Hong v Commissioner of Inland Revenue
[2019] NZCA 336
•26 July 2019 at 3 pm
| IN THE COURT OF APPEAL OF NEW ZEALAND I TE KŌTI PĪRA O AOTEAROA |
| CA649/2018 [2019] NZCA 336 |
| BETWEEN | BOON GUNN HONG |
| AND | COMMISSIONER OF INLAND REVENUE |
| Hearing: | 2 July 2019 |
Court: | Courtney, Venning and Dunningham JJ |
Counsel: | Appellant in person |
Judgment: | 26 July 2019 at 3 pm |
JUDGMENT OF THE COURT
AThe appeal is dismissed.
BThe appellant must pay the respondent costs for a standard appeal on a band A basis and usual disbursements.
____________________________________________________________________
REASONS OF THE COURT
(Given by Dunningham J)
Introduction
Mr Hong is a lawyer. In 2006 he made two loans to clients of his legal practice. In his 2011 income tax return he claimed deductions, having written off the outstanding amounts of these loans as bad debts.
The Commissioner of Inland Revenue (the Commissioner) disallowed and reversed the deductions and imposed further shortfall penalties on the basis that Mr Hong had failed to take reasonable care.[1]
[1]Pursuant to s 141A(1) of the Tax Administration Act 1994.
On 29 March 2018, the Taxation Review Authority (the Authority) upheld the Commissioner’s decision.[2] It found:
(a)the deductions did not fall within s DB 31 of the Income Tax Act 2007 (ITA), the exception carved out from the general principle that bad debts are not deductible; and
(b)the Commissioner was justified in imposing shortfall penalties under s 141A of the Tax Administration Act 1994 (TAA).
[2]Hong v Commissioner of Inland Revenue [2018] NZTRA 3.
Mr Hong then appealed the Authority’s decision to the High Court.[3] However, Jagose J upheld the Authority’s decision, describing it as “comprehensive” and “well‑reasoned”.[4] Mr Hong now appeals to this Court.
Issues
[3]Pursuant to s 26A of the Taxation Review Authorities Act 1994.
[4]Hong v Commissioner of Inland Revenue [2018] NZHC 2539 at [6].
The issues on this appeal are whether the High Court was correct to uphold the Authority’s finding that:
(a)Mr Hong was not entitled to claim deductions for the two debts in his 2011 income tax return pursuant to s DB 31 of the ITA (and carry the losses through into his 2012 income tax return)?
(b)Section DB 31 of the ITA overrides the general permission to claim deductions against expenses of a business found in s DA 1 of the ITA, so that when a deduction is denied under s DB 31 it cannot be claimed under s DA 1?
(c)Mr Hong was liable to pay shortfall penalties under s 141A of the TAA for not taking reasonable care?
Mr Hong also appeals the High Court’s award of costs against him.[5]
The lending
[5]Hong v Commissioner of Inland Revenue [2018] NZHC 3077.
Mr Hong is a barrister and solicitor in sole practice. In 2005, a company he owned, Orano Developments Ltd, sold a property for $1,300,000 and he set aside $1,000,000 from the sale proceeds for a fund that he calls his “Benevolence on the Conscience Loan Fund”. In his evidence to the Authority he explained that the fund was used to help clients whom he considered would benefit from his assistance. His criteria for access to the fund were as follows:
(a)it was to help longstanding clients;
(b)the clients were people who were in financial difficulty but whom he was “confident” could overcome their difficulties with his help;
(c)the clients had to be “good people”; and
(d)the need for assistance must be related to a matter that came up in the course of acting for the client.
In return he says the clients had to agree to “do right” by him and pay not just interest, but also a bonus once he had got them out of their dilemma.
Mr Hong kept the operation of the fund confidential, saying he did not want to be pressured for loans by other clients. He said the ultimate objective of the fund was to generate higher returns so that he could benefit the Word Wildlife Fund, being the charitable organisation he has chosen to leave the funds to in his will.
The first of the two loans in question was an unsecured loan for $50,000 advanced on or about 12 July 2006 to a Mr Chan (the Chan loan). A document described as an “Acknowledgment of Loan and Debt” was signed in the following terms:
TO: B G HONG [‘BGH’],
Barrister & SolicitorsRE:LOAN OF $50,000.00 FROM YOU ME FOR OCEANCITY CHINESE RESTAURANT
I, BILL CHAN, SAI KWONG director of Far South Investment Co. Limited hereby acknowledge as follows:-
1. I have requested BGH to loan me some funds as I had overspent funds renovating my restaurant OCEANCITY CHINESE RESTAURANT and need the funds urgently to clear rent and other creditors owed in respect of some of the renovation works as I am unable to source such finance from usual lending institutions.
