Edwards v Commissioner of Inland Revenue
[2016] NZHC 1796
•5 August 2016
IN THE HIGH COURT OF NEW ZEALAND WELLINGTON REGISTRY
CIV-2015-485-526 [2016] NZHC 1796
UNDER the Income Tax Act 2007 and the Tax
Administration Act 1994
IN THE MATTER OF
an appeal from a decision of the Taxation
Review Authority dated 8 June 2015BETWEEN
BRIAN DONALD EDWARDS First Appellant
EDWARDS BROS CONSTRUCTION (HAWKES BAY) LIMITED
Second Appellant
AND
COMMISSIONER OF INLAND REVENUE
Respondent
Hearing: 12 October 2015 Counsel:
M T Lennard for Appellants
P Courtney and P Ieong for RespondentJudgment:
5 August 2016
JUDGMENT OF WILLIAMS J
Contents
Introduction ............................................................................................................. [1] Relevant provisions ................................................................................................. [4] The broad issues .................................................................................................... [10] The facts ................................................................................................................. [14] The captive insurance scheme............................................................................. [15] Craybay ............................................................................................................... [18] Mr Edwards’ and Ms Paterson’s evidence in the TRA ........................................ [23] The Commissioner’s decision.............................................................................. [29] The TRA appeal..................................................................................................... [30] The standard for time bar rulings ....................................................................... [36] Appellants’ submissions ...................................................................................... [36] Crown submissions.............................................................................................. [39]
EDWARDS v COMMISSIONER OF INLAND REVENUE [2016] NZHC 1796 [5 August 2016]
Analysis .................................................................................................................. [40] Some history ........................................................................................................ [41] Legarth ................................................................................................................ [45] Recent authorities................................................................................................ [48] My view of the authorities ................................................................................... [66] The effect of s 138P ............................................................................................. [77] Conclusion .......................................................................................................... [84] The shortfall penalty cross-appeal....................................................................... [87] Submissions ......................................................................................................... [90] Analysis ............................................................................................................... [96] Conclusions and disposition ............................................................................... [117]
Introduction
[1] In April and May 2014, the Commissioner of Inland Revenue reassessed the appellants’ income tax for the tax years 2004–2008. She found they had made impermissible deductions from declared incomes in those years ($158,967.32 for the first appellant and $700,000 for the second). The deductions were for premiums paid by way of promissory notes to a “captive insurance scheme” they planned to establish. Ordinarily the Commissioner is not allowed by the terms of s 108 of the Tax Administration Act 1994 (TAA) to reopen tax assessments that are more than four years old. The Commissioner had first to lift the four year time bar against such reassessments contained in the section. She found the time bar could be lifted because the relevant returns were fraudulent or wilfully misleading as required by s 108(2). Once the bar was lifted and the reassessments made, she also imposed shortfall penalties for evasion ($8,458.33 and $43,312.52 respectively).
[2] The appellants appealed those rulings to the Taxation Review Authority (TRA). In a judgment issued on 8 June 2015, the TRA upheld the Commissioner’s decision to lift the time bar.1 She also upheld the Commissioner’s substantive reassessments. But the TRA reduced the shortfall penalties because, she found, the Commissioner had not established evasion. The TRA accepted the Commissioner’s alternative argument that the appellants were grossly careless in claiming the
relevant deductions. A reduced penalty was therefore justified.
1 Edwards v Commissioner of Inland Revenue [2015] NZTRA 9 [TRA decision].
[3] The taxpayers now appeal to this Court against the Commissioner’s time bar ruling only. They do not challenge the substantive reassessments. The Commissioner cross-appeals on the TRA’s evasion findings in relation to shortfall penalties.
Relevant provisions
[4] Section 108(1) of the Tax Administration Act 1994 (TAA) contains a time bar against reassessments. It provides that the Commissioner may not amend any assessment so as to increase the amount assessed or decrease the amount of a net loss at any time more than four years from the end of the tax year in which the taxpayer has provided the return in question. All returns in the present case were more than four years old at the date of the Commissioner’s reassessment.
[5] Subsection (2) of s 108 sets out the relatively narrow circumstances in which the time bar may be lifted and a reassessment made. Importantly for the purposes of this appeal, the subsection is subjectively worded. It provides as follows:
If the Commissioner is of the opinion that a tax return provided by a taxpayer––
(a) is fraudulent or wilfully misleading; or
(b) does not mention income which is of a particular nature or was derived from a particular source, and in respect of which a tax return is required to be provided,––
the Commissioner may amend the assessment at any time so as to increase its amount.
[6] If the Commissioner holds the required opinion under s 108(2), she may also rule that the taxpayer is liable to pay, in addition to any reassessment, a shortfall penalty for “evasion or similar act” under s 141E. The qualifying acts are listed in s 141E(1) as follows:
A taxpayer is liable to pay a shortfall penalty if, in taking a tax position, the taxpayer––
(a) evades the assessment or payment of tax by the taxpayer or another person under a tax law; or
(b) knowingly applies or permits the application of the amount of a deduction of withholding a tax made or deemed to be made under a tax law for any purpose other than in payment to the Commissioner; or
(c) knowingly does not make a deduction, withholding of tax, or transfer of payroll donation required to be made by a tax law; or
(d) obtains a refund or payment of tax, knowing that the taxpayer is not lawfully entitled to the refund or payment under a tax law; or
(da) attempts to obtain a refund or payment of tax, knowing that the taxpayer is not lawfully entitled to the refund or payment under a tax law; or
(e) enables another person to obtain a refund or payment of tax, knowing that the other person is not lawfully entitled to the refund or payment under a tax law; or
(f) attempts to enable another person to obtain a refund or payment of tax, knowing that the other person is not lawfully entitled to the refund or payment under a tax law––
(referred to as evasion or a similar act).
[7] The penalty payable for any of the acts under subs (1) is 150 per cent of the
resulting tax shortfall, but this may be reduced at the Commissioner’s discretion.2
[8] Alternatively, under s 141C, a taxpayer may be liable to a lesser penalty if he or she is not guilty of evasion or similar act, but instead is merely “grossly careless in taking a taxpayer’s tax position”. Gross carelessness under subs (3) means “doing or not doing something in a way that, in all the circumstances, suggests or implies complete or a high level of disregard for the consequences.”
[9] The penalty for gross carelessness is 40 per cent of the resulting tax shortfall
(pursuant to subs (2)).
The broad issues
[10] The taxpayers do not challenge the correctness of the Commissioner’s reassessments. They thus accept that deductions were claimed in the relevant years that should not have been. Rather, they challenge the Commissioner’s authority to
make the reassessments at all. The appellants say the facts did not meet the test for
2 See subs (4).
lifting the four year time bar. They say the TRA was wrong to uphold the Commissioner in this respect. This aspect of the appeal is thus an attack on the correctness of the Commissioner’s finding that the taxpayers were fraudulent or wilfully misleading when they claimed the deductions in the relevant years.
[11] This direct challenge to correctness raises a prior issue: whether the TRA was correct when she concluded that, on appeal, she had no power to undertake a full merits review of that finding of the Commissioner because s 108(2) is subjectively worded. If the TRA’s view in that respect was correct, the relevant opinion is that of the Commissioner and it cannot be usurped by the TRA except where illegality or irrationality are established. This is the most important issue in the primary appeal.
[12] Subsequent issues arise on the primary appeal as to whether, in any event, the TRA applied the correct test for fraudulent and wilfully misleading, and whether there was sufficient evidence to support the conclusions reached on application of the correct test. But, as we shall see, these issues effectively become subsumed in the Commissioner’s cross-appeal in relation to evasion and I will address them, where necessary, there.
[13] The cross-appeal by the Commissioner relates to the TRA’s shortfall penalty decision. It raises the issue of whether the TRA applied the correct test for “evasion or similar act”. The Commissioner also argues, essentially, that the TRA’s findings in relation to evasion were so inconsistent with the evidence as to be irrational.
