Dandelion Investments Ltd v Commissioner of Inland Revenue

[2002] NZCA 311

IN THE COURT OF APPEAL OF NEW ZEALAND CA204/01

BETWEEN	DANDELION INVESTMENTS LIMITED
Appellant

AND

COMMISSIONER OF INLAND REVENUE

RESPONDENT

Hearing:	22 and 23 May 2002
Coram:	Gault P McGrath J Anderson J
Appearances:	B M Grierson for the Appellant A C Beck and R Wallace for the Respondent
Judgment:	5 December 2002

JUDGMENT OF THE COURT DELIVERED BY MCGRATH J

Table of Contents

Paragraph Number

Introduction.................................................................................. [1]

Background Facts......................................................................... [5]

The Departmental investigation.................................................. [15]

Taxation Authority Review decision........................................... [25]

High Court decision...................................................................... [33]

The legislation............................................................................... [41]

Issues on appeal............................................................................ [49]

Decision

Ground A:  Curative effect of de novo hearing..................... [50]

Ground B:  Was the assessment made in time?..................... [65]

Ground C:  The Policy  Statement on s99............................ [72]

Ground D:  Was s99 wrongly applied?................................... [76]

The scope of inquiry in the objection process............................ [90 ]

Conclusion..................................................................................... [95]

Introduction

1. Dandelion Investments Limited, formerly named Holyoake Industries Limited, appeals against a judgment delivered in the High Court by Tompkins J on 3 August 2001.  In that judgment, which is reported as CIR v Dandelion Investments Limited (2001) 20 NZTC 17,293, the High Court allowed an appeal by the Commissioner of Inland Revenue against a decision of the Taxation Review Authority.  The Authority’s decision is reported as case U11 (1999) 19 NZTC  9,100.

2. The appeal concerns the disallowance by the respondent Commissioner of Inland Revenue of a claim by the appellant for deduction of an interest expense of $570,080 from its taxable income for the year ended 31 March 1986.  The interest was paid on a loan advanced to the appellant to fund the acquisition by a subsidiary of shares in a United Kingdom company.  The funds were further applied in offshore transactions the ultimate effect of which was to return them to the appellant to enable the loan to be repaid.  The appellant received from its subsidiary a tax free dividend of $484,000 as part of the transaction and claimed the deduction for its interest expense.

3. In 1991 the Commissioner of Inland Revenue reassessed the appellant and disallowed the interest deduction, applying the general anti-avoidance provision of the Income Tax Act 1976 (the 1976 Act) to do so.  On objection by the appellant the Authority reversed the Commissioner’s decision to disallow the deduction, holding that the Commissioner’s reassessment decision was provisional only, and in any event out of time.  Furthermore the process in the course of reassessment was held to be flawed, owing to a number of serious faults in the Department’s procedures and its general conduct towards the appellant taxpayer. The Authority then went on to find that the transaction concerned was a tax avoidance arrangement which, in the circumstances, was of a kind that the anti-avoidance provision in the 1976 Act would have caught if it had been properly applied.

4. The judgment of the High Court upheld an appeal by the Commissioner against the Authority’s findings that the reassessment was time-barred or alternatively vitiated by the flawed process.  The High Court also rejected a cross appeal against the Authority’s finding that the transaction was a tax avoidance arrangement to which s99 of the 1976 Act could be applied.  The appeal was accordingly allowed, the Authority’s decision set aside, and the objection to the Commissioner’s disallowance of the interest deduction dismissed.  The appellant appeals against the High Court judgment.

Background facts

1. In March 1986 the appellant entered into a transaction in which it subscribed for 2.8 million shares at $1.00 each in a wholly owned New Zealand company, Centratherm Distributors Ltd (Centratherm), which purchased 50% of the shares in a United Kingdom company referred to as Austral.  A subsidiary of Equiticorp Ltd funded the appellant advancing it $2.8million and receiving from the appellant a promissory note for $570,080 to cover interest for the term of the loan which was one year and a day.

2. The funds applied to acquisition of the shares in Austral were further applied in a series of offshore transactions, the net effect of which was to return the loan funds to the lender, to provide the appellant with a tax free dividend of $484,000 and to enable a deduction for the payment of interest of $570,080 to be claimed by the appellant in its return of taxable income for the year ended 31 March 1986.

3. These were the elements of the transaction in which the appellant immediately participated.  The Authority found that each took place on the same day as did the series of further transactions.  There was evidence indicating that the nature of the further downstream elements was known to the appellant as on 4 March 1986, shortly after the transaction was put in place, Bell Gully Buddle Weir, a law firm, had written to the appellant reporting  on the security of the appellant’s position in being able to cash up its investment and uplift the funds necessary to repay the advance of $2.8million to the Equiticorp subsidiary.  The solicitor’s letter set out the structure of the transaction as follows:

re:  Euronational Corporate Services Limited

As this matter is now completed we write to confirm certain details of the transaction.

A.The structure of the transaction is as follows:

1.Equiticorp through its subsidiary Ewoch Two Limited advanced $2.8 million to Holyoake Industries and Holyoake Industries issued a Promissory Note (P.N.).

2.Holyoake Industries subscribed for shares in Centratherm (2.8 million ordinary shares of $1.00 each).

3.Centratherm purchased shares amounting to 50% of the voting capital of Austral from Portcullis – Holyoake through Centratherm therefore controls Austral.

4.Austral owns all the shares in Pembroke – Holyoake therefore controls Pembroke.

5.Warkworth lends Pembroke 2.8 million and Pembroke issues a Convertible Note to Warkworth.

6.Pembroke lends $2.8 million to Benwall who lends this sum to Fairhaven who purchases from Ewoch Two Limited the P.N. issued by Holyoake.

7.Fairhaven guarantees repayment by Benwall of its loan from Pembroke and charges the P.N. (which it purchased from Ewoch) in favour of Pembroke.

8.The P.N. is delivered to CITC as custodian on the basis that if the loan to Pembroke from Warkworth is not paid on due date, the proceeds of the P.N. (ex Holyoake) can be paid to Pembroke.  Pembroke would then hold $2.8 million from Holyoake.

9.Warkworth has agreed with Austral that it will purchase the shares which Austral owns in Pembroke for the sum of $2.8 million if required by Austral to do so.

10.As security for its obligation to pay this purchase price Warkworth has charged the C.N.’s it holds (issued by Pembroke) in favour of Austral.

11.To unwind the transaction the following would occur:

(a)Austral (controlled by Holyoake) would require Warkworth to

purchase the shares in Pembroke.

(b)Warkworth would call up the Convertible Note from Pembroke.

(c)Pembroke would call up the loan to Benwall.

(d)Benwall would call up the loan to Fairhaven.

(e)Fairhaven would call on Holyoake to repay the P.N.

12.If all the above happened simultaneously then Austral would receive $2.8 million which it would transfer to Centratherm and then to Holyoake to allow Holyoake to pay the P.N. under 11(e) above.

1. The Solicitors’ letter went on to address the question of risk and to list the documents they had examined which included legal opinions from solicitors in London and Rarotonga.  The former advised that Portcullis and Austral were incorporated in  the United Kingdom.  The latter advised that Warkworth, Pembroke, Benwall and Fairhaven were all companies incorporated in the Cook Islands.  In all cases they had power to enter into the transactions to which they were parties.  The advice concluded:

   Based upon all the foregoing we confirm that in our opinion your company is not at risk from a security standpoint in being able to liquidate its investment and recover $2.8 million to enable it to repay the P.N. issued initially to Ewoch Two Limited.  Enclosed is an opinion from Peat Marwick on the tax aspects of the transaction and we confirm that you have not asked us, and we do not offer any opinion on, the taxation aspects.  This does not mean that we believe the scheme is suspect – it simply means that no formal opinion is given.

2. The opinion from Peat Marwick, chartered accountants, was dated 21 February 1986 and also addressed to the appellant. It referred to the appellant’s request for advice on the taxation implications of a “funding proposal” made to the appellant which formed the basis of the transaction later entered into.  It advised that if the $2.8 million from the credit facility were used to capitalise a New Zealand subsidiary of the appellant, being a company included in its group, the interest payable by the appellant would be deductible under s106(1)(h)(ii) of the 1976 Act.  The dividend income received by Centratherm, and subsequently the appellant, would be exempt from New Zealand income tax. 