2. BGH has agreed to advance me a loan to me on terms follows:-
a.Amount of loan: $50,000.00;
b.Less $1,000.00 owed to you on the restaurant liquor licence application;
c.Short term of loan: Repayable on demand with interest at 10% on repayment.
3. I undertake to pay back the loan as quickly as I can.
4. I, BILL CHAN, SAI KWONG hereby authorise you to pay the net loan advance of the amounts and to the accounts as follows:-
a.$44,000.00 to Far South Investment Co. Ltd [Bank account details]
b.$5,000.00 to Bill Chan [Bank account details]
No part of the debt was repaid, nor was interest paid on it. Mr Chan’s company, Far South Investment Co Ltd (Far South), went into liquidation in 2009.
Both the Authority and the High Court found that the loan was made to Mr Chan personally. However, Mr Hong disputes that finding, saying it was advanced to Mr Chan’s company, Far South.
The second loan of $300,000 was made by Mr Hong to a Mr Tololi on 20 December 2006 (the Tololi loan). The loan was described to be “repayable on demand with fair interest to [Mr Hong] on repayment”. Mr Hong explained that Mr Tololi allowed him to retain surplus funds from other transactions which he handled for Mr Tololi to reduce the debt. However, a balance of $122,280 was still owing on this loan when Mr Tololi was adjudicated bankrupt in July 2010.
Section DB 31 of the ITA
The Commissioner assessed the deductibility of the two loans under s DB 31 of the ITA. The relevant parts of that section provide:
DB 31 Bad debts
No deduction (with exception)
(1)A person is denied a deduction in an income year for a bad debt, except to the extent to which—
(a) the debt is a debt—
(i) written off as bad in the income year:
(ii)for which the debtor is released from making all remaining payments under the Insolvency Act 2006 excluding Part 5, subparts 1 and 2 of that Act, or under the Companies Act 1993, or under the laws of a country or territory other than New Zealand, and the person is required to calculate a base price adjustment by section EW 29 (When calculation of base price adjustment required) for the debt for the income year:
…
(b)in the case of the bad debts described in subsections (2) to (5), the requirements of the relevant subsection are met.
…
Deduction: financial arrangement debt: dealers and holders
(3)A person is allowed a deduction, quantified in subsection (3B), for an amount of a bad debt owing under a financial arrangement to which the financial arrangement rules apply, if—
(a)the person carries on a business for the purpose of deriving assessable income; and
(b)the business includes dealing in or holding financial arrangements that are the same as, or similar to, the financial arrangement; and
(c) a requirement of subsection (1)(a) is met for the bad debt; and
(d)the person is not associated with the person owing the amount written off.
To deduct the bad debts in question under this section, Mr Hong needed to establish:
(a)either:
(i)the relevant debts were written off as bad between 1 April 2010 and 31 March 2011;[6] or
(ii)the debtors were released from making all remaining payments by law, under the Insolvency Act 2006 or the Companies Act 1993;[7] and
(b)he carried on business for the purpose of deriving assessable income;[8] and
(c)that the business included dealing in or holding financial arrangements that were the same as, or similar to, the financial arrangement for which the deductions are claimed.[9]
[6]Section DB 31(1)(a)(i).
[7]Section DB 31(1)(a)(ii).
[8]Section DB 31(3)(a).
[9]Section DB 31(3)(b).
The Authority and the High Court held that Mr Hong failed to establish any of those requirements. Mr Hong appeals each one of those findings.
Were the debts written off during the 2011 income year (s DB 31(1)(a)(i))?
Both the Authority and the High Court held that Mr Hong had not satisfied them that the debts had been written off during the financial year in which he sought to deduct the bad debts.