The facts
[14] The first appellant is a farmer, businessman and qualified civil engineer. He was, between 2004 and 2008, a partner in a farming partnership with his two brothers, and a shareholder with them in Edwards Bros Construction (Hawkes Bay) Ltd. This company engaged in construction and mining. In this judgment I will refer to these entities as Edwards Partnership and Edwards Construction respectively. I will generally refer to the first appellant simply as Mr Edwards.
The captive insurance scheme
[15] The case concerns a captive insurance scheme Edwards Partnership and Edwards Construction said they intended to set up in 2004. It was proposed, they said, that the insurance requirements of both entities would be provided through a company controlled by Mr Edwards or wider Edwards Brothers interests. Mr Edwards said he and his brother had, over the years, become increasingly concerned at the amount of money their group of businesses was having to spend on insurance. Far better, he said in evidence, to pay the premiums to an entity they controlled if such a scheme could be made to work.
[16] Before setting up this captive insurance scheme, Mr Edwards obtained advice from a tax specialist about the proper tax treatment of any insurance premiums Edwards Partnership and Edwards Construction might pay to such a scheme. The advice was that, provided certain conditions were met, premiums would be deductible. Relevant parts of the advice were as follows:3
I have advised that provided that the Captive Insurance Company is a genuine general insurance company and in fact can show that it is bearing genuine insurance risk itself as opposed to reinsuring 100%, the insurance premium should be deductible.
…
Naturally the Captive Insurance Company will need to comply with general insurance practices including calculation of unearned premium income, reserves for claims, incurred but not reported claims etc. It would appear that they would need expert advice from an actuary or other insurance expert to insure the adequacy of its reserves.
It has come to my attention that requirements beyond the ambit of taxation will also need to be met. Under the insurance Deposits Regulations (sic) a deposit of $500,000 is required to be established and maintained with the Insurance Authorities. There are also requirements that the company may need to meet Insurance Company Ratings requirements. I understand that as a captive not offering insurance to the general public the insurance ratings requirements may be able to be avoided.
…
[17] In summary, the advised requirements were that the new insurance company could demonstrate that it bore actual risk, had sufficient cash reserves to meet claims
3 Tax advice letter, Barry King, 4 August 2004.
from within the group and had made a deposit with “Insurance Authorities”, in the sum of $500,000.
[18] Mr Edwards initially instructed his accountant, Ms Patricia Paterson, to establish a New Zealand company4 but discussions with Australian business associates led him to conclude the captive insurance company should instead be incorporated in Australia. This was because Mr Edwards had been led to believe by these connections that the Australian regulatory requirements were not as strict as those in New Zealand.
Craybay
[19] Meanwhile the Edwards brothers already owned a business in Australia. They had operated Craybay Construction in Brisbane as a general construction business. According to Mr Edwards, his intention at that point was that Craybay would change its business to that of an insurer for Edwards Partnership and Edwards Construction, and be incorporated and renamed Craybay Insurance Pty Ltd. The
$500,000 deposit also required by Australian law to be lodged with Australian insurance regulators would be paid when funds became available. There were no such funds to hand at that point.
[20] Mr Edwards decided therefore that annual insurance premium payments to Craybay would be made by way of promissory notes payable on demand, and Craybay would be later registered as an insurance company once the Edwardses and/or Craybay Insurance could afford to pay the insurance bond.
[21] The first promissory notes were issued to Craybay by Edwards Partnership and Edwards Construction on 31 July 2004. Craybay Construction was not in fact incorporated as Craybay Construction Pty Ltd until 12 August 2004 (and was never incorporated as Craybay Insurance Pty Ltd). This was nearly two weeks after the first batch of promissory notes were issued. Thereafter Edwards Partnership and Edwards Construction issued promissory notes to Craybay annually for $100,000
and $175,000 respectively until 2007. In 2008, Mr Edwards issued his last
4 With himself and his daughters as shareholders to keep it separated from Edwards Partnership and Edwards Construction.
promissory note on behalf of the partnership. These annual payments by promissory note were brought to an end at around that time because one of the Edwards brothers (Ross Edwards) withdrew from Edwards Partnership and Edwards Construction. The withdrawal was acrimonious. Mr Edwards said he decided then not to proceed with finalising the insurance scheme because the scheme had come to involve too much effort, and the money required to pay out the departing brother made raising the required $500,000 deposit too difficult.
[22] Craybay, though formally incorporated, never changed its name to Craybay Insurance Pty Ltd. The company remained involved in construction activities in Australia in 2005 and 2006 but did not trade at all after 2006. It never provided any insurance services either to Edwards Partnership or Edwards Construction.
Mr Edwards’ and Ms Paterson’s evidence in the TRA
[23] Mr Edwards said that between 2004 and 2008 he genuinely believed that he (as a member of Edwards Partnership) and Edwards Construction were entitled to claim income tax deductions for the promissory notes even though Craybay was not registered as an insurance company and the bond required to be lodged with Australian insurance regulators had not been paid.
[24] Ms Paterson gave evidence before the TRA on behalf of the appellants. She confirmed much of Mr Edwards’ narrative. She prepared the accounts for Edwards Partnership and Edwards Construction during the tax years in question and she confirmed that relevant promissory notes had been executed each year by each entity. These were recorded in the financial statements under the entry ‘Insurance’. Ms Paterson said her view was that because the promissory notes constituted a legal obligation to pay Craybay, they were properly deductible for tax purposes.
[25] Ms Paterson confirmed that her firm also prepared financial accounts for Craybay, while another firm of accountants in Australia filed Craybay’s Australian tax returns in the 2005 and 2006 years. The promissory notes were not declared as income in Craybay’s tax returns for those years. Nor were they recorded as income or assets in Craybay’s financial accounts. No financial accounts or tax returns were prepared for Craybay in later years.
[26] Ms Paterson advised the TRA that as Mr Edwards had decided not to proceed with the scheme, she reversed all the promissory notes deductions for the years 2004 to 2008 in the 2008 year.5 Ms Paterson subsequently received tax advice that she should have sought IRD permission to reverse the deductions in the income year in which they had been claimed but, she said, she did not consider at the time that this was required.
[27] Ms Paterson confirmed that she advised Mr Edwards that Edwards Partnership and Edwards Construction were entitled to the promissory note deductions. But she accepted in hindsight that this advice was “possibly incorrect”. She considered at the time that the fact that Craybay was not then incorporated and registered as an insurance company was immaterial. She said she understood the tax specialist’s advice to be that the insurance company had to be set up at some stage rather than at the outset. She accepted that she did not at any stage ask Mr Edwards whether Craybay Insurance had been properly established.
[28] There was considerable delay in Mr Edwards providing to the IRD evidence of the promissory notes themselves, so that during the course of the IRD audit, there appeared to be no insurance company at all and no record of any promissory notes. It was not until 30 April 2013 (nearly three years after the IRD investigation began)6 that the promissory notes were finally provided by Mr Edwards. He claimed that he eventually found them in storage in a warehouse. The 2008 promissory note was
never found.
The Commissioner’s decision
[29] On 10 April 2014, the Commissioner released a report setting out her findings.7 She found that the time bar could be lifted because she was of the opinion that the tax returns provided were fraudulent or wilfully misleading. The total
impermissible deductions for Mr Edwards (2004-2008) were $158,967.32, and for
5 As a result of an administrative mistake on the part of the accountant’s firm, the deduction was
not in fact reversed until 2009 but nothing turns on that.
6 Following a GST audit in April 2010, a decision was taken in May 2010 to widen the investigation to include a review of the income tax returns for Edwards Partnership and Edwards Construction.
7 Office of the Chief Tax Counsel Adjudication Report (10 April 2014).
the company (2004-2007), $700,000. She found that they were liable for shortfall penalties under s 141E for evasion or similar act. The default penalty of 150 per cent of the shortfall was reduced by 75 per cent under s 141I because the shortfall was temporary as the deductions were reversed in 2008. A further 50 per cent reduction was granted under s 141FB for previous good behaviour. The resulting penalties imposed were $8,458.33 for Mr Edwards and $43,312.52 for the company.