3. The opinion referred to the tax position in New Zealand of three of the Cook Island companies involved in components of the transaction as follows:

   Interest Paid by Pembroke, Benwall and Fairhaven

   As stated in your letter, the interest paid by Pembroke, Benwall and Fairhaven (which we understand to be non-resident entities and having no fixed establishment in New Zealand for tax purposes) arises from transactions executed offshore.  We consider that no New Zealand source would arise and confirm that therefore no liability to New Zealand income tax would arise in respect of that interest.

4. Finally the opinion included a discussion of the possibility that the Commissioner would invoke s99 to avoid the transaction negating the tax advantage.  It observed that s99 was not often invoked by the Commissioner but that if it was successfully invoked any tax advantage gained would be negated.  It also said it was not the Commissioner’s practice to levy penalties in addition to removal of the tax advantage.  There was an offer of further advice on the application of s99 if requested.

5. The High Court Judge accepted that two diagrams prepared on behalf of the Commissioner in the course of the hearing before the Authority gave a broad picture of what the transaction involved.  The diagrams are attached as appendices to the High Court judgment.  The first indicates how the transaction was put in place on 27 February 1986.  It shows the movement of $2.8 million from the Equiticorp subsidiary to the appellant, to Centratherm and then Portcullis and thence to the first of the Cook Island companies, Warkworth.  Thereafter, as indicated in the solicitor’s letter of 4 March 1986, the $2.8 million is passed on successively to Pembroke, Benwall and Fairhaven.  The diagram shows Fairhaven paying $2.24 million to the Equiticorp subsidiary to acquire the promissory note, leaving Fairhaven with $0.56 million of the funds received.  The diagram shows separate payments of “interest” of $71,000 from Warkworth to Pembroke and $555,000 from Benwall to Pembroke.  Pembroke itself pays a $484,000 “dividend” to Austral and the same sum is passed on, as a dividend, to Centratherm then to the appellant.  The appellant pays $570,080 to the Equiticorp subsidiary which accordingly receives in total $2,810,080 funding its advance to the appellant and leave it with a surplus of $10,080.  This completes the circular flow of funds. 

6. The second diagram indicates the manner in which the transaction is unwound on the expiry of the term of the loan on 27 February 1987.  It shows $2.8 million passing from the appellant to Fairhaven and successively to Benwall, Pembroke, Warkworth, Austral and Centratherm, and finally, to complete to the appellant.

7. The Judge also referred to a letter dated 25 February 1986, sent by Euronational Corporate Services Ltd to the appellant, which was before the Authority.  It was headed “$2.8m Investment Proposal” and confirmed advice in discussions that the return from the proposal concerned to the appellant would be in the vicinity of 20% per annum.

The Departmental investigation

1. On 22 December 1986 the Commissioner of Inland Revenue issued an assessment of tax payable by the appellant based on its return for the year ended 31 March 1986.  The effect of doing so was to set 31 March 1991, that is four years from the end of the income year in which the Commissioner had first assessed the appellant, as the date by which any reassessment of taxable income for the 1986 year would have to be made, if it was not to be statute barred under s25 of the 1976 Act.

2. On 25 February 1991 Mr Barker, an investigating accountant at the Inland Revenue Department, wrote to the appellant referring to the solicitors’ letter of 4 March 1986 and to the deduction of interest of $570,080 claimed in the appellant’s tax return for the 1986 year.  Mr Barker said that it was his view that the transactions referred to in the letter constituted an arrangement with the purpose of tax avoidance.  He said that the transactions were circuitous between associated persons, virtually simultaneous, and they had a manifest tax advantage.  He reported that he proposed to submit the case to the Head Office of the Department for consideration as a possible tax avoidance scheme coming within s99 of the 1976 Act which is its general anti-avoidance provision.  Mr Barker said that if that view was ultimately reached an adjustment would be made to previous assessments to counteract the tax advantage obtained, by disallowing the deduction for interest.

3. Earlier, on 11 February 1991, Mr Barker had reported to the Assistant Controller (Investigations) of the Department’s Northern Region that he had reached the stage in his investigation of the appellant’s tax affairs of needing legal advice concerning his provisional opinion that s99 could be invoked to nullify the benefit of the interest deduction. On 20 February the Assistant Controller (Investigations) reported to the Head Office of the Department seeking an urgent decision as to the proposed re-assessment and pointing out that the time bar for any reassessment would expire on 31 March 1991.

4. On 11 March 1991 Mr Lim, a solicitor in the Department, provided an opinion to the Manager (Legal Services) and Director (Legal Services) at the Department’s head office in which he recommended:

   Approve the request to invoke s.99 subject to the verification of statements of facts in the Investigating Accountant’s report and the outcome of further investigation undertaken.

Mr Lim referred in his opinion to the limited time he had been given to consider the matter.  The opinion had been written without any detailed examination of documentation, and should be treated as a preliminary opinion.  It might need to be reviewed at a later stage.

1. There are two handwritten notations on Mr Lim’s advice.  Both are dated 12 March 1991.  That of the Manager (Legal Services) reads:

   I agree with recommendation to invoke s99.  We should await the result of further investigation, and review further.

The notation of the Director (Legal Services) was:

I approve the request to invoke s.99.

1. Towards the end of March 1991 Mr Barker prepared a letter to the appellant advising that the decision had been reached to invoke s99 and to reassess the appellant to counteract the tax advantage obtained in the consequence of the arrangement described in his letter of 25 February.  The letter also said that the reassessment “will disallow” the $570,080 interest deduction claimed for the year ended 31 March 1986 and that the notice of reassessment “will advise” the appellant of its right to object.

2. At the same time Mr Barker prepared an Income Tax Notice of Adjustment in respect of the appellant for the 1986 year.  This increased the appellant’s taxable income from $385,262 as returned by $570,080 to $955,342.  The annotation on the form explaining the adjustment was “As per Inspector’s report”.  The Authority inferred that this reference was to Mr Lim’s report of 11 March 1991 that had been signed off by both the Director and Manager for Legal Services.  The other document, created at the same time, is a Notice of Assessment for the year ended 31 March 1986.  Unlike the other two documents it is dated, 26 March 1991.  In this document there is an entry cancelling terminal tax of $168,788 for the 1986 year.  Re-assessed tax is $429,903.90.  Additional tax is also debited at $26,111.52 leaving a debit balance of $287,226.78 for that year.

3. The evidence was imprecise as to whether this material was sent out to the taxpayer on 26 March.  Mr Barker had been on leave during the last week of March and made arrangements for another officer to attend to its despatch.  It was clear that the fact of the reassessment was known to a solicitor acting for the appellant by Wednesday 3 April, which was the Wednesday immediately following Easter Monday. The solicitor had telephoned the Department that day and indicated an intention to object.  He submitted a letter of objection on 4 April 1991.

4. On 7 May 1991 Mr Barker wrote a further report on his investigation.  In the course of stating the reason for that report he said:

   As the re-assessment relates to the year ended 31 March 1986 to conform with section 25 it had to be issued before 31 March 1991.  I understand that the re-assessment was issued on 26 March 1991.  Thus this report covers the investigation which led to the re-assessment and recommends that it is approved.

This report concluded:

It is recommended that approval is given to the issue of the amended assessment to Dandelion Investments Ltd for the year ended 31 March 1986, the tax to be calculated on the income of $955,342 which includes the discrepancy of $570,080…

That recommendation was approved on 7 May 1991 by an Assistant Controller Investigations.

1. The objection sent in on 4 April 1991 languished in the Department until May 1992 when Mr Barker became aware of it.  He had to seek a copy of the reassessment and notice of adjustment from the solicitor who had lodged the objection.  He set 14 October 1992 as the extended time within which further submissions in support of the objection were to be made.  In the interim Mr J G Russell was instructed to represent the appellant.  He wrote to the Department seeking further information.  This involvement was seen as a delaying strategy and in response to it the Department ceased to cooperate with the appellant.  On 21 October 1992 the objection was disallowed.  Mr Russell reacted by complaining that the decision was unfair and had been made without adequate information.  The Department rejected Mr Russell’s allegations and maintained it had validly disallowed the objection.  On 14 December 1992 Mr Russell asked that a case be stated to the Authority.