To satisfy s DB 31(1)(a)(i) there must be some act to constitute a physical write-off of the debt within the relevant financial year.[10] In this case, Mr Hong’s evidence was that he operated a simple single entry accounting system based on Excel spreadsheets. The only spreadsheet which recorded any write-off was the profit and loss spreadsheet for the 2011 income year. Mr Hong gave evidence that his office administrator, Ms Chan, had entered the write-offs in the spreadsheet during the 2011 income year. However, there was no other evidence of that entry or its timing. Mr Hong did not call Ms Chan to give evidence and the Authority found that his evidence as to the steps taken by his legal executive was not reliable and held he had not established, on the balance of probabilities, that the debt had in fact been written off prior to the end of the 2011 financial year.
[10]Budget Rent A Car Ltd v Commissioner of Inland Revenue [1995] 3 NZLR 90 (HC) at 98–99.
The High Court agreed with this finding, which was based on a number of strands of evidence:
(a)Ms Chan, who was said to have made all the computer entries for inclusion in the spreadsheet, was not called to give evidence. An inference was available that what she may have said in evidence would not have assisted Mr Hong.[11]
(b)The 2011 return was completed at the same time as those for 2006 to 2010 and 2012, after the Commissioner initiated an audit of Mr Hong because of his failure to prepare returns for those years.
(c)The Inland Revenue investigator gave evidence that profit and loss accounts were usually prepared after the end of the financial year as it was then that all the final figures were available.
(d)On 24 September 2012, Mr Hong advised the Commissioner “[his] staff had entered all the transaction details for [him] to complete the returns over this weekend”, and sought an extension of time to 1 October 2012 to complete the returns.
(e)Mr Hong himself had said that he had included the bad debts in the 2011 return that was filed in late 2012, “as more or less it was then that I turned my mind to this”.
(f)In his notice of response to the Authority, Mr Hong did not assert that Ms Chan had inserted the write-offs in the profit and loss spreadsheet during the 2011 income year but, rather, he favoured a “substance over form” argument in respect of the timing of the physical write-off.[12]
[11]Ithaca (Custodians) Ltd vPerry Corp [2004] 1 NZLR 731 (CA) at [153].
[12]Saying in his Notice of Reply dated 21 September 2015 “…could IRD use such a lack of technicalities to deprive you to (sic) something which at substance to you are entitled to … NO”.
A further strand of evidence relied on by the Authority was the metadata for the profit and loss accounts which were emailed to the Commissioner on 11 October 2012 in the form of soft copy Excel spreadsheets. The investigator stated that when he checked the metadata, he noted that it showed the spreadsheet that comprised the profit and loss account for the year ended 31 March 2011 was created on 20 September 2012 by Mr Hong. This was the same date as the profit and loss accounts for the other years.
Mr Hong, both in the High Court and before us, challenged the investigator’s ability to give evidence about what he found in the metadata and whether this could be relied on to support the conclusion that the write-off was only done when the profit and loss account spreadsheet was created. Mr Hong’s objections were:
(a)this evidence had not been raised in the Commissioner’s statement of position and therefore infringed s 138G of the TAA; and
(b)the investigator’s evidence of what the metadata showed was inadmissible, as it was opinion evidence which could only be provided by an expert.
For these reasons, Mr Hong submits his evidence should have been rejected.
However, s 138G only limits the Commissioner to “the issues and the propositions of law” that are disclosed in the Commissioner’s statement of position. As the Authority pointed out, the question of when the loans were written off was always an issue in dispute. Section 138G does not prevent the introduction of evidence to support the issues raised.
We also do not accept that the investigator’s evidence of what the metadata recorded as the time and date of content creation, required expert evidence. The investigator reported what he saw when he looked at the metadata for the spreadsheet and Mr Hong did not dispute that the metadata showed that the 2011 profit and loss spreadsheet was created on 20 September 2012. What Mr Hong wished to argue was that this did not prove when the write off was entered because exactly the same creation date was found for each of the other spreadsheets which were incorporated with his returns.
In our view, even if Mr Hong is right that does not change the conclusions to be drawn. As Jagose J accepted, that fact that all the spreadsheets record the same date and time for the date created suggests the 20 September 2012 spreadsheets are copies of earlier created documents and brings into question whether 20 September 2012 was in fact the date of creation.[13] However, as Jagose J noted, the Authority’s finding of the spreadsheets’ “true creation date” was distinct from its conclusion that Mr Hong failed to establish the bad debts were written off during the 2011 income year.[14] Even if we ignore the evidence of what the metadata showed, the other evidence identified at [18]–[19] above points to the profit and loss account spreadsheet being created after the end of the 2011 financial year.
[13]Hong v Commissioner of Inland Revenue, above n 4, at [13].
[14]At [14].
We accept that Mr Hong has failed to discharge the onus of demonstrating that the write-offs were actually recorded in the spreadsheet during the 2011 income year.
Were debtors released from making all payments in the 2011 income year (s DB 31(1)(a)(ii))?
Having found that Mr Hong has not satisfied the requisite s DB 31(1)(a)(i), we turn to consider the alternative route under s DB 31(1)(a)(ii) that the debtors were released, by operation of law, from making all remaining payments. We note that neither the Authority nor the High Court erroneously treated these as conjunctive requirements as claimed by Mr Hong. Jagose J clearly approached these as alternatives and confirmed that the Authority had also taken this approach.[15]
[15]At [16].
The Tololi loan could only satisfy this requirement if Mr Tololi was discharged from bankruptcy under s 304 of the Insolvency Act. Mr Tololi was only discharged from bankruptcy in 2013, which was after the 2011 income year. The Court, therefore, did not err in finding this requirement had not been satisfied in respect of the Tololi loan.
Turning to the Chan loan, there was a dispute over whether that loan had been advanced to Mr Chan’s company, Far South, or Mr Chan in his personal capacity. This finding was important as it determined the entity which had to have had its debts released by operation of law in order to satisfy s DB 31(1)(a)(ii).
We are satisfied that the Authority and the High Court were correct to reject Mr Hong’s contention that the loan was advanced to Far South and not to Mr Chan. The loan document set out at [10] above makes it clear that the loan was advanced to Mr Chan in his personal capacity, as evidenced by the use of personal pronouns throughout. For example, “I have requested BGH to loan me some funds”, “BGH has agreed to advance me a loan” and, “I undertake to pay back the loan as quickly as I can”. The reference to Mr Chan being the director of Far South simply identifies his occupation and the payment of part of the monies advanced into the account of Far South’s bank was in accordance with a direction given by Mr Chan.
Being satisfied that Mr Chan was the borrower, then again, the Insolvency Act applies. Mr Chan has never been adjudicated bankrupt and so this provision is not satisfied.
Did the appellant carry on a business of dealing in or holding financial arrangements (whether standalone or as part of his legal practice) (s DB 31(3))?
Even if Mr Hong had established one or other of the criteria in s DB 31(1)(a), he still needed to satisfy the criteria in s DB 31(3) to claim deductions for the bad debts. The key issue in dispute here was whether Mr Hong was carrying on a business for the purpose of deriving an assessable income which involved money lending.
The High Court endorsed the Authority’s finding that the appellant’s primary business was providing legal services and the lending was a side project to which he gave minimal time and energy.[16] Mr Hong’s lending activities were therefore neither a standalone business nor part and parcel of his legal practice.
[16]At [18(b)].
In determining whether Mr Hong was in the business of money lending, both the Authority and the High Court relied on the leading case on what constitutes the carrying on of a business, Grieve v Commissioner of Inland Revenue.[17] The Grieve business test involves a two-fold enquiry into:[18]
(a)the nature of the activities carried on; and
(b)the subjective profit making intention of the tax payer.
Mr Hong disputes the findings of the Authority and the High Court as to whether he met those requirements.
[17]Grieve v Commissioner of Inland Revenue [1984] 1 NZLR 101 (CA).
[18]At 110.
In Grieve it was said that while statements of the taxpayer’s intentions may be relevant:[19]
actions will often speak louder than words. Amongst the matters which may properly be considered in that inquiry are the nature of the activity, the period over which it is engaged in, the scale of operations and the volume of transactions, the commitment of time, money and effort, the pattern of activity, and the financial results.
[19]At 110.
Mr Hong’s submissions were primarily directed to the Authority’s assessment of these issues which led to it concluding he was not engaged in the business of lending. He explains that the small number of loans he made (the only other client he loaned to being a Mr and Mrs Kinnon) was because he was “stymied” from making further loans by the Kinnons’ failure to repay their loan. For this reason, the small number of loans could not be used to make an adverse finding about whether he was in the business of lending.
Similarly, he takes issue with the Authority’s findings about the lack of a commercial basis for his lending. Jagose J made similar findings, noting the lending activity was not carried on in an organised and a coherent manner or with sufficient continuity and extent. These findings included:
(a)Over the period from 2005 when the fund was established to when the Commissioner declined the deductions, there were only a very small number of loans to three sets of clients.
(b)The loans were all extended in the space of one to two years between 2005 and 2006.
(c)The appellant admitted that he forgot about the Chan loan for a number of years and was only reminded of it when Mr Chan came back and asked for a further loan. Mr Hong was confused about the number and amounts of the loans extended to both Mr Tololi and Mr Chan.
(d)Mr Hong could not produce in evidence any loan or settlement statements provided to the debtors or other documents showing loan balance and accrued interest. The only documents provided were the loan documents in respect of the Chan and Tololi loans.
(e)Interest appeared to be payable at the discretion of the borrower. Even where payment of interest was a term of the loan, it did not appear to have been sought, even prior to the default.
(f)The only interest income declared in the entire period to 2012 was $28,931 in the 2006 income year.
(g)No risk assessments or due diligence was conducted, save for Mr Hong’s assertion that he only loaned to clients he knew and trusted.
(h)Mr Hong did not take any action to enforce recovery of the outstanding loan balances.
(i)No security was taken over any property in respect of the lending. Despite describing his arrangement with Mr Tololi as an equitable mortgage, it clearly was not as it did not give him any security over property.
(j)The loan to Mr Tololi was not extended in the usual way, but rather was advanced so that Mr Hong was not in breach of an undertaking given by Mr Hong as to the ability of his client to settle a property purchase.
(k)Mr Hong was familiar with commercial lending, having advanced funds to another person in 1998 with conventional lending documentation but in contrast, the lending in respect of the conscience fund was not carried out in a similarly commercial manner.
(l)Finally, the confidentiality of his lending services speaks against them being part of a conventional business activity.
Mr Hong made a number of assertions to counter these conclusions, including that:
(a)his loan acknowledgements were “binding, effective and enforceable”;
(b)he loaned to longstanding clients that he trusted to save him the “time of doing extensive due diligence”;
(c)he considered the Authority placed too much weight on his lack of time commitment, saying “time is my scarcest commodity”;
(d)he did have security for the Tololi loan, as the authority he had to deduct any surpluses from any sale of Mr Tololi’s group’s property and use them to repay the loan was an “equitable mortgage”; and
(e)he did not need to advertise his money lending services, as he was confident he would have “ample clients in need” who would come to him for financial assistance.
However, Mr Hong’s explanations do not overcome the overwhelming evidence which, viewed objectively, falls well short of establishing he was engaged in the business of money lending.
While Mr Hong refers to a range of cases in support of his assertion that he met the business test, we are not satisfied that any of them reflect the totality of circumstances in which the present loans were advanced and the claims made.[20]
[20]Case 5/2011 [2011] NZTRA 1, (2011) 25 NZTC 1-005; Case Z21 (2010) 24 NZTC 14,286 (TRA); Dale v Nichols Constructions Pty Ltd [2003] QDC 453; Budget Rent A Car Ltd v Commissioner of Inland Revenue, above n 10; Case W3 (2003) 21 NZTC 11,014; and Porter Hire Ltd v Blanchett, (2006) 9 NZCLC 264,070.
Despite Mr Hong’s repeated assertions that he subjectively intended to make a profit from these activities, we do not consider that Mr Hong was carrying on a lending business for the purpose of deriving assessable income.
Instead we agree that this lending was better described as a passive investment or charitable advancement of funds, which is how the Commissioner characterised it. Mr Hong’s profit making intention (while subjectively present) in reality amounted to little more than a “hope” that the client would eventually be able to pay interest or even a bonus to Mr Hong. We consider that the Authority and the High Court were right to find that Mr Hong was not carrying on a money lending business for the purpose of deriving assessable income.
The alternative argument was that it was “part and parcel” of Mr Hong’s law practice. In this regard, he describes his fund as “circulating capital” which he uses for “saving my clients, as their survival meant I could continue generating fees from them”.
Jagose J, however, held there was no sufficient connection between Mr Hong’s legal services business and the financial arrangements that he sought to deduct as bad debts. It was not sufficient that the loans at issue happened to be to his clients. As Jagose J noted:[21]
The two services do not naturally or easily co-exist. Mr Hong lending money to his clients raises significant issues under the Lawyers and Conveyancers Act (Lawyers: Conduct and Client Care) Rules 2008 – specifically, in addressing conflicting interests – about which there is no indication Mr Hong is aware or has addressed.
[21]Hong v Commissioner of Inland Revenue, above n 4, at [20].
He also noted that it is significant that Mr Hong did not use his firm’s business bank account for the lending activities.
Mr Hong categorically rejects the risk of acting in a conflict of interest, saying that he works on a “conscience to conscience basis” and if clients “cannot pay me… I have no issues over such”. In his view, there cannot be a conflict of interest when his primary concern has been to assist the clients out of their financial dilemma, rather than to earn interest.
In our view, Mr Hong cannot have matters both ways. If the loans are advanced to clients (whether through his firm or through a separate entity such as his company Orano Holdings Ltd), there is the potential for a conflict of interest and Mr Hong would be required to comply with the relevant rules requiring independence, including a prohibition on engaging in conflicting business activities.[22] Prioritising the benevolent aspect of the lending over the financial aspect does not remove that risk and, as we have already noted, tells against it being a normal business activity.
[22]Lawyers and Conveyancers Act (Lawyers: Conduct and Client Care) Rules 2008 at Chapter 5, including in particular rr 5.4 and 5.5.
For these reasons, we uphold the High Court’s findings that there is insufficient connection between Mr Hong’s legal services business and the financial arrangements he seeks to deduct as bad debts to satisfy s DB 31(3).
Does s DB 31(1) govern the deductibility of the write off or is it able to considered under the general permission in s DA 1?
Mr Hong argues in the alternative that if the loans were not deductible under s DB 31(1), both loans should have been able to be deducted under s DA 1, the general provision allowing the deductibility of business expenses. Section DA 1 provides:
DA 1 General Permission
Nexus with income
(1)A person is allowed a deduction for an amount of expenditure or loss… to the extent to which the expenditure or loss is—
(a)incurred by them in deriving—
(i)their assessable income; or
…
(b)incurred by them in the course of carrying on a business for the purpose of deriving—
(i)their assessable income; or
…
This provision is described in the ITA as the “general permission”.[23]
[23]Income Tax Act, s DA 1(2).
Mr Hong argues that the loans in question ought to be deductible under the general permission as a business loss incurred in the course of his law practice. In support of this submission he points out that the expenditure is used for “saving my clients” so he could “continue generating fees from them”.
However, Mr Hong has failed to consider the inter‑relationship between s DB 31 and the general permission in s DA 1 as set out at s DA 3. In particular, s DA 3(5) provides:
DA 3 Effect of specific rules on general rules
…
Express reference needed to override
(5)A provision in any of subparts DB to DZ takes effect to override the general permission or a general limitation only if it expressly states that —
(a)it overrides the general permission or the relevant limitation; or
(b)the general permission or the relevant limitation does not apply.
Section DB 31(6)(a) expressly provides that subs DB 31(1) overrides the general permission in s DA 1. In other words, bad debts are only deductible if they meet the criteria in s DB 31. For this reason, both the Authority and the High Court correctly identified that when a deduction is denied under s DB 31(1) it is unnecessary to consider whether it can be deductible under the general permission.
Did the Court err in finding that Mr Hong was liable to pay a shortfall penalty under s 141A of the TAA?
The final ground of Mr Hong’s appeal was to argue that the Commissioner should not have imposed a penalty on him under s 141A of the TAA, as he took reasonable care in taking the tax position he did on the deductibility of the bad loans.
Section 141A of the TAA governs the imposition of shortfall penalties where:
(a)the taxpayer has taken a tax position;
(b)a shortfall arises from the tax position taken; and
(c)the taxpayer did not take reasonable care in taking the tax position.
The Authority upheld the Commissioner’s decision imposing shortfall penalties of $2,126.74 and $1,242.01 for the years ended 31 March 2011 and 31 March 2012 respectively. That decision was upheld by Jagose J, although he departed from the Authority on whether Mr Hong should have sought tax advice from the tax adviser. He noted that s 141A(2B) provides a “safe harbour”, in that a person will have taken reasonable care if that person relies on an action or advice of a tax adviser engaged by the taxpayer. If a requirement of taking reasonable care is to seek advice from a tax adviser there would be no “margin” left between the “reasonable person” and the statutory “safe harbour”.[24]
[24]Hong v Commissioner of Inland Revenue, above n 4, at [22].
However, he held that Mr Hong had nevertheless failed to do what a reasonable person in his circumstances would have done, which was to have:
(a)taken sufficient steps to understand his obligations as a taxpayer commensurate with the complexity and exceptionality of the tax position to be taken;
(b)kept adequate books and records to substantiate the deductions claimed; and
(c)filed returns and paid tax on time.
In his view, Mr Hong could also not avail himself of the other safe harbour provision in s 141A(3) of having taken an acceptable tax position. The position taken by Mr Hong was objectively unacceptable, that is, it could not on rational grounds be argued to be right.[25] Without evidence to assert that the debt had been written off in that income year, or that the debtor was released from making repayment, there was no basis for claiming a deduction.
[25]At [23] citing Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2 NZLR 289 at [184].
Because Mr Hong had fallen well short of the standard of care expected of taxpayers generally, he upheld the (reduced) penalty imposed by the Commissioner.
Mr Hong, however, says the Judge was wrong to conclude he had not taken reasonable care in arriving at his view that the debts were deductible, as he took the position he did “based on my interpretation of the tax laws, rules and the judicial precedents”. In any event, even if he failed to establish that he had written off the debts on or about June 2010, he had recorded it when he filed his tax returns in 2012, so any such shortfall would have been merely “temporary”.
We accept, as Jagose J held, that it will not always be necessary to take advice from a tax adviser to have taken reasonable care. However, while Mr Hong said that he had undertaken research on the issue, that was, as the respondent pointed out, contradicted by the evidence. Specifically, Mr Hong:
(a)acknowledged he was unfamiliar with tax laws and the types of deductions in question;
(b)failed to recognise the significance of the deductions claimed as compared with his declared income;
(c)did not seek assistance from a tax professional because he said it was expensive (rather than because he had researched the position himself); and
(d)sent correspondence to the Commissioner which contradicted his assertion that he undertook his own careful research. For example, in his letter of 25 March 2013, he refers to wanting to undertake legal research on the issues “but did not have enough time to locate any judicial precedent/determinations”, and asked whether the Commissioner can “point me towards any authorities on this issue”.
In light of this evidence, Mr Hong’s assertion that he did research the position in advance of claiming the deductions is not accepted. That failure, coupled with the failure to keep adequate books to substantiate the deductions claimed and to file income returns for the entire income period from 2006 to 2012 until October 2012, supports the Authority’s and the High Court’s conclusion that Mr Hong failed to take reasonable care in taking the tax position that led to the shortfall.
Equally, Mr Hong could not claim protection through having taken “an acceptable tax position”. That term is defined in the TAA as a position which is not an “unacceptable tax position”.[26] The latter phrase is defined in s 141B(1) as a tax position that, viewed objectively, “fails to meet the standard of being about as likely as not to be correct”. As the test is an objective one, Mr Hong’s evidence that he believed the position taken was correct, or not unacceptable, is irrelevant. In the absence of evidence to establish the criteria for deductibility under s DB 31 had been met, Mr Hong could not demonstrate he had taken a stance that could be rationally argued to be right.
[26]Tax Administration Act, s 3(1).
For these reasons, there was no error in either the Authority or the High Court upholding the penalties imposed by the Commissioner.
Did the High Court err in finding the respondent was entitled to recover costs for preparation of the common bundle and for travel and accommodation expenses associated with the High Court proceeding?
In a costs judgment issued on 26 November 2018, Jagose J ordered Mr Hong to pay costs on a 2B basis, plus disbursements for transport and accommodation totalling $813.51.[27] Mr Hong takes issue with the costs awarded for preparation of the common bundle by the respondent. He also takes issue with the claim for accommodation and transport costs, saying the Commissioner “had the choice of engaging counsels (sic) who are resident here in Auckland”.
[27]Hong v Commissioner of Inland Revenue, above n 5, at [8].
However, we accept that because of the difficulties with the bundle of documents Mr Hong prepared for the hearing before the Authority, it was agreed between Mr Hong and the respondent that the respondent would prepare the bundle for the High Court hearing. There was no suggestion that this would be done at no cost. As this was a step taken in the appeal by the respondent, she was entitled to claim the appropriate daily recovery rate for the time considered reasonable for taking that step pursuant to r 14.2 of the High Court Rules 2016. The Judge’s decision awarding those costs was entirely consistent with the High Court Rules costs regime and we can see no basis for overturning or amