (including the FDS) and the finished buildings on it at the time of sale to AMP;
(b)The supply of letting and construction services under the development option.
Is the supply of letting and construction services under the development option income or capital?
[100] Mr Pearson accepts in his submissions that if the taxpayer is found to have supplied “tenanting and construction services” to AMP, “then the receipts would be taxable. Nobody has suggested to the contrary.”
[101] It follows that the development payments are taxable. I note that there can be no real suggestion in this case that the development payments were merely ancillary to the supply of the land.53 The land sale price was $31.28 million. The further development payments totalled $26.6 million. Nor is there any difficulty in apportionment, unlike in Buckley & Young.54
Are the development payments business income?
[102] If, as I have found, the taxpayer was engaged in the supply of letting and construction services to AMP after 16 February 2004, this point is not in issue. Mr
53 See [73] above.
54 See [78] above.
Pearson concedes that such payments would be business income for the purposes of s CB 1.
[103] That must be correct. From 16 February 2004 the sole activity the taxpayer carried out was the location of tenants and the construction of retail units for them on AMP’s land. This activity was organised, coherent, and directed to making a profit from the difference between costs (of leasing and construction) and receipts (the development payments).55
[104] Receiving payments for letting and construction services became the ordinary business of the taxpayer during the relevant period. Receipts for such services were therefore income.
Shortfall penalties
[105] The Commissioner submits that shortfall penalties are appropriate in this case because the taxpayer has taken an unacceptable tax position as defined in s 141B of the Tax Administration Act 1994:
141B Unacceptable tax position
(1) A taxpayer takes an unacceptable tax position if, viewed objectively, the tax position fails to meet the standard of being about as likely as not to be correct.
[106] The Court of Appeal has noted that there is “some element of fuzziness in the underlying concept”.56 As the provision states, the lens used is objective rather than subjective. The taxpayer’s actual belief is irrelevant.57 But so too is the fact that I have ruled against the taxpayer. That is not determinative of the question. If the taxpayer’s argument “can objectively be said to be one that, while wrong, could be argued on rational grounds to be right”, shortfall penalties will not be appropriate.58
But it must be ones about which reasonable minds could differ.
55 Grieve v Commissioner of Inland Revenue [1984] 1 NZLR 101 (CA) at 106.
56 Accent Management Ltd v Commissioner of Inland Revenue [2007] NZCA 230, (2007) 23
NZTC 21,323 at [168].
57 Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2
NZLR 289 at [184].
58 At [185], citing Walstern Pty Ltd v Commissioner of Taxation (2003) 138 FCR 1 at [108].
[107] I take the view that the short answer in this case is that the Authority, in a cogent and careful decision – albeit one ultimately I have disagreed with – upheld the taxpayer’s argument. It was therefore plainly a stance which a reasonable mind might adopt. In addition, the taxpayer may have gleaned some support for its stance from the Commissioner’s own incorrect GST audit.59
[108] Shortfall penalties will not be imposed.
Summary
[109] The agreement contains two supplies. The first is the transfer of land, payment for which is a capital receipt. The second is letting and construction services concerning the still undeveloped FDS land, now owned by a third party. Receipts for such services were not merely ancillary to the sale of the land. Those receipts were income, and taxable.
[110] The stance taken by the taxpayer, while wrong, was rationally arguable. Shortfall penalties will not therefore be imposed.
Result
[111] Appeal allowed.
[112] If costs cannot be agreed, brief (and prompt) memoranda may be filed.
Solicitors:
Crown Law, Wellington for Appellant
Duncan Cotterill, Wellington for Respondent
Stephen Kós J
59 See [92] above.
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