Taxation Review Authority decision

1. The Taxation Review Authority hearing on the appellant’s objection extended over a period of some 23 days between August and November in 1998.  The appellant was represented by Mr Russell as its agent.  The Authority, Willy DCJ, released his decision on 4 May 1999. He addressed four issues. One was whether there had been a valid reassessment of the tax liability for the 1986 year prior to the time bar coming into effect on 31 March 1991.  Here two points were raised by the appellant.  The first was whether the reassessment was time barred because the notice of it was not received by the appellant until after 31 March 1991.  The Authority found that the reassessment was not received by the objector until 3 April 1991, after the date the time bar became operative.  He held this was fatal to the validity of the reassessment.

1. The other aspect of the validity argument concerned whether the circumstances indicated that the reassessment by the Commissioner was only a provisional calculation of the appellant’s tax liability. The Authority decided this was the case because the reassessment had been done in haste, to stop time running. Here the Authority was particularly influenced by the tentative nature of the views expressed in the opinions given during March 1991, the qualifications expressed in the notation of 12 March 1991 by  the Manager (Legal Services) to the effect that the Department should await the result of further investigations and review, and the fact that on 7 May 1991 Mr Barker had written a final report in which he recommended “that approval be given to the issue of the amended assessment…”.  The Authority held that at the time it was issued within the Department on 26 March 1991 the reassessment was neither definitive as to the taxpayer’s liability nor a final assessment of tax in compliance with the statutory scheme.  It was accordingly void.

2. The second issue considered by the Authority was whether the Commissioner’s policy statement in relation to the manner in which the Department would apply s99 gave rise to obligations which had to be complied with.  The legal question was whether such a policy statement could give rise to a reasonable expectation that a statutory power would be exercised in a particular way.  The Authority applied observations of Baragwanath J in his judgment in the High Court in Miller v Commissioner of Inland Revenue (1997) 18 NZTC 13001, 13047 indicating that in an appropriate case where the Commissioner acted inconsistently with a taxpayer’s legitimate expectation founded on a policy statement, that could constitute an abuse of power.

3. The Authority held that the terms of the Commissioner’s policy statement on s99 had not been complied with.  The Department had not analysed the arrangement carefully and thoroughly to ascertain its purpose and effect on whether it was a fair and reasonable inference that tax avoidance was more than a mere incidental purpose of the arrangement.  The Department had failed, in particular, to get further legal analysis done in light of the tentative nature of the opinion on which it acted.  This was contrary to a policy which had come into effect in February 1990. 

4. The Authority was accordingly satisfied there had not been the careful and thorough analysis contemplated by the policy such as could have provided a fair and reasonable basis for the Commissioner’s conclusion that s99 could apply to the arrangement.  The assessment invoking s99 was not in accordance with the policy statement and was therefore held to be a nullity.

5. The third question addressed by the Authority was whether the Commissioner’s officials were improperly motivated in their discharge of their responsibilities by the fact that Mr J G Russell was representing the appellant.  Mr Russell first became involved in September 1992, and had taken over all dealings with the Department on behalf of the appellant by 12 October 1992.  As indicated he appeared on the appellant’s behalf at the hearing before the Authority.

6. The Authority found that as a result of the Department’s attitude to Mr Russell, and its general resistance to his appointment, the appellant taxpayer was not treated even-handedly as the law required.  He held that Mr Russell was not given access to documents relevant to the objection until very shortly before the hearing.  He also held that a deliberate decision had been taken to call as the principal witness for the Commissioner an officer with limited knowledge of the case and in particular the process followed by the Commissioner.  As the appellant bore the onus of proof in what was an objection largely founded on criticism of the process leading to the assessment, it had been disadvantaged, and put to extra cost by the way the evidence for the Commissioner was called.  The Authority found this had undermined the ability of the appellant to prove the assessment was wrong.  He held that a lack of impartiality by the Department and an unnecessary obstruction of the appellant as objector was proved, and that this finding also vitiated the assessment.

7. The final issue addressed by Judge Willy was whether, if the process by which the reassessment was done had been valid and within time, s99 would have been correctly applied to disallow the deduction.  He concluded that objectively the only tenable explanation for the wholly artificial transaction was tax avoidance.  On the merits the Commissioner had been right to apply s99.  Because, however, of the failures to validly reassess the appellant he upheld the objection.

High Court decision

1. In the High Court the Commissioner challenged the Authority’s finding that there had been an invalid exercise of the statutory power to reassess the appellant.  The appellant cross-appealed against the Authority’s further finding that on the merits s99 had been correctly applied by the Commissioner.

2. In his judgment Tompkins J disagreed with the Authority’s view that s25 required that notice of a reassessment had to be received by the taxpayer prior to the time-bar becoming effective. His Honour applied the distinction between the making of a reassessment and the giving of notice of it, as recognised by this Court (since the Authority’s decision) in Hyslop v Commissioner of Inland Revenue [2001] 2 NZLR 329 para 20. The statutory obligation to notify the taxpayer of the reassessment arose under s29 of the 1976 Act which also provided that omission to do did not invalidate the assessment (s29(6)). Tompkins J held the assessment was made on 26 March 1991 within the four year limitation period. The undated letter advising of the decision to invoke s99 and disallow the interest deduction referred to the appellant’s right to object to the reassessment. Tompkins J said it was a reasonable inference that the notice of the reassessment dated 26 March was enclosed with this letter.

3. The High Court also disagreed with the Authority’s conclusion that the reassessment was a provisional determination which did not qualify as an assessment of tax under the statutory scheme.  Tompkins J held that the decision to invoke s99 had been taken by the Director (Legal Services) on 12 March 1991.  The reassessment itself was made on 26 March 1991.  It was a genuine attempt to ascertain the appellant’s taxable income for the 1986 year.  The only issue at the time was whether s99 should be invoked and Tompkins J was in no doubt that the Commissioner had made a careful, honest and considered decision to do so.  The decision could not be said to have been taken cursorily or perfunctorily, but even if it had been that would not have invalidated it: Commissioner of Inland Revenue v Canterbury Frozen Meat [1994] 2 NZLR 681, 691 per Richardson J.

4. The third issue in the High Court concerned the Authority’s finding of a breach of the appellant’s legitimate expectations arising from the Commissioner’s policy statement on how s99 would be applied.  Tompkins J referred to the decision of the Privy Council delivered by Lord Hoffmann in O’Neil v Commissioner of Inland Revenue (2001) 20 NZTC 17,051.  Lord Hoffmann said in a passage we later set out that the Commissioner’s statutory duty to reassess the taxpayer in any case to which s99 applies could not be made subject to internal conditions of a kind said to be reflected in the policy statement.  Nor did the Privy Council think the Commissioner had intended to restrict his duty in that way (para 26).  This judgment contradicted the legal basis on which the Authority had proceeded.  It was not of course available when the Authority reached its decision.

5. The final issue in the appeal arose from the Authority’s finding that the Department had been motivated by improper considerations.  Of this Tompkins J said that on the facts as found by the Authority there was little doubt that the Department had acted inappropriately in a significant number of respects because of its attitude to Mr Russell.  However Mr Russell’s involvement as agent for the appellant only began 18 months after the reassessment.  The Judge held that in those circumstances the Authority’s conclusion that the Department’s conduct vitiated the assessment could not stand. He went on to consider the associated question of whether there had been a fair and adequate consideration of the objector’s view prior to the Commissioner’s decision to disallow the objection.  The Judge was not disposed to disturb the Authority’s findings that the appellant’s views had not been fairly and adequately considered after the reassessment before the objection was disallowed.  That however had been cured by the lengthy fresh hearing before the Authority.  The Judge was critical of the parties and the Authority for focussing on the actions of Departmental officers at the hearing rather than the correctness of the assessment.  The findings of improper motive or purpose leading to an inadequate consideration of the objection accordingly could not give rise to relief as the effect of such conduct was cured.

6. Tompkins J finally addressed the cross-appeal against the finding that the transaction was a tax avoidance arrangement to which s99 could properly have been applied.  In Commissioner of Inland Revenue v BNZ Investments Ltd [2002] 1 NZLR 450 a majority of this Court had held that in order to establish the element of consensus between parties necessary to constitute an “arrangement” for the purposes of s99 the meeting of minds had to encompass, explicitly or implicitly, the dimension said to amount to tax avoidance, even if the taxpayer did not know that is what it amounted to (para 52). The appellant had argued that there had been no such meeting of minds in this case. This submission was rejected by Tompkins J. He found that it was clear from the letter of the solicitors to the appellant of 4 March 1986 that the appellant knew exactly the nature of the whole transaction and that the steps which were to be taken formed a single transaction. With that knowledge there was the necessary meeting of minds between the appellant and other participants necessary to constitute an arrangement under s99.

7. The Judge saw the real issue in the cross-appeal as whether tax avoidance was a purpose or effect of the arrangement in more than an incidental way.  The appellant had argued that its purpose was acquisition of shares in Austral by subscribing for $2.8 million shares in Centratherm which took up the shares in Austral.  If that were so, however, there was no explanation of why it was necessary to construct such an elaborate framework of entities as were involved in the transaction.  The Judge described Centratherm, in particular, as a mere shell.   Looking at the series of transactions in a practical way the Judge concluded that the net effect was that the appellant paid interest of $570,080, which it sought to deduct from taxable income, and received a dividend of $484,000, from which most interest could be paid and which was a tax-free receipt.  At the end of the series of transactions Centratherm, the company which the appellant acquired,  had no assets or liabilities and was liquidated.

8. As the Judge saw it the focus of the Court’s consideration had to be the overall effect of the arrangement rather than individual component transactions within it.  An indication of that was that those responsible for setting the arrangement up had seen the purpose of passing the funds through Cook Island companies as being to earn tax free income.  From the appellant’s point of view the tax free status of the $484,000 dividend, which covered most of its interest outgoings, was significant.  Ultimately the appellant would achieve this by undertaking a transaction, which its solicitors had certified was risk free, and which would leave it with a debt owing to a wholly owned company the capital of which was equal to the debt.  The Judge held that the only reasonable conclusion was that the whole purpose of the arrangement was to reduce the appellant’s tax liability.  The Commissioner had accordingly acted correctly in disallowing the interest deduction and had validly reassessed the appellant.  The Judge accordingly upheld the Authority’s finding on the merits and in view of his earlier findings on the process issues allowed the cross-appeal.

The legislation

1. The starting point in the statutory scheme is s19(1) of the 1976 Act which imposes on the Commissioner the duty in every year and thereafter as necessary to “make assessments in respect of every taxpayer of the amount on which tax is payable and the amount of that tax”.  Section 23(1) of the Act empowers the Commissioner to alter and add to assessments as thought necessary “in order to ensure the correctness thereof”.  Notice of any “fresh liability” to tax, or of any increase in any existing liability is to be given to the taxpayer affected under s23(2). 

2. Section 25 of the 1976 Act is a limitation provision.  It reads:

   25  Limitation of time for amendment of assessment

   (1)  When any person has made returns and has been assessed for income tax for any year, it shall not be lawful for the Commissioner to alter the assessment so as to increase the amount thereof after the expiration of 4 years from the end of the year in which the assessment was made.
   (2)  [Fraudulent or wilfully misleading returns]  Notwithstanding subsection (1) of this section, in any case where, in the opinion of the Commissioner, the returns so made are fraudulent or wilfully misleading or omit all mention of income which is of a particular nature or was derived from a particular source, and in respect of which a return is required to be made, it shall be lawful for the Commissioner to alter the assessment (being an assessment made on or after the 1st day of April 1958) at any time so as to increase the amount thereof.

The validity of an assessment is not affected if any of the provisions of the Act are not complied with, by reason of s26.  Under s29 the Commissioner must give notice of any assessment to the taxpayer as soon as conveniently may be after it is made.

1. Part III of the 1976 Act includes provisions dealing with objections to assessments.  Section 30(1) provides that any person assessed for income tax may object to the assessment in writing stating shortly the grounds of the objection within a specified time.  In the case of an amended assessment the right of objection is confined to the extent to which it imposes a fresh liability, or increases an existing liability to tax (s30(2)).  The Commissioner is required to consider all such objections and may alter the assessment of tax.  If the objection is not wholly allowed the objector may by notice in writing require that the objection be heard and determined by the Authority (s31).  The powers of the Authority on hearing any objection are set out in s32 which provides:

   32.  Powers of Taxation Review Authority on determination of objection or case stated

   (1)  On hearing any objection the Authority may-

   (a)Confirm or cancel or vary the assessment, or reduce the amount thereof, or increase the amount thereof to the extent to which the Commissioner was empowered to make an assessment of an increased amount at the time he made the assessment to which the objection relates, and that last-mentioned assessment shall be altered by the Commissioner to such extent as may be necessary to conform to that determination:

   (b)Make any assessment which the Commissioner was empowered to make at the time he made the assessment to which the objection relates, or direct the Commissioner to make such an assessment, in which case an assessment shall be made by the Commissioner so as to conform to that direction.

And under s36 of the Inland Revenue Department Act 1974 the objector is limited on the hearing and determination of any objection to the grounds stated in his objection and the burden of proof is on the objector.

1. In Commissioner of Inland Revenue v V H Farnsworth Ltd [1984] 1 NZLR 428 Richardson J at p433 said of these provisions:

   There are two features of this statutory scheme which call for some emphasis at this point.  The first is that the proceedings whether in the Taxation Review Authority or the High Court do not involve a general review of the liability of the objector for income tax in the particular year.  It is the original objection which is referred to the Authority or the Court and “the questions arising for the determination of the Court” (or the Authority) are necessarily limited to those arising from the particular objection.  In short, the inquiry, whether before the Court or the Authority, is specifically and directly confined in that way.  It is not a general appeal where liability to tax is at large.  The objector selects the ground on which he wishes to challenge the assessment and that decision on his part determines the scope of the inquiry into the correctness of the assessment.

   The second is that the objector is limited to the grounds of his objection to the assessment which was made by the Commissioner.  Section 36 is in imperative terms and cannot be waived by the Commissioner or the Court.  As the High Court of Australia said of its Australian counterpart in Molloy v Federal Commissioner of Land Tax (1938) 59 CLR 608, 610: “The provision is made for the purpose of protecting public revenue and the court is bound to give effect to it.” It is expressly accepted by the Commissioner in this case that as the objector is so limited he is entitled to be provided with such details of the assessment process as are necessary to enable him properly to frame his objection.

As Mr Grierson emphasised, the objector’s entitlement arises at the time an objection is being prepared rather than later when the objection is before the Authority.  It is equally true that there is no such entitlement under tax legislation until after the assessment is made: Hyslop v Commissioner of Inland Revenue, para [22].

1. Turning from the procedural to the substantive provisions of the 1976 Act, s106 disallows certain deductions of interest.  Section 106(1)(h)(ii) in particular provides:

   106.  Certain deductions not permitted

   (1) …in calculating the assessable income derived by any person from any source, no deduction shall, except as expressly provided in this Act, be made in respect of any of the following sums or matters:
   …
   (h)  Interest…except so far as the Commissioner is satisfied that-

   (i) …

   (ii) It is payable by one company included in a group of companies in respect of money borrowed to acquire shares in another company included in that group of companies:

2. Section 99 of the 1976 Act, which was applied by the Commissioner to disallow the appellant’s deduction of interest of $570,000, relevantly provides:

   Section 99   Agreements purporting to alter incidence of tax to be void

   (1)  For the purposes of this section-
   “Arrangement” means any contract, agreement, plan, or understanding (whether enforceable or unenforceable) including all steps and transactions by which it is carried into effect:
   “Liability” includes a potential or prospective liability in respect of future income:
   “Tax avoidance” includes-

   (a) Directly or indirectly altering the incidence of any income tax:
   (b) Directly or indirectly relieving any person from liability to pay income tax:
   (c) Directly or indirectly avoiding, reducing, or postponing any liability to income tax.

   (2)  Void arrangements. Every arrangement made or entered into, whether before or after the commencement of this Act, shall be absolutely void as against the Commissioner for income tax purposes if and to the extent that, directly or indirectly,-

   (a)Its purpose or effect is tax avoidance;  or

   (b)Where it has 2 or more purposes or effects, one of its purposes or effects (not being a merely incidental purpose or effect) is tax avoidance, whether or not any other or others of its purposes or effects relate to, or are referable to, ordinary business or family dealings,-

   whether or not any person affected by that arrangement is a party thereto.
   (3)  Adjustment of income. Where an arrangement is void in accordance with subsection (2) of this section, the assessable income of any person affected by that arrangement shall be adjusted in such manner as the Commissioner considers appropriate so as to counteract any tax advantage obtained by that person from or under that arrangement, and, without limiting the generality of the foregoing provisions of this subsection, the Commissioner may have regard to such income as, in his opinion, either-

   (a)That person would have, or might be expected to have, or would in all likelihood have, derived if that arrangement had not been made or entered into; or

   (b)That person would have derived if he had been entitled to the benefit of all income, or of such part thereof as the Commissioner considers proper, derived by any other person or persons as a result of that arrangement.

   (4)  Deemed derivation of income. Where any income is included in the assessable income of any person pursuant to subsection (3) of this section, then, for the purposes of this Act, that income shall be deemed to have been derived by that person and shall be deemed not to have been derived by any other person.
   …

1. Two provisions in the 1976 Act are invoked by the appellant to support its proposition that subsequent transactions are taxable.  The first is s63(2) which so far as is relevant provides:

   Section 63  Exemption of dividends from tax

   …
   (2)  Subject to this section, dividends derived by any company that is resident in New Zealand or by any group investment fund (as defined in section 211A of this Act) from companies (other than from companies that are exempt from income tax in New Zealand or from building societies under the Building Societies act 1965) or from any group investment fund (as so defined) shall be exempt from income tax in New Zealand.

2. The second provision is s243(2) which relevantly provides:

   Section 243  Classes of income deemed to be derived from New Zealand

   …
   (2)  Subject to sections 244 and 245 of this Act, the following classes of income shall be deemed to be derived from New Zealand:

   …

   (l)Income, being interest, or a redemption payment, derived from or in respect of money lent in New Zealand:

   (m)Income, being interest or a redemption payment, derived from or in respect of money lent outside New Zealand to-

   (i)Any person who is resident in New Zealand, except where the money lent is used by him for the purposes of a business carried on by him outside New Zealand through a fixed establishment outside New Zealand; or

   (ii)Any person who is not resident in New Zealand if the money lent is used by him for the purposes of a business carried on by him in New Zealand through a fixed establishment in New Zealand:

Issues on appeal

1. The appellant appeals to this Court against the High Court’s judgment on four grounds.  The first was that the High Court was wrong to conclude that the hearing before the Authority cured flaws in the process of the Commissioner. The second ground of appeal was that the High Court had been wrong to reverse the Authority’s finding that the reassessment was not made by 31 March 1991.  The third ground was that the High Court’s reversal of the Authority’s decision that the Commissioner was in breach of obligations as to the manner of application of s99 was wrong.  Those obligations were said to have been assumed under the Commissioner’s policy statement.  The final ground was that the application of s99 to disallow the interest deduction was wrong being the result of an incomplete investigation, a failure to analyse the whole of the transaction, and an incorrect view that the whole purpose or effect of the arrangement was to avoid tax.

Decision

Ground A:  Curative effect of de novo hearing

1. Mr Grierson for the appellant submitted to this Court that the High Court’s decision that the de novo nature of the hearing before the Authority cured any defects in the Commissioner’s process when determining the objection was wrong in law.  He argued, citing the passage set out above in the Court’s decision in V H Farnsworth, that the Authority’s hearing had been confined by the terms of the objection and that the appellant’s ability to frame those terms had been seriously impeded by the departmental conduct complained of.  He also said that the Judge had failed to appreciate that the restricted scope of the Authority’s jurisdiction precluded it from curing the effects of improper conduct.  Mr Grierson also argued that the conduct concerned was in breach of s27(1) of the New Zealand Bill of Rights Act 1990 and of s6(1) of the Tax Administration Act 1994 when it came into effect.  The Authority had no power to order payment of costs to compensate the appellant and the only appropriate remedy and sanction available was for the Authority to cancel the assessments in issue, as it had done.

2. Leading counsel for the Commissioner, Mr Beck, referred to a decision of the High Court at an earlier stage of this litigation in which Salmon J had decided that the Authority’s jurisdiction is de novo in nature: Dandelion Investments Ltd v Commissioner of Inland Revenue (1996) 17 NZTC 12,689, 12,693.  Mr Beck also argued that the grounds of objection had been stated very broadly.  There was no suggestion that the appellant was unable to raise any matter it wished before the Authority and it had in fact raised a number of process questions not mentioned in the notice of objection.  He submitted that Salmon J’s decision was binding on the appellant and that the Authority’s hearing was truly a de novo one which cured irregularities of process.  He also argued that the point was a new one not raised by the case stated on appeal to the High Court. In relation to conduct since the reassessment Mr Beck argued that Tompkins J was right to decide that what was later done in disallowing the objection could not affect the validity of the earlier act of reassessment.

3. The question in the case stated to the High Court that gave rise to the Judge’s finding the subject of this ground of appeal was as follows:

   Whether the Commissioner fairly and adequately considered the objector’s view and in any event whether that is relevant?

4. It was in that context that Tompkins J held that the fresh hearing before the Authority had cured any procedural defect arising from the Commissioner’s failure to consider submissions from the appellant before disallowing the objection.  The appellant’s argument attacking the High Court’s finding was not, however, focussed on the disallowance of the objection.  It rather addressed whether the appellant had been impeded in framing the objection in the first place by a lack of information concerning the basis for the decision to reassess.  That question was not one raised by the case stated to the High Court.

5. Under the case stated procedure of s43 of the Inland Revenue Department Act 1974 questions of law or fact for the determination of the High Court had to be stated by the Authority in the case.  The case stated in the present instance was in a form agreed by counsel and, as a High Court Judge observed in directing that it be signed by the Authority, in a much more detailed form than a case usually would be.  The High Court was confined by the statute to the issues raised in the case stated unless a stipulated procedure for amendment were followed:  (Hyslop para 13 cited above).

6. The second appeal to this Court, under the 1974 Act, was an appeal against the High Court decision.  Accordingly, there is no scope for this Court to address issues not raised in the case stated and decided in the High Court.  On that basis alone this ground of appeal must fail.  Nevertheless we think it appropriate in this case to set out our views on the merits of the argument that because the appellant was impeded in framing the terms of its objection the fresh hearing before the Authority did not cure the Commissioner’s irregular processes and conduct.

7. Here the crucial question is whether the information available to the appellant on 3 April 1991, when its solicitor submitted an objection to the reassessment, was sufficient to enable the proper framing of the appellant’s objection (Farnsworth p43 cited above).

8. At that time the “Notice of Assessment” dated 26 March 1991 and the notice of adjustment along with the undated letter advising the decision to invoke s99 were in the appellant’s hands.  That letter expressly referred to the more extensive earlier letter of 25 February 1991 which had discussed the transaction giving rise to the claimed interest deduction and warned that consideration was being given to whether it was a tax avoidance arrangement.  The letter had also referred to the “circuitous” nature of the transaction, the “virtually simultaneous” character of its component elements and made the point that they were entered into between “associated persons”.  The letter of 25 February 1991 had also annexed a copy of the solicitors’ letter sent to the appellant on 4 March 1986, which had outlined the steps being taken in detail.  This indicated the appellant was informed of the structure of the transaction and its principal downstream elements.  This was the information available to the appellant when its solicitor prepared the notice of objection to the reassessment.

9. The solicitor stated the grounds of objection in April 1991 by asserting first that the interest deduction claimed arose from genuine borrowing by the appellant of the $2.8 million which funded its subscription for shares in Centratherm and secondly that the application by Centratherm of those funds to secure a tax free dividend did not justify application of s99. He added that as the notice of assessment had provided no grounds for what the Department had done, with possible resulting prejudice to the appellant’s ability to specify full and complete grounds of objection, the appellant reserved its right to expand those grounds.

10. In his written and oral submissions Mr Grierson emphasised the appellant’s lack of information on the basis for the adjustment to the appellant’s assessable income made under s99(3) and as to how other participants would be treated.  He submitted this was a denial of natural justice in breach of s27(1) of the New Zealand Bill of Rights Act 1990.  No detailed argument was submitted on whether that provision applies to the Commissioner but even if it does we are satisfied it was not breached in this case.  It had been made clear that the interest expense had been disallowed and the information that had been supplied over the previous two months provided the appellant with adequate context for that basis of reassessment.  The solicitor for the appellant did not seek further information.  He was content to frame the objection in a broad way while seeking to reserve the right to expand grounds later.  It is unnecessary to consider the effect if any of that reservation.  Looking at the matter in the round we are satisfied that all that was reasonably necessary for the appellant to submit its objection in terms of the entitlement recognised in V H Farnsworth Ltd was provided to the appellant.  In these circumstances the argument that the confined terms of the objection precluded the fresh hearing before the Authority from curing irregular process falls away.

11. The relevant question in the case stated of course concerned the failure of the Commissioner to allow the appellant’s agent to make submissions at all before disallowing the objection. But, as the High Court Judge found, to the extent this was a defect in the appellant’s procedure it was one which was plainly cured by the Authority’s examination of the correctness of the assessment in the course of determining the objection.

12. Similarly, the findings made by the Authority in relation to the failure of the Commissioner to call witnesses who could shed light on departmental processes in relation to this investigation did not prevent the Authority from conducting an extensive hearing into all aspects of the appellant’s criticisms of the Department’s process and correctness of the assessment.  Like the High Court Judge we do not excuse the Department’s conduct but hold that it did not affect the scope of the ultimate hearing which determined the objection.  In these circumstances s6 of the Tax Administration Act 1994 does not need to be addressed.

13. While the Authority’s hearing was directed to revising incorrect assessments its curative effect on irregular departmental procedures was recognised by Salmon J in the earlier case stated proceeding from which there was no appeal.  It was open to the Authority under s34 of the 1974 Act to determine his own procedure subject only to requirements of that Act and regulations.  The powers concerned were also adequate to enable the Authority to deal with any conduct by the parties abusive of its hearing processes. 

14. In this case we are satisfied that it cannot be said that any problems with the Commissioner’s earlier processes were left unremedied by the Authority’s fresh hearing. 

15. For these reasons the appeal on this ground fails.

Ground B:   Was the assessment made in time?

1. As already indicated it was common ground that any reassessment of the appellant’s taxable income for the 1986 year had to be completed by 31 March 1991.  Mr Grierson first submitted to us that the High Court had wrongly concluded that the reason why the notice of assessment dated 26 March 1991 was time-barred (if it otherwise qualified as an assessment) was because it was not received by the appellant until 2 or 3 April 1994.  It is plain from the record, however that this was precisely the basis on which the Authority held the time bar applied.  After referring to a passage of Mr Barker’s evidence in cross-examination the Authority in his decision said of this issue:

   The witness then agrees rightly that a notice of increased assessment is not given until it is received by the person to whom it is addressed in the ordinary course of posting.

   Mr Barker returned to work on Tuesday 2 April (after Easter) and [the solicitor’s] telephone call was received on 3 April at 12.10 pm.

   In my view, on this issue the Commissioner has the onus of proof.  It is for him to establish by credible evidence that the assessment on which he bases his claim against the taxpayer was issued within any statutory time limits.  He has failed to do so – indeed the probability is that this assessment was not received by the objector until after 31 March 1991.  Probably on 2nd or 3rd April.  The assessment is therefore statute barred and the Commissioner fails on this point. (Page 9,112)

2. Mr Grierson next submitted to us that the date stamped document might have been back-dated and that, on the evidence, the likely true date of the notice of assessment was 2 April 1991, being the day when Mr Barker returned to work after the Easter break.  He reiterated his earlier submission to the High Court as to the provisional nature of all steps that took place prior to 7 May 1991, when the recommendation in Mr Barker’s final report was approved.  Mr Grierson argued that date, which of course was out of time, was the true date of reassessment. 

3. The decision to reassess was taken by the Director (Legal Services) at Head Office on 12 March 1991.  It was the result of an exercise of judgment on information available with the time-bar imminent.  It was neither an arbitrary decision nor one made in disregard of the law or facts known to the Commissioner.  It was also the outcome of a genuine attempt to ascertain the assessable income of the appellant on the information available at the time.  As such it met the requirements of a foundation for the assessment as summarised by this Court in Commissioner of Inland Revenue v NZ Wool Board (1999) 19 NZTC 15,476, paras 42 to 49. 

4. The act of assessment was the creation in the Department of the notice of assessment dated 26 March 1991 which was an administrative consequence of the Director’s decision.  The subsequent recommendation in the report of 7 May 1991 that “approval be given to the issue of the amended assessment”, in this context was simply a ratification of the decision previously taken and implemented. 

5. In response Mr Beck said that the appellant was once again advancing a new argument in this Court.  It had not put in issue at either earlier hearing that the notice of assessment document was not created until April 1991. He submitted it was not open to the appellant in this Court to raise a challenge to the correctness of the stamped date on the document.

6. We are satisfied the submission for the Commissioner is right.  The position here is essentially the same as that on which we decided the first ground of appeal in that the appellant is seeking to shift its ground in a manner not permitted by the 1974 Act.  The question put to the High Court in the case stated on appeal in relation to the time-bar question was:

   Is an assessment invalidated when notice is received by a taxpayer after the expiry of four years from the issue of the original assessment but where the amended assessment was made before the expiry of four years?

7. The High Court Judge found that the answer to this question was “No” as decided by this Court in Hyslop.  No issue was raised in the case stated to the High Court as to the date of the notice of assessment and it is plainly too late for the appellant to raise such a challenge now.  Nor, in any event, was there any evidence to displace the date of 26 March 1991 stamped on the document.  All the circumstances rather indicate the document was created by that date.  We would reject out of hand Mr Grierson’s belated and speculative suggestion that the document may have later been back-dated.  The reality is that, as the Judge held, the time-bar point in relation to this document was effectively decided by this Court in Hyslop, prior to the High Court judgment, and in the Commissioner’s favour.  It is not open to the appellant in this Court to meet that inconvenience by altering the ground on which it asserts the reassessment was time-barred.   This ground of appeal accordingly also fails.

Ground C:  The Policy Statement on s99.

1. The appellant under this ground of appeal challenges the reversal by the High Court of the Authority’s finding concerning failure to comply with the policy statement on the manner of application of s99.  Mr Grierson acknowledged that in O’Neil (at p17060 cited above) the Privy Council held that the same policy statement was not intended to lay down conditions at all.  He argued, however, that the Privy Council had recognised that the Commissioner,  in making the statement as to the procedures to be followed in applying s99 had reassured the public that he would think very carefully about whether the section applied to a particular case. Mr Grierson said this “reassurance” called for a thorough and careful analysis before making an assessment on the basis of s99 and, if that were not done, judgments required by s99 to be made by the Commissioner would be wrong. Mr Grierson argued that failure to consider constituent parts of the arrangement in this case had resulted in the Commissioner wrongly applying s99.

2. The particular passage in the Privy Council’s judgment delivered by Lord Hoffmann concerning the nature of the relevant policy statement, reads as follows:

   A more fundamental point is that their Lordships do not think that the [Commissioner’s Policy Statement] was intended to lay down conditions at all.  They do not consider that the parts of the document relied upon by the appellants do more than to reassure the public that the Commissioner and his officers will think very carefully about whether s99 applies to any particular case.  But his statutory duty is to reassess the taxpayer in any case in which s99 applies and this duty cannot be made subject to internal conditions.  Nor do their Lordships think that he intended to restrict his duty in such a way. (page 17,060, para 26)

3. When the whole of this passage is considered it can immediately be seen that the Privy Council held that the policy statement by the Commissioner as to the manner in which s99 would be applied was no more than an administrative reassurance to the public.  Statements of policy could not, in any event, be elevated to the character of conditions which restricted the Commissioner’s statutory duty to apply s99 in any case in which it applied.  Nor did the Privy Council think that was the intention of the Commissioner in making the policy statement concerned, which is of course the same one as that relied on by the appellant in this case.  The futility of the appellant’s argument in face of the Privy Council’s judgment is plain.

4. In the end this ground fails for the reasons articulated by the Privy Council, reflecting as they do earlier observations of this Court as to the limited scope for application of the principle of legitimate expectation to confine the Commissioner in the exercise of statutory duties in relation to assessment functions:  Brierley Investments Ltd v Bouzaid [1993] 3 NZLR 655, 662, 664 and Commissioner of Inland Revenue v NZ Wool Board (1999) 19 NZTC 15476, paras 55 to 62. The Commissioner cannot act in a manner incompatible with statutory powers which must be exercised to a specified end.  As it was put by this Court in NZ Wool Board:

   Legitimate expectation cannot frustrate an honest appraisal by the Commissioner of the income tax liability of the taxpayer by means of an assessment of that liability.  Faced with the time bar, if the Commissioner concludes that there is a proper basis for making an assessment the Commissioner is required to make an assessment.  In that regard there could be no justification for restraining the Commissioner from making an assessment in the discharge of the Commissioner’s statutory duty before the time bar would otherwise apply or for quashing an assessment as so made (para 62).

For these reasons this ground of appeal also fails.

Ground D:  Was s99 wrongly applied?

1. The appellant expressed this ground in its points on appeal as follows:

   The (Authority) and High Court judgments that Section 99 applied to the arrangements are erroneous because the use of Section 99 requires the application of a Commissioner directed process to determine whether any tax was avoided before Section 99 can be applied and such process was lacking and also the outcome of those judgments causes double taxation.

2. We did not understand Mr Grierson seriously to contend that the appellant was not a party to an “arrangement” in terms of the definition in s99.  Clearly the knowledge that the appellant possessed, when embarking on the transaction, of what would transpire downstream following its acquisition of the shareholding in Austral met the requirements of a consensus, or meeting of minds in relation to how the promoter and its nominees would produce revenue of a tax free character.  Contrary to the position as found at first instance, and upheld on appeal, in the BNZ Investments Ltd case (cited above) in the present case there was a very substantial meeting of minds as to what steps or activities would be undertaken by the Cook Island companies downstream.  The correspondence from the appellant’s solicitors and its chartered accountants gave a comprehensive summary of intended capital movements but also indicated that interest income would be earned in Cook Islands transactions.  Although the solicitors’ letter followed implementation of the transaction it was apparent that key documents had been made available and examined. The appellant was aware that interest income would be converted into a dividend in the course of Cook Islands transactions so that what otherwise would be taxable revenue in its hands would be tax free.  In this case the tax avoidance dimension and its implications were known to the taxpayer.  We have no doubt that on the plain facts the appellant’s actions in investing in Centratherm, and through it acquiring the shareholding in Austral, were part of a composite arrangement which included the downstream transactions organised by Euronational.  As we say, the focus of Mr Grierson’s argument on this ground was rather on whether “its purpose or effect is tax avoidance” in terms of s99(2).  He submitted it was not.

3. The appellant challenges the High Court’s judgment that viewed as a whole the only conclusion that can reasonably be reached is that the whole purpose of the arrangement was to reduce the respondent’s tax liability (para93).  The Authority had likewise found “the transaction was wholly artificial and contrived solely for the purpose of obtaining a tax benefit” (p9,134). Mr Grierson said these findings were based on an incomplete view.  It overlooked the position of others involved in the nine party series of transactions that the Commissioner had treated as a tax avoidance arrangement.

4. In developing this contention Mr Grierson endeavoured to show that downstream transactions, forming part of the arrangement, gave rise to taxable income under New Zealand law.  He argued that if the investigation which had resulted in the application of s99 had been soundly conducted the incidence of liability from downstream transactions would have been revealed.  He said this indicated there was no purpose or effect of tax avoidance under s99(2)(a) citing the decision of McGechan J in BNZ Investments Ltd v Commissioner of Inland Revenue (2000) 19 NZTC 15732 at para 107. He also argued the consequence of application of s99 has inappropriate double taxation.

5. Mr Grierson’s argument addressed the particular tax position of the dividend of $484,000 paid by the United Kingdom company Austral to Centratherm.  To be exempt in the hands of Centratherm under s63(2) the dividend had to be derived from a company which was not exempt from income tax in New Zealand. Mr Grierson argued that Austral was exempt from income tax in New Zealand because it was resident overseas.  A proper investigation on this approach, he said, would have taxed Centratherm on its receipt of the dividend (though not Dandelion’s receipt of an equivalent dividend from Centratherm).  On this argument section 99 would have been unnecessary and inapplicable.  At the very least, counsel said, these matters should have been investigated. 

6. However the prospect that an investigation would have established that Austral had residence outside of New Zealand so as to be exempt from paying tax in New Zealand in terms of s63(2) were clearly slim.  In its report of 21 February 1986 Peat Marwick had said:

   It is our opinion that, in accordance with the provisions of the Act existing at the present time, the dividend income received by Centratherm and subsequently by Holyoake, will be exempt from New Zealand income tax, pursuant to section 63 of the Act.

That opinion was presumably based on s241(2)(b) of the 1976 Act which provides that “a company shall be deemed to be resident in New Zealand within the meaning of this part of the Act” if it “had its head office in New Zealand”.  The head office of a company under s241(3) “means the centre of its administrative management”.  Austral had by the time it paid the dividend become a subsidiary of Centratherm, which was wholly owned by the appellant. The prospect of Austral being shown then to have a head office outside of New Zealand was accordingly highly improbable.  We see no merit in the argument that on a further investigation the appellant would have been shown to be taxable, at the point of receipt by its subsidiary Centratherm, of the dividend from Austral. 

1. The final element of the argument that the arrangement’s downstream transactions produced taxable income was based on the Act’s provision for certain classes of income to be deemed to be derived from New Zealand.  In particular s243(2)(l) and (m) are relied on.  Mr Grierson argued these were wide ranging provisions which could have been applied to tax income from the downstream transactions in the Cook Islands by linking those receipts to the original advance of $2.8 million made in New Zealand which he said was the source of the business concerned.  An indication of the type of receipt which Mr Grierson said might be taxable on application of these provisions was the profit of $560,000 made by the Cook Islands company Fairhaven which redeemed for $2.8 million the promissory note from the appellant which it had acquired for $2.24 million under the arrangement.  This was said to be New Zealand income being “a redemption payment derived from or in respect of money lost in New Zealand” under s243(2)(m).

2. These arguments are not so much contentions that the purpose of the composite arrangement was other than to enable the appellant to avoid tax as arguments that such a purpose was not achieved by the arrangement.  We have already indicated that we do not accept the argument based on Austral’s status under s63(2).  Nor do we accept the assertion that returns from downstream transactions in the Cook Islands could have been made subject to New Zealand income tax following a proper investigation by application of s243.  It is sufficient to say that the contention is highly speculative and the Commissioner was entitled to treat any such prospect as an illusion.  The Commissioner was under no duty to investigate the position of the downstream parties let alone to assess them.  Nor was the Commissioner in breach of any duties to inform the appellant of what the Department knew about their activities.  Nor does the liability of the Equiticorp subsidiary to pay tax on the interest received from the appellant have any bearing on the question whether the purpose and effect of the corporate arrangement are of tax avoidance.

3. Clearly one motive of the appellant in entering into the arrangement was to reduce its tax obligations.  In considering whether the arrangement had a vitiating purpose of tax avoidance it is instructive to consider whether the appellant also had a legitimate purpose for the transaction concerned.  Mr Grierson argued that the purpose of the arrangement was to invest in Austral a company which he said, by reference to a “consolidated statement of position” in the agreed bundle of documents before the Authority, had shareholders funds of US $248,520 as at 28 February 1986 which was more than sufficient to cover the NZ $484,000 dividend.  We are satisfied however that the funds shown in the appropriation account were not those of Austral but of another company, probably Pembroke, whose affairs were included in the consolidated statement.  A balance sheet of Austral alone as at 26 February 1986 shows its appropriation account in deficit.  Shareholders funds are shown at US $1,484,000 (perhaps equating to NZ $2.8 million) in a revaluation reserve.  A notation to this balance sheet suggests these may be unspecified investments “valued at the Directors estimate of market value”.

4. We are satisfied that, considered in the context of the transaction, the financial statements shown to us by counsel demonstrate that Austral was not a company of substance.  The High Court Judge was also right to describe Centratherm, the company acquired for $2.8 million, as a shell. In reality there was no true business purpose to be achieved by the appellant in entering into the transaction other than to obtain the benefit of a deduction of an interest expense of $570,080 by making a payment of that sum which was to be offset by a tax free dividend receipt of $484,000.  The transaction was circular in its inception and unwinding.  Once unwound after the 12 months term of the loan it had no financial effects for the appellant, other than its net outlay of $86,080 and, presumably a liability for the fees of its advisers.  There was no risk to the appellant during that period.  No element of  business dealing other than tax avoidance can be identified as a purpose of the arrangement.  It is an artifice involving a pretence and not a real group investment transaction at all.  The concessional treatment of interest expenses under s106(1)(h)(ii) of the 1976 Act for borrowings to acquire shares in what would be a group company was not, on its true construction, intended to give the taxpayer the opportunity of obtaining a deduction in this way.  It is the type of arrangement which s99 was enacted to counteract in terms of the approach taken to the provision by the Privy Council in O’Neil at para 10 and by this Court in BNZ Investments Ltd at para 40. In those circumstances we agree with the High Court Judge that the purpose and effect of the composite arrangement was one of tax avoidance. The arrangement was accordingly void under s99(2).

5. The Commissioner adjusted the income of the appellant under s99(3) by disallowing the interest deduction of $570,080.  Mr Grierson argued that this invoked s99(4) of the 1976 Act, which deems income included in assessable income of any person under s99(3) to have been derived by that person and not derived by any other person.  Mr Grierson said that to tax the Equiticorp subsidiary for the interest received while at the same time disallowing the appellant to deduct that expense was “double taxation”.  We do not agree with this analysis as there is no necessary inconsistency in disallowing the appellant’s deduction of the interest while at the same time taxing it as income in the recipient’s hands.  But in any event the Commissioner was entitled in the exercise of the discretion under s99(3) to disallow the appellant’s claim for deduction and as long as the Commissioner was of the opinion it was a proper adjustment to make under s99(3) it cannot be attacked on the basis that the Commissioner has not simultaneously amended an inconsistent assessment of another taxpayer: Miller v Commissioner of Inland Revenue [1999] 1 NZLR 275, 289, 292 CA.

6. This argument is really part of the appellant’s general complaint that others participating in the composite arrangement were not taxed.  It is a complaint that s99(3) has been applied to the appellant alone unfairly and in breach of the duty to maintain the integrity of the tax system under s4 of the Tax Administration Act 1994.  The argument of unfairness overlooks the fact that the transaction set up under the void arrangement was put together for the appellant’s benefit and that the appellant was the major beneficiary of it.  It outlaid $86,080 (being the difference between the interest it paid and dividend it received) and in return obtained a tax deduction of $570,080.  The other entities participating merely shared the $86,080 as their return. In any event we reiterate that the Commissioner was entitled to decide that disallowance of the claimed deduction was a proper adjustment under s99(3) and no question under s6 of the Tax Administration Act 1994 or otherwise arises because of the subsequent changes in its ownership, different treatment of other participants, or any other reason.

7. In applying s99 the Commissioner adjusted the appellant’s income by disallowing the deduction of interest paid under the arrangement.  As the Authority said this adjustment was “simple and appropriate” as well as being “the most effective and fair way of counteracting the tax advantage”.  (Pages 9134 to 9135)  It was a proper treatment of a taxpayer who had obtained a tax advantage and it met the requirements of s99(3). We do not accept that the liability of other taxpayers, in particular that of the Equiticorp subsidiary pay to tax on interest it received, involves any element of inappropriate double taxation.

8. For these reasons this ground of appeal also fails.

The scope of inquiry in the objection process

1. Before concluding this judgment, in agreement with Tompkins J, we wish to indicate that in undertaking a lengthy examination of the departmental processes concerned the Authority exceeded the scope of its statutory powers.  As we have said the function of the Authority was to hear and determine the objection disallowed by the Commissioner by conducting a fresh hearing into the matters raised in the objection, in which questions of validity as well as correctness of the assessment could be considered.  But the Authority’s role remained one which was concerned with the correctness of the assessment.  It did not extend to conducting what was effectively a broad based judicial review of the process leading up to the Commissioner’s assessment and disallowance of the objection and subsequent conduct of the proceeding before the Authority.  What transpired is contrary to the general primacy of the objection procedure over judicial review as the means of challenge which will ascertain the correct tax liability.

2. Prior to the issue of an assessment the process of the Commissioner can be challenged in judicial review proceedings in the High Court in order to impugn the validity of the prospective assessment; BNZ Finance Ltd v Holland (1996) 17 NZTC 12,658.  Once an assessment has been made or apparently made under s27 of the 1976 Act, its correctness can be challenged only through the statutory objection proceedings.  In Commissioner of Inland Revenue v Canterbury Frozen Meat Co Ltd [1994] 2 NZLR 681, 688 Richardson J drew a distinction, however, between “challenging the correctness of a decision on the one hand and challenging the process followed and the character of the resulting decision on the other”. In the former instance the statute limited a taxpayer to challenging the process through the statutory procedure. In the latter the Court recognised there could be a challenge on public law grounds by judicial review.

3. These basic principles of jurisdiction were reiterated in Golden Bay Cement Co Ltd v Commissioner of Inland Revenue [1996] 2 NZLR 665 at pp670-671. In that case this Court observed that not only was the objection procedure under the 1976 Act the primary means of challenging an assessment, or apparent assessment, but under that statutory procedure the validity of an assessment could be challenged as well as its correctness (at p664). That of course was so whether the power to assess was challenged under the statutory procedure before the Authority or the High Court in the first instance. In Golden Bay Cement this Court further emphasised the primary nature of the statutory objection procedure by indicating that where the statutory process was available the Court would only rarely exercise its discretion to grant relief by way of judicial review.  It would do so only in exceptional cases and typically, where an abuse of power was involved.  In the normal course, including cases where the issue was whether the time bar under s25 of the 1976 Act applied, the challenge was to be by way of the statutory route.  The Court’s approach has since been affirmed in NZ Wool Board v Commissioner of Inland Revenue [1997] 2 NZLR 6 CA and by the Privy Council in Miller (cited above at paras 17 and 18).

4. To the extent that the appellant in this case used the objection procedure to challenge whether the actions of the Commissioner constituted a valid assessment made within time, the Authority’s process was of a kind contemplated by these authorities.  But the Authority’s wider process challenge to what took place after the act of assessment was not.  In accepting that jurisdiction questions could be raised in the statutory process the decisions of this Court in Canterbury Frozen Meat and Golden Bay Cement did not, and were never intended to, invite fishing expeditions into the internal processes of the Department seeking administrative law grounds on which to mount objections to substantive assessments.  That is what transpired in the present case.

5. In the course of the statutory procedure the administrative decisions of the Commissioner are challenged in a manner that enables the correct decision on the taxpayer’s liability to prevail, if necessary through invoking the appeal process.  In the end, if it is determined that the taxpayer was initially assessed by a genuine exercise of judgment as to the assessable income and, ultimately, was correctly assessed, the respective principles underlying the statutory review scheme and judicial review are in harmony.  Importantly, as well, the integrity of the tax system in the eyes of the public is maintained.  The force of complaints of improper motive then falls away as is indicated by Commissioner of Inland Revenue v NZ Wool Board para 49; and Russell v Taxation Review Authority (2001) 20 NZTC 17,418 para 9.

Conclusion

1. Mr Grierson was able to point to some minor factual errors in the High Court judgment including an observation by the Judge that the $2.8 million advance was paid back to the Equiticorp subsidiary on the same day.  Strictly the funds were returned by way of an interest payment and for acquisition of the promissory note by Fairhaven.  Likewise there was an error as to the date of winding up of Centratherm.  None of these minor discrepancies however has any bearing on the substance of the High Court judgment which in our view reached a correct conclusion on each issue raised in the appeal.

2. For these reasons each of the grounds of appeal against the judgment of the High Court fails.  The appeal is accordingly dismissed with costs to the respondent of $10,000 together with all reasonable disbursements to be fixed by agreement or failing agreement by the Registrar.

Solicitors

B M Grierson, Auckland, for Appellant
Crown Law Office, Wellington, for Respondent