The TRA appeal
[30] Mr Edwards and Edwards Construction appealed the time bar and shortfall penalty decisions to the TRA.
[31] The TRA considered that her jurisdiction in relation to the time bar appeal was constrained by the subjective language in s 108(2). She said that this language meant she could not review de novo the substance of the Commissioner’s opinion. The TRA considered she could not go beyond essentially judicial review grounds. Within this parameter, the TRA concluded that the Commissioner’s opinion that the deductions were fraudulent or wilfully misleading was honestly held and reasonably available to her on the evidence as it existed when the ruling was made. She refused to revisit it and found that the Commissioner was entitled to undertake the reassessments accordingly.
[32] The TRA did not however agree with the Commissioner’s conclusion that claiming these deductions amounted to evasion or similar act under s 141E and so a shortfall penalty of 150 per cent was not payable. She took this view essentially because:8
In the present case there was no evidence of any intention by [Mr Edwards] to deliberately delay payment of the disputants’ tax obligations. It was Mr [Edwards’] evidence (which was not challenged) that the deductions were reversed and the income was returned (albeit in the wrong years) when Mr [Edwards] made the decision not to proceed with the insurance scheme. To that point in time, Mr [Edwards] understood and proceeded on the basis that the deductions were able to be claimed.
The onus is on the Commissioner to prove evasion on the balance of probabilities. After careful consideration I am not satisfied for the reasons
8 TRA decision, above n 1, at [84] and [85].
set out above that Mr [Edwards] had the requisite knowledge or subjective recklessness to evade the assessment or payment of tax.
[33] Instead the TRA considered the lower gross carelessness standard applied as set out in s 141C. The Judge concluded in that respect:9
Mr [Edwards] is a successful business man and qualified civil engineer. I accept that he was not knowledgeable in tax and accounting matters. However I would expect a reasonable person with his background and experience to appreciate that if it is intended to take advantage of a business structure (in this case a captive insurance company) that it was necessary to ensure that it was properly set up.
I agree with the Commissioner’s submission that in light of the tax specialist’s advice, such a person knowing that the captive insurance company had not been properly established, would have made enquiries to check that the absence of this structure did not prevent the disputants from claiming the very significant deductions which were proposed.
… [D]eductions were simply claimed without further enquiries being made as to the correctness of this action. I consider that this was a risk which was readily foreseeable by a reasonable person in Mr [Edwards’] position.
… Taking the above matters into account I am of the view that
Mr [Edwards] was grossly careless in claiming tax deductions for the
‘insurance payments’. Furthermore as Mr [Edwards] was the mind of
[Edwards Construction], I find the [Edwards Construction] was also grossly careless. Shortfall penalties for gross carelessness are therefore imposed (with the attendant reductions discussed above).
[34] A 40 per cent shortfall penalty for gross carelessness was then imposed by the TRA subject to a 75 per cent reduction as provided for under s 141I. The reduction was to recognise the tax shortfalls had only temporary effect (the deductions were, as I have said, repaid in 2008). A further 50 per cent reduction was made for previous good behaviour.
[35] I will address the taxpayer’s appeal first and then turn to the Commissioner’s
cross-appeal.
9 At [94]-[97].
The standard for time bar rulings
Appellants’ submissions
[36] Mr Lennard submits that the TRA was wrong to refuse to review the Commissioner’s time bar ruling on a de novo merits basis. He submitted that the controlling authority is Commissioner of Inland Revenue v Legarth,10 a 1969 Court of Appeal decision. In that case the Court of Appeal held that the Taxation Review Board was required to review substantively the opinion of the Commissioner even though s 24 of the Land and Income Tax Act 1954 was worded subjectively. Crucially, Mr Lennard submitted, s 24 of the 1954 Act was materially identical to the controlling provision in this case, s 108 of the TAA.
[37] The Court in Legarth, Mr Lennard pointed out, held that the subjective wording of the provision was neutralised by the terms of s 18(2) of the Inland Revenue Department Amendment Act 1960. This set out the powers of the Board of Review when considering objections. The Board had “… all the powers, duties, functions, and discretions of the Commissioner in making the determination.” The Court concluded that the Board stood in the Commissioner’s shoes in all respects when considering an objection in relation to the opinion formed under s 24. The Board could come to its own opinion as if it were the Commissioner.
[38] Mr Lennard submitted that Legarth is binding on this Court, and subsequent cases tending to suggest that a lesser standard of review is applicable are all either distinguishable, wrong, and/or, to the extent actually applicable, supportive of the appellant’s case on a proper reading.
Crown submissions
[39] For the Crown, Ms Courtney submitted that the TRA applied the correct review standard. The taxpayer must show that the Commissioner’s opinion was not honestly held, that she had applied a wrong legal test, or the opinion was simply not
reasonably open to her on the evidence. Legarth, she submitted, no longer
10 Commissioner of Inland Revenue v Legarth [1969] NZLR 137 (CA).
controlled the review standard in challenges to time bar decisions. Her reasons may be summarised as follows:
(a) Ms Courtney accepted that s 138E(1)(e)(iv) TAA prohibits substantive challenges to the Commissioner’s time bar opinion under s 108A relating to GST, and that there is no similar prohibition in relation to her time bar opinions under s 108 in relation to income tax. This distinction, the Commissioner submitted, appears to be a historical aberration created by the 1960’s decisions in Maxwell v Commissioner
of Inland Revenue and Sleeman v Commissioner of Inland Revenue.11
It has been overtaken by subsequent events, it was submitted, and the prohibition that is express in relation to GST should now be taken as implied in relation to income tax.
(b)The statutory context has changed. The equivalent time bar provision for GST returns (s 108A) has no substantive review provision and GST time bar decisions can only be challenged by way of judicial review (see Auckland Institute of Studies Ltd v Commissioner of Inland Revenue12 (AIS)). There is, the Commissioner submitted, no longer any reason to apply a different standard for income tax to that applicable to the GST time bar. Legarth was decided at a time when the modern law of judicial review had yet to be developed. The Court
in that case reached its view because unless it found an express right of appeal, there would, on the state of administrative law at the time, be no review at all.
(c) As Heath J noted in Vinelight Nominees Ltd v Commissioner of Inland
Revenue,13 under the old legislation challenges to the Commissioner’s
opinion were brought at the same time as the substantive reassessment
11 Maxwell v Commissioner of Inland Revenue [1962] NZLR 683 (CA); Sleeman v Commissioner of Inland Revenue [1965] NZLR 647 (SC). I will address these decisions in the analysis section below.
12 Auckland Institute of Studies Ltd v Commissioner of Inland Revenue (2012) 20 NZTC 17,685 (HC) [AIS].
13 Vinelight Nominees Ltd v Commissioner of Inland Revenue, HC Auckland CIV-2005-404-2774,
22 July 2005 [Vinelight No 1].
in a single objection package. By contrast, in the case before me, the two were split in the sense that the appellants offer no challenge to the correctness of the reassessment itself.
(d)The introduction in 1996 of challenges to “disputable decisions” under s 138P has further significantly changed the statutory context. The TRA no longer has omnibus powers per s 16(2) of the Taxation Review Authorities Act 1994 (equivalent to the old s 18(2) which provided the basis for the Legarth decision) to step into the shoes of the Commissioner. Instead disputable decisions that are not “assessments” under the TAA (lifting the time bar meets that description), cannot now be remade by the TRA in a challenge under Part 8A as if the TRA were the Commissioner. Now the TRA may only direct the Commissioner to alter her decision in order to bring it into compliance with the TRA’s view.
(e) Modern Court of Appeal authority has followed AIS and impliedly overruled Legarth: see Wire Supplies Ltd v Commissioner of Inland Revenue.14
Analysis
[40] To properly understand the Legarth decision upon which Mr Lennard relies, a brief summary of early 1960s tax law is unfortunately required. I will be brief.
Some history
[41] In 1962, in Maxwell, the Court of Appeal found that any opinion adopted by the Commissioner under s 24 of the Land and Income Tax Act in relation to the lifting of time bars was unreviewable on any practical basis. This was for two reasons. First, because the equivalent of the current s 138E TAA (then s 45 Land and Income Tax Act) excluded from the standard statutory objection process any decision
that, by the terms of the Act, was left to the “discretion, judgment or determination
14 Wire Supplies Ltd v Commissioner of Inland Revenue [2007] NZCA 244, [2007] 3 NZLR 458 at [87].
of the Commissioner”. This covered a wide class of decisions including all time bar decisions. On seeing this the Maxwell Court expressed dismay that the taxpayer would be left “… wholly at the mercy of the Commissioner’s opinion.”15 Such immunity from challenge was so problematic according to Gresson P, that it “may well be regarded as contravening basic principles of justice”.16 The second reason was that, in those days, the Court took a narrow view of its inherent judicial review powers, so that without access to the objection procedures there was no alternative procedure for challenge in the face of a widely worded privative clause contained in s 26 of the Act.17
[42] In 1960 (prior to Maxwell), s 45 of the Land and Income Tax Act had been replaced with a new s 35. This provision listed, for the first time, the specific provisions of the Act that were to be excluded from the statutory objection process. Subsection (f) provided that there could be no objection in relation to “any matter which by any provision in … Part II … of this Act is left to the discretion, judgement, opinion, approval, consent, or determination of the Commissioner.” Part II contained (among other things) the Commissioner’s time bar decisions. This specific provision thus continued the effect of s 45’s more general wording.
[43] In 1962, in response to the concerns the Court of Appeal expressed in Maxwell, subs (f) was amended. Section 24 – which provided for income tax time bar decisions – was explicitly exempted from the exclusory effect of s 35. This change meant that any decision of the Commissioner to lift the income tax time bar became reviewable under the objection process.
[44] Each iteration of s 24 since 1962 has been similarly protected from the impact of successive objection exclusion provisions. Today s 138E performs that
function. It provides that there is no right of challenge under the Part 8A challenge
15 Maxwell, above n 11, at 697.
16 At 697.
17 In 1965, Wilson J in the Supreme Court in Sleeman, above n 11, took the view that this interpretation of s 45 was wrong because an “opinion” was different to, and less final than, a
“discretion judgment or determination”. I rather doubt the merit of that analysis although it was picked up by later Courts. Opinions can, in my experience, be very final indeed. In any event, Wilson J was clearly bound by higher authority in Maxwell. By then however, the amendment to what became s 35(f) had been made suggesting that Parliament accepted the Court of Appeal’s view in Maxwell and the disagreement became moot.
procedures in relation to a long list of decision-making provisions if the decision also relates to a matter left to the “discretion, judgment, opinion, approval, consent or determination of the Commissioner.” In line with historical treatment of the issue, the s 108 income tax time bar is not in the list, though other similar time bar provisions are – such as s 108A in relation to GST returns. The Commissioner is right that the protection of objection rights in relation to s 108 is thus something of a relic in the Act.
Legarth
[45] Legarth was decided in 1969 after the amendment of s 35(f).18 The case related to 13 year-old undeclared wool receipts. The Commissioner decided to lift the time bar in order to reassess Legarth’s income for the relevant tax years. At issue was the standard of review to be adopted by the Board when it decided the objection brought by Legarth. Did the subjective language of s 24 mean effectively a judicial review standard was to be applied, or could the Board review de novo the Commissioner’s opinion on whether Legarth’s return was fraudulent or misleading?
[46] The Court of Appeal found unanimously, in three separate judgments, that the Board was empowered to review the Commissioner’s opinion on lifting the time bar on its merits. Critical to that finding was s 18(2) of the Inland Revenue Department Act 1960. That provision granted the Board wide powers of review:
For the purpose of hearing and determining any objection, the Board shall have all the powers, duties, functions and discretions of the Commissioner in making the determination.
[47] This provision, the Court of Appeal held, meant the Board could stand in the
Commissioner’s shoes even in relation to matters of her subjective opinion.
Recent authorities
[48] Section 16(2) of the Taxation Review Authorities Act (the statute which establishes the TRA and sets out its powers) is still in substantially the same terms.
The subsection provides:
18 Legarth, above n 10.
For the purpose of hearing and determining any objection or challenge, an Authority shall have all the powers, duties, functions, and discretions of the Commissioner in making the determination.
[49] Notwithstanding this, a number of recent decisions in this Court, and one in the Court of Appeal, have departed from the Legarth approach. These decisions have distinguished Legarth on the basis of differing facts or statutory contexts.
[50] The Commissioner says these cases indicate a general rejection of the Legarth merits review principle. Mr Lennard, for the appellants, argues the recent cases are either misread by the Commissioner, wrong or distinguishable.
[51] The first in this line of modern cases is AIS. The case related to GST treatment of services provided outside New Zealand to international students. The Commissioner wished to reopen AIS’ GST returns made between six and four years prior to the proposed reassessment. Because the GST time bar provision (s 108A) is included in the s 138E list, AIS could not challenge the Commissioner’s opinion under Part 8A. Rather, the challenge had to be brought by way of ordinary application for judicial review.
[52] Rodney Hansen J set out his view of the correct approach to the GST time bar provision in the following terms:19
I take from the authorities the following principles:
(a) The critical issue is whether the Commissioner was honestly of the opinion that the plaintiff knowingly failed to make full and true disclosure of all material facts.
(b) The onus of proving that the opinion was not honestly held is on the plaintiff.
(c) In order to successfully challenge the decision of the Commissioner to assess or reassess outside the four year period the plaintiff must show:
(i) the Commissioner did not honestly hold the opinion.
(ii) the Commissioner misdirected himself on the legal basis on which the opinion was to be formed.
19 AIS, above n 12, at [102].
(iii) the opinion was one which was not reasonably open to the
Commissioner on the information available to him.
[53] Mr Lennard suggested this limited review standard simply reflected the judicial review procedure that AIS was required to adopt, but I do not think this is necessarily right. The authorities referred to by the Judge in coming to his conclusions were Maxwell, Sleeman and Legarth. The Judge was setting down a standard he considered applicable to all such subjectively worded provisions.
[54] Mr Lennard is right however that although the Judge referred to Legarth in passing, he did not grapple with its conclusion, which was, as I have said, diametrically opposed to the conclusion he reached. That may perhaps be explained by the fact that the time bar in relation to GST is on the s 138E non-reviewability list anyway, but if that was in the Judge’s mind, he did not say so explicitly.
[55] Two other recent cases did more squarely address the applicability of the Legarth principles. These were Vinelight Nominees Ltd v Commissioner of Inland Revenue20 (Vinelight No 1) and Vinelight Nominees Ltd v Commissioner of Inland Revenue21 (Vinelight No 2). They related to the Commissioner’s decision to reopen income tax returns under s 108(2) and so (unlike AIS) engaged the same provisions
as the present case.
[56] In Vinelight No 1, Heath J addressed an application by both parties to settle preliminary questions under the High Court Rules. Heath J traversed the judgments in Legarth. He pointed to important procedural differences between the current approach to challenges and that which obtained in the 1960s:22
The present Act envisages two distinct steps as part of the reassessment process when the time bar created by s 108(1) of the Act applies. The first is the need for the Commissioner to form an opinion under s 108(2) which provides a triggering event (the reopening decision) for reassessment. The second is for the Commissioner to reassess, a process which brings into play other provisions of the Act dealing with assessments generally.
In the days when Legarth was decided, the challenge to the reopening decision and the assessment were heard together. However, the Tax
20 Vinelight No 1, above n 13.
21 Vinelight Nominees Ltd v Commissioner of Inland Revenue (2005) 22 NZTC 19,519 (HC) [Vinelight No 2].
22 Vinelight No 1, above n 13, at [15]-[16].
Administration Amendment Act (No 2) 1996 introduced the concept of a “disputable decision” by which particular decisions of the Commissioner under a tax statute could be litigated through the Courts. It is that amendment that Mr Lennard submitted entitled his clients to challenge the reopening decision at this time [i.e. prior to the Commissioner’s reassessment].
[57] The Judge then reviewed the terms of s 138E and found that the reopening decision was prima facie amenable to challenge under Part 8A in its own right and without having to wait for the substantive reassessment.
[58] Heath J set appropriate preliminary questions accordingly. Two of the preliminary questions related to the review standard applicable to the Commissioner’s opinion under s 108(2).
[59] The preliminary questions then came before Lang J for decision. Contrary to Heath J’s view, Lang J concluded that it was not appropriate for the challenge to the Commissioner’s opinion under s 108(2) to be heard separately from the reassessment challenge itself. He considered:23
[The reopening opinion] does not exist in its own right, and has no real meaning or significance until an assessment is issued. It is but one of the steps to be taken by the Commissioner before he issues an assessment. Any challenge to the opinion should logically, therefore, be made in the context of a challenge to the assessment as a whole.
[60] Lang J doubted therefore whether a s 108(2) opinion was a disputable decision capable of challenge at all.24
[61] In case his conclusion in that respect was wrong, Lang J went on (in obiter), to conclude that in any event Legarth did not apply to the facts before him. He said:25
There is, however, an important distinction between the facts in Legarth and those in the present case. In Legarth the Court was dealing with an objection to actual assessments. No assessments have yet been issued in the present case. As a result, the Court was considering an entirely different situation to that posed by the present case.
23 Vinelight No 2, above n 21, at [26].
24 At [48].
25 At [64].
[62] Lang J preferred the approach of Rodney Hansen J in AIS, and indicated that, were it necessary he would have adopted the narrow review principles referred to in that case as I have set them out above. Lang J did not consider that the fact that AIS was a proceeding in judicial review made any material difference. He concluded:26
I consider that these [AIS] criteria strike an acceptable balance between the right of the taxpayer to be able to challenge the Commissioner’s opinion at an early stage of the assessment process, whilst preserving the Commissioner’s ability to form an initial opinion in circumstances where he is unlikely to have all the information needed to reach a final conclusion.
[63] The final decision for mention in this brief summary is the Court of Appeal decision in Wire Supplies Ltd v Commissioner of Inland Revenue.27 That case related to taxation structuring referred to generally as the “Russell template”, the details of which need not concern us. At issue, for my purposes, was the Commissioner’s decision under s 25(2) of the Income Tax Act 1976 (that Act’s equivalent of s 108(2) TAA) under which the four year time bar could be lifted if the taxpayer’s return was,
in the opinion of the Commissioner, fraudulent or wilfully misleading
[64] In that case, the appeal related both to the reopening against the time bar and the reassessments themselves. The appellant argued that the Commissioner’s time bar opinion was not honestly held. The appellant produced internal memoranda where IRD staff seemed to express doubt about whether the s 25(2) standard had been met. It was in this context that the Court considered (following the dictum of Rodney Hansen J in AIS) that:28
There is an onus on the taxpayer to persuade the Court, on the balance of probabilities, that the Commissioner (or the Commissioner’s delegate) did not honestly hold the opinion, that he or she misdirected himself or herself as to the legal basis upon which the opinion was to be formed, or that the opinion was one which was not reasonably open to the decision-maker on the information available to him or her.
[65] It could be said that this was an implied rejection of the Legarth full review principle by the modern Court of Appeal.
26 At [70] (emphasis added).
27 Wire Supplies Ltd v Commissioner of Inland Revenue, above n 14.
28 At [87].
My view of the authorities
[66] I do not accept, at least not fully, the proposition advanced by the Commissioner that Wire Supplies represents the end point of an evolving line of authority set against the Legarth approach. Rather, in my view, each of the cases appears to have either its own distinctive facts built into the reasoning, or relevant caveats of material significance.
[67] The Court in AIS did not have the advantage of the omnibus powers vested in the TRA pursuant to s 16(2) because it was a GST case, and the taxpayer could only bring proceedings in the High Court by way of judicial review. The Court could not step into the Commissioner’s shoes in the way that the TRA can. The Taxation Review Board’s wide powers of decision on appeal, it will be remembered, was the crucial factor in Legarth.
[68] The Vinelight decisions seem to hinge very much on timing. Heath J’s point of distinction was that, unlike Legarth, the challenge before him was preliminary because no substantive reassessment had been undertaken by that stage. This was also critical to Lang J’s reasoning. Lang J doubted whether the reopening decision had any legal existence at all until the assessment was made. Again the timing point was crucial. The Judge recorded that counsel for the Commissioner:29
…emphasised this distinction, and reiterated that the Commissioner accepts that the plaintiffs have a right to challenge the correctness of his opinion once assessments have been issued.
[69] This, in my view is crucial. The concession related to correctness not mere legality or validity. And it related to the correctness of the reopening opinion, not the resulting reassessment. It was necessary to strike a balance between the right of the taxpayer to challenge and the right of the Commissioner to form an opinion because
the challenge arose at an “early stage of the assessment process”,30 in which the
Commissioner was unlikely to have all the information necessary to reach any final
conclusion. The opinion had therefore to be “tentative rather than final in nature”, to
29 Vinelight No 2, above n 21, at [64].
30 At [70].
use the phrase adopted by Rodney Hansen J and accepted thereafter;31 a phrase, I might add, whose original provenance is Wilson J’s dissent from Maxwell in the Sleeman decision.32
[70] In the case before me, the Commissioner’s opinion is not tentative at all. All information is in and the reassessments have been completed. It does not matter that the appellants in this case do not actually challenge the assessments. That was not the point in Vinelight or AIS. Rather, the point was the incomplete nature of the investigation. Here, the investigation is complete and the time bar opinion final.
[71] In Vinelight, counsel for the Commissioner seems to have accepted that once all information is in and the reassessments are done, Legarth controls the applicable standard. It would, the Commissioner seemed to accept, be untidy to adopt a double review standard: one with respect to the final reopening decision and another with respect to the reassessment, when both are usually considered by the TRA at the same time in a single assessment.
[72] And as to the Court of Appeal decision in Wire Supplies, that decision is perhaps limited by the nature of the challenge being brought. There was no attack, on my reading of the judgment, on the correctness of the Commissioner’s opinion. Rather, the suggestion was that the opinion was not honestly held. There does not seem to have been any debate about the applicability of earlier authority such as Legarth because such debate was unnecessary. The challenge in that case was different to the challenges in preceding cases. In any event, the Court recorded its
own caveat on the AIS approach:33
That is not to say that the Court could not inquire into the question of whether the basis for the opinion existed. If, notwithstanding the existence of an IR150 certificate [recording the Commissioner’s opinion], the return in question was produced and it was established that it did, in fact, mention the income of the relevant type, then it would be open to the Court to find that the invocation of the time bar was invalid.
31 AIS, above n 12, at [106].
32 Sleeman, above n 11, at 650.
33 Wire Supplies, above n 14, at [90].
[73] As the Commissioner points out, such a conclusion may be unsurprising given that the inclusion or non-inclusion of an item of income is a simple question of fact. The item is either included or it is not. Nonetheless, the Court of Appeal accepts that a correctness inquiry will be available albeit in relation to the simple, rather black and white issue then confronting the Court.
[74] In my view, Legarth was (with respect) clearly right in terms of the construction of s 24(2) and s 18(2) of the old legislation. The intention of the legislature must have been that whatever decision-making authority was vested in the Commissioner became vested in the Board when an objection was lodged. Once the matter had arrived at Board level, it was the opinion of the Board that mattered, not that of the Commissioner.
[75] That statutory context remains whenever the challenge to the Commissioner’s opinion is brought after the reassessment is completed and the Commissioner can no longer be said to be the holder of a tentative opinion. In those circumstances, the combined effect of s 108(2) and s 16(2) is the same as s 24(2) and s 18(2) in Legarth. I accept the Commissioner’s submission that this seems to be an historic relic in the legislation, but it is there in the language of the statute nonetheless and must be applied until amended or repealed, either expressly or impliedly.
[76] In that regard, I do not consider that the introduction in 1996 of the disputable decision process makes any difference to that interpretation of the relevant provisions. I turn to address that particular point now.
The effect of s 138P
[77] The Commissioner rightly pointed to s 138P which adds a further layer of complexity to the task of interpreting the statute. A 1996 amendment to the TAA introduced the concept of disputable decisions under a new Part 8A. Disputable decisions were then subdivided between assessment and non assessment disputable decisions. Insofar as disputable assessment decisions are concerned, the TRA, as a hearing authority under Part 8A has broad powers under s 138P(1). It can:
(a) confirm or cancel or vary an assessment, or reduce the amount of an assessment, or increase the amount of an assessment to the extent to which the Commissioner was able to make an assessment of an increased amount at the time the Commissioner made the assessment to which the challenge relates; or
(b) make an assessment which the Commissioner was able to make at the time the Commissioner made the assessment to which the challenge relates, or direct the Commissioner to make such an assessment.
[78] But in respect of disputable decisions that are not assessments (the reopening opinion is not an assessment) subs (2) provides that there are limits on what the TRA can do. It:
(a) must not make or alter the disputable decision; and
(b) may direct the Commissioner to alter the disputable decision to the extent necessary to conform to the decision of the hearing authority with the effect the hearing authority specifies.
[79] The reciprocal provisions of subs (3) require the Commissioner to make or amend a disputable decision in such a way that it conforms to the hearing authority’s determination should the hearing authority’s conclusion differ from that of the Commissioner.34 Was this change intended to signal that income tax time bar opinions were now to be brought into line with other time bar decisions? If that is so, the signal is very subtle indeed.
[80] The structure of s 138P(1) and (2) mirrors a format used elsewhere in the Act. Sections 135(2) and 136(18) contain a similar split. “Interlocutory” or non-final discretions located within a larger process of decision-making are constrained in those sections in the same way s 138P(2) is. None of these provisions has been judicially tested and, unsurprisingly, I have found nothing in the history of the enactment of s 138P to explain what level of review the legislature might have had in mind when enacting it.
[81] On the face of it, subss (2) and (3) introduce a procedural rather than a substantive change. The TRA must now direct the Commissioner to bring her
34 Hearing Authority is defined in s 3 of the TAA as either the TRA or this Court as the case requires. Taxpayers may elect to have their challenge considered by this Court rather than the TRA.
decision into line with the TRA’s findings rather than make the dispositive order itself. And the Commissioner must comply with any such direction. But there is nothing in the subsection to suggest that if the TRA reached a different view to that of the Commissioner on the substance of a non-assessment disputable decision, it could not require the Commissioner to change her decision accordingly.
[82] This interpolation of an additional link in the chain of final disposition seems to be no more than a recognition of the subjective wording of the Commissioner’s power. It seems designed to maintain, as it were, the structure of the respective formal responsibilities under the Act while transferring substantive control to the TRA. It cannot, in my view, be said to impliedly repeal s 16(2) of the Taxation Review Authorities Act. I acknowledge of course that s 138P is a specific provision compared to s 16(2) which is general. But the wording of s 138P does not, in terms, negate the effect of s 16(2), it simply adds a procedural twist. The TRA can no longer be said to have the direct powers of the Commissioner but it may nonetheless direct the Commissioner as if it did have such powers and the Commissioner must comply. There is nothing in that interplay that suggests the Commissioner’s opinion is sacrosanct if lawful, reasonable and honest.
[83] The specific and special treatment of the income tax time bar and the decision in Legarth have, together, been in place for 45 years. I would have expected that overturning them, if that were the legislature’s purpose, would be achieved through more direct language than that to which the Commissioner points in s 138P(2).
Conclusion
[84] It follows that the TRA was wrong to restrict her reconsideration of the Commissioner’s time bar ruling to whether the Commissioner’s opinion was honestly held and reasonably available on the evidence. Instead the TRA ought to have reviewed the ruling de novo. The appeal must therefore succeed on that ground.
[85] The question then arises as to whether it is appropriate for me now to do what the TRA would not – that is to reconsider the substantive time bar ruling at this point. Ordinarily the matter would be sent back for reconsideration by the TRA.
[86] Before I turn to the next step in this matter however, and because there is considerable overlap between the Commissioner’s cross-appeal and this aspect of the primary appeal, I will turn to the cross-appeal first before finally resolving whether it is appropriate for me to pre-empt any reconsideration by the TRA of the time bar ruling itself.
The shortfall penalty cross-appeal
[87] As I have said, the Commissioner ruled that the promissory note deductions amounted to evasion or similar act as described in s 141E(1) TAA. This entitled her to impose shortfall penalties of up to 150 per cent of deductions. The TRA disagreed with this finding. The TRA found that evasion was not proved to the required standard because there was no evidence of an intention to evade the payment of tax, nor of subjective recklessness in that respect. Instead the TRA found that a reasonable person, knowing the captive insurance scheme had not been properly established, would have made further inquiries to determine whether insurance premium deductions were properly claimable. Successive failures to do this were, the TRA found, not evasion, but merely gross carelessness under s 141C.
[88] It can be seen that there is an obvious, if subtle, overlap between the subjective recklessness as to fraud or wilful misleading accepted by the Commissioner and upheld by the TRA in her time bar ruling, and the equally subjective evasion recklessness rejected by the TRA in her shortfall penalty finding.
[89] On the approach to the appeal taken by the TRA, these findings are, I accept, at different levels. In the first, the TRA merely accepted that the Commissioner’s finding as to wilful misleading was honest and reasonable, rather than necessarily right. But given the TRA’s rejection of evasion, it seems clear that she would have come to a different view to that of the Commissioner on the time bar if she had considered the issue de novo as I have found was required. So if I uphold the TRA’s shortfall penalty finding, it is difficult to see how a finding of subjective recklessness as to fraud can survive at least on my view of the time bar appeal standard. The tests for reckless evasion and fraud are essentially the same as the TRA made clear when
she applied Babington v Commissioner of Inland Revenue35 and R v Rowley (No 2)36 to support the test for evasion recklessness.37 Babington is in fact a fraud or wilfully misleading case, not, strictly, an evasion case.
Submissions
[90] The Commissioner argued that the TRA had failed fully to articulate the correct test for reckless evasion. In particular, the TRA had not recorded that knowledge of relevant facts will be sufficient to establish reckless evasion without actual knowledge that the relevant facts amount to unlawful conduct. The Commissioner alleged that the TRA also neglected to record that failure to inquire into a matter upon which the taxpayer is on inquiry will be sufficient and such wilful blindness can be inferred from surrounding objectively established facts. It was, the Commissioner argued, the TRA’s failure to pose the legal test in these more comprehensive terms that distracted her from considering the available evidence in the correct light.
[91] Applying the test in Edwards (Inspector of Taxes) v Bairstow,38 the Commissioner next argued that the TRA’s conclusion was entirely unsupported by the evidence and inconsistent with it, or, in the alternative, inconsistent with the true and only reasonable conclusion available on the facts.
[92] The Commissioner argued that although Mr Edwards and Ms Paterson both said they honestly believed, following independent tax advice, that Mr Edwards was entitled to make the deductions, they were interested witnesses whose evidence needed to be more critically assessed. The TRA was obliged to test the credibility of that position against known facts, the Commissioner argued, and the Judge failed to do this. As the TRA found, Mr Edwards was an experienced and successful businessman. There was no suggestion that he lacked ordinary intelligence or acuity. It was improbable therefore that he would have believed that deductions could be
properly claimed when, on the facts:
35 Babington v Commissioner of Inland Revenue [1958] NZLR 152 (SC) at [156-157].
36 R v Rowley (No 2) [2012] NZHC 1778, (2012) 25 NZTC 20-133, at [457].
37 TRA decision, above n 1, at [75].
38 Edwards (Inspector of Taxes) v Bairstow [1956] AC 14 (HL).
(a) there was no entity of any kind in existence whose demonstrated business and purpose was the assumption of risk of loss on behalf of Edwards Partnership and Edwards Construction;
(b)the payee (whatever its business) had not been incorporated until after the first payments were made;
(c) the company was, at least in 2007 and 2008, not actively engaged in any form of business at all;
(d)these alleged arrangements had no supporting documentation of any kind, other than the promissory notes; and
(e) Craybay (a company controlled by Mr Edwards and whose financial accounts were prepared by Ms Paterson in 2005-6) never declared or recorded the promissory notes as income or assets in Queensland.
[93] In these circumstances, the Commissioner argued, a reasonable person would have known to make further inquiries before claiming the insurance premium deductions. The Commissioner submitted that the TRA made no effort to explain why the irresistible inference could not properly be drawn that Mr Edwards must have known too.
[94] For the appellants, Mr Lennard argued that evasion requires either subjective intention to evade, or wilful blindness in the face of an actual appreciation of a risk that the position adopted understates true tax liability. While, he argued, the evidence suggested a reasonable person could well have been put on inquiry as to the correctness of the deductions, the evidence did not establish the necessary subjective component for reckless evasion. On the contrary, it was argued, the evidence of Mr Edwards and Ms Paterson was that they both genuinely believed the promissory notes were deductible in the tax year issued. They were not challenged in cross- examination with respect to that claimed belief. There was, Mr Lennard argued, an obligation on the Commissioner to confront both witnesses in that respect. Thus, it was argued, although there was some material from which to infer subjective
intention or wilful blindness, there was also much material from which to reject such inferences. For example:
(a) Mr Edwards had obtained specialist tax advice with respect to captive insurance schemes.
(b)He had obtained accounting advice throughout and this was to the effect that deductions were appropriate.
(c) When the scheme could not proceed because of the withdrawal of Ross Edwards, the deductions were reversed in the year of the scheme’s failure. This reversal was made without the prompting of any actual (or threat of a possible) IRD audit.
[95] It was therefore entirely open to the TRA to refuse to find, on the balance of probabilities (the burden being on the Commissioner), that subjective intention or recklessness was not made out.
Analysis
[96] While it is true that in a general appeal such as this, I am entitled to come to my own conclusion on the evidence and owe no particular deference to the conclusion reached by the TRA,39 the ability of the Judge at first instance to assess witness credibility will be a relevant factor in whether a court on general appeal ought to set first instance credibility conclusions aside. The point is made in Austin, Nichols & Co Inc v Stichting Lodestar but more emphatically in the often cited Court
of Appeal decision in Rae v International Insurance Brokers (Nelson/Marlborough) Ltd.40 There, it was suggested that appellate courts will always show considerable deference to conclusions reached on the evidence by a trial judge who hears and sees
the witnesses first-hand.41
39 Austin, Nichols & Co Inc v Stichting Lodestar [2007] NZSC 103, [2008] 2 NZLR 141.
40 Rae v International Insurance Brokers (Nelson/Marlborough) Ltd [1998] 3 NZLR 190 (CA).
41 At 198 per Tipping J and 198-199 per Thomas J.
[97] In my view, the TRA was well aware of the correct test for subjective recklessness. Citing Rowley (No 2) and Babington, the Judge identified recklessness as an alternative mens rea standard. During the course of summarising the Commissioner’s case, she set it out the relevant meaning of recklessness:42
The Commissioner contends in light of this evidence that the disputants either knew that the deductions that they were claiming were not properly deductible or, at the least, that the facts known to them at the time would have put the disputants on inquiry to seek further clarification as to the deductibility of the insurance expenses. The failure to make further enquiries amounted to wilful blindness or at the least, subjective recklessness.
[98] I am satisfied too that the Judge was well aware of the inferences that the Commissioner invited the TRA to draw. These are succinctly recorded at [76] of the decision. Further, Mr Lennard is correct that the extent of his clients’ knowledge of risk and possible wilful blindness to it was never explored with them in cross- examination. Mr Edwards’ evidence was that he genuinely believed all deductions were properly claimable and he took this view on the basis of advice he received. Ms Paterson’s evidence was that she had advised Mr Edwards to that effect. She said she genuinely believed at the time that her advice was correct.
[99] Neither witness’s view was directly challenged by the Commissioner in cross-examination. The Commissioner’s approach was not to meet the evidence head on, but rather to work around it by obtaining admissions from the witnesses that might form a basis for the drawing of contrary inferences. For example, it was established through Mr Edwards that:
(a) there was no insurance or policy documentation to support the existence of inter-company insurance contracts;
(b)no company called Craybay Insurance Pty Limited had ever been established;
(c) no income or assets equivalent to the value of the promissory notes had ever been recorded in the Craybay accounts, and no income
42 TRA decision, above n 1, at [77].
declared for tax purposes even though Mr Edwards was a shareholder and director in that company; and
(d)the required $500,000 deposit to establish an insurance company had never been paid; and so forth.
[100] In my view, it would have been good practice to put to Mr Edwards the proposition that he knew there was a risk that the promissory note deduction ought not to have been claimed, but he chose to do nothing about resolving the issue before claiming it. I am not, however, prepared to find the Commissioner was under an obligation to do so in terms of s 92 of the Evidence Act 2006. Mr Edwards must have known that his generally innocent explanation was not accepted by the Commissioner, and he cannot have been taken by surprise when the Commissioner invited the TRA to draw the negative inferences identified by counsel. There is no fairness issue here.
[101] But by choosing (for strategic reasons no doubt) to stay away from a direct assault on Mr Edwards’ subjective knowledge, the Commissioner took a risk. She left unsullied the declaration of Mr Edwards’ honest belief in the lawfulness of the deductions and his accountant’s declarations to the same effect. Carefully crafted questions could well have established Mr Edwards’ high sensitivity to the question of lawful deductibility – why else would he have sought specialist tax advice? And they might have established that Mr Edwards had some inkling that there was a risk in claiming premiums before the insurance scheme was properly set up. That would have been enough to found a submission on reckless evasion. Similar testing of Ms Paterson’s evidence would also have been of assistance. The failure to test this issue with either witness inevitably made an argument that the TRA’s conclusion was essentially irrational, more difficult to sustain.
[102] Faced with this difficulty, the Commissioner cited two decisions of note. The first, Edwards (Inspector of Taxes) v Bairstow sets out the well-known test to be applied when the Court is asked to set aside findings of fact on the basis that they
give rise to an error of law.43 The Commissioner argued before me that the TRA had
43 Edwards (Inspector of Taxes) v Bairstow, above n 38.
made such a fundamental mistake in assessing the evidence that we were in error of law territory. Lord Radcliffe’s triple formulation is the one most often cited:44
[I]t may be that the facts found are such that no person acting judicially and properly instructed as to the relevant law could have come to the determination under appeal. In those circumstances, too, the Court must intervene. It has no option but to assume that there has been some misconception of the law and that this has been responsible for the determination. … I do not think that it much matters whether this state of affairs is described as one in which there is no evidence to support the determination or as one in which the evidence is inconsistent with and contradictory of the determination, or as one in which the true and only reasonable conclusion contradicts the determination. Rightly understood, each phrase propounds the same test. For my part, I prefer the last of the three, since I think that it is rather misleading to speak of there being no evidence to support a conclusion when in cases such as these many of the facts are likely to be neutral in themselves, and only to take their colour from the combination of circumstances in which they are found to occur.
[103] Edwards was also a tax appeal from the UK equivalent of the TRA, but there, appeals could only be brought on a question of law. The Inspector of Taxes argued that the Tax Appeal Authority had made a wrong finding of fact. Their Lordships had first then to identify the area of overlap between findings of fact at first instance and questions of law, in order to resolve the appeal before them. As the case before me is a general appeal, I am not so constrained. Nonetheless, it is well to recall that their Lordships were very clear that the test recognised only a very narrow overlap
between findings of fact and questions of law. As Viscount Simonds noted:45
I think that there has been no case cited to us in which the question, however framed, whether the determination of the commissioners was maintainable, could be answered more clearly and decisively than in the present case.
[104] The settled primary facts, he said, led “irresistibly to the opposite inference or conclusion” to that adopted by the Commissioners.46 In modern legal vernacular, the Commissioners’ findings were irrational and therefore gave rise to a question of law.
[105] The second case cited before me by the Commissioner was an oral decision
of the British Columbian Court of Appeal in which O’Halloran JA upheld a Judge- alone verdict in a defamation case.47 The claimed defamation was contained in a
44 At 36.
45 At 30.
46 At 29.
47 Faryna v Chorny [1952] 2 DLR 354 (BCCA).
letter written in Ukrainian. The trial Judge found for the plaintiff despite evidence from the Ukrainian-speaking recipient of the letter (and it seems the only one who read it other than the plaintiff herself) that he did not know the meaning in Ukrainian of the defamatory word complained of. Nor, the recipient said, did he know the person referred to in the letter by position rather than name. This evidence was uncontradicted at trial.
[106] The trial Judge found for the plaintiff and rejected the recipient’s evidence. The appellant defendant complained that this finding was not open to the Court, because the Judge was effectively bound by the recipient’s uncontroverted evidence that he did not understand the allegedly defamatory statement and did not know to whom it referred.
[107] The Court of Appeal found the trial Judge was entitled to come to his own view on the basis of the whole body of evidence:48
The credibility of interested witnesses, particularly in cases of conflict of evidence, cannot be gauged solely by the test of whether the personal demeanour of the particular witness carried conviction of the truth. The test must reasonably subject his story to an examiner of its consistency with the probabilities that surround the currently existing conditions. In short, the real test of the truth of the story of a witness in such a case must be its harmony with the preponderance of the probabilities which a practical and informed person would readily recognise as reasonable in that place and in those conditions. Only thus can a Court satisfactorily appraise the testimony of quick minded, experienced and confident witnesses, and of those shrewd persons adept at the half-lie and of long and successful experience in combining skilful exaggeration with partial suppression of the truth.
[108] The Commissioner’s argument before me was effectively that the preponderance of the evidence so irresistibly pointed to Mr Edwards’ knowledge of the risk that deductions were unlawful (and therefore to reckless evasion), that the failure to directly attack his honest belief through cross-examination ought not to prevent an appellate Court from rejecting the TRA’s finding.
[109] To step back and look at the relevant evidence as a whole in this case, it is my view that it establishes two essential propositions as follows:
48 At 357 (emphasis added).
(a) Mr Edwards knew that in the tax year during which he issued the promissory notes, and claimed the deductions, Craybay did not provide the insurance services for which the promissory notes paid. The company could not: it had no resources, no capital reserves from which to meet any claims if made, and no administrative, actuarial or other infrastructure with which to carry out its alleged insurance purpose; and
(b)Mr Edwards nonetheless genuinely intended to establish and run a captive insurance scheme at some point in the future and maintained that intention from 2004 until the scheme’s failure in 2008.
[110] As to (a), Mr Edwards must have known this because he was an owner in and the guiding hand of all relevant parties. He thus knew both what Edwards Partnership and Edwards Construction were paying for Craybay with the promissory notes, and what Craybay could actually provide. He must have known that at no point between 2004 and 2008 could Craybay have provided him or Edwards Construction any of the insurance services for which they were promising to pay handsomely.
[111] As to (b), the Commissioner’s failure to challenge either successfully or at all, Mr Edwards’ future intentions with respect to the scheme means that this must be accepted. There is, in addition, evidence from which to infer that intention, not least being the obtaining of professional advice from two experts (Ms Paterson and the tax specialist) and the reversal of all claims without the need for any intervention from the IRD, once the scheme failed.
[112] Was there, on the basis of these two propositions, an inevitable further inference that Mr Edwards knew there was a real risk that the promissory notes were not deductible until the scheme was fully established, but, ignoring that known risk, he went ahead and claimed them anyway?
[113] I do not think that conclusion is inevitable or irresistible, or the only reasonable inference available at all. There was evidence that Mr Edwards relied on
the advice of Ms Paterson as to his entitlement to make the deductions. The Judge accepted that, though an experienced businessman, Mr Edwards had no particular expertise or knowledge of tax or accounting matters. Ms Paterson said she advised Mr Edwards that the premiums were deductible. There was no challenge to this. Even if viewed with scepticism, that evidence is not lightly to be discounted. Ms Paterson was an independent and experienced accountant. And once Ross Edwards left the partnership and it became clear that Mr Edwards had not the time, money or inclination to make the scheme work, the whole proposal was dropped and the deductions were reversed. There was no IRD audit to prompt such a step. This factor too, tended to support the proposition that the deductions were a matter of bad judgement and sloppy administration rather than wilful blindness to known risk. I accept that there is also material from which the more serious inference of evasion can be drawn, but that is not the test in Edwards v Bairstow. If there is more than one possible inference reasonably available on the evidence, the test is not satisfied.
[114] In the less stringent context of general appeals, the Supreme Court still cautioned that an appeal court should “rightly hesitate to conclude that findings of fact or fact and degree are wrong”, given the first instance Tribunal’s advantage in assessing witness credibility if credibility is an important factor in the case.49 And the Court cited Rae50 with broad approval in that regard. Witness credibility was at the heart of the decision the TRA had to make in this case.
[115] The TRA, fully aware of the broad background of the case, saw and heard both Mr Edwards and Ms Paterson give evidence. The Judge obviously came to the view that the Commissioner had not proved that Edwards was dishonest, although it was clearly established that he was very careless and tried, with little competence, to implement a half-baked idea that he thought might save Edwards Partnership and Edwards Construction some money. That conclusion was very much open to the Judge on the evidence. And without having had the same advantage as the TRA, I do not feel that I am in any better position to assess credibility than she was. In fact, I am at a considerable disadvantage in that regard. I am not prepared to overturn her
findings.
49 Austin Nichols, above n 39, at [5].
50 Rae, above n 40.
[116] The cross-appeal must fail accordingly.
Conclusions and disposition
[117] In this appeal and cross-appeal, I have reached the following conclusions:
(a) The TRA wrongly restricted her review of the Commissioner’s decision under s 108(2) to whether the Commissioner’s opinion was honestly held and reasonably available on the evidence. Rather, the TRA ought to have reviewed the substantive ruling de novo.
(b)The shortfall penalty cross-appeal is dismissed and the TRA’s finding that Mr Edwards’ conduct amounted to gross carelessness under s 141C rather than evasion or similar act under s 141E is upheld.
(c) Because the test for evasion or similar act under s 141E is in this case the same as that for fraud or wilful misleading under s 108 and the facts to which the test is to be applied are the same; and because I accept the TRA’s findings on evasion; the Commissioner’s time bar ruling was wrong on the facts.
(d)In light of the terms of s 138P, the matter is remitted back to the Commissioner with a direction that her time bar decision and subsequent reassessments be set aside and a finding substituted that the requirements of s 108(2) are not met.
[118] I propose to make orders to the foregoing general effect, but in case there are issues with the form of such orders, I propose to delay finalising them to give counsel an opportunity to file memoranda if necessary. The orders will be formally issued in five working days unless I hear otherwise from counsel.
[119] The appellants will be entitled to costs in this court on a category 2B basis. If agreement cannot be reached on an appropriate award, brief memoranda may be filed. Costs in the TRA may be dealt with there bearing in mind the result in this appeal.
Williams J
Solicitors:
NSA Tax Limited, Auckland for Appellants
Crown Law, Wellington for Respondent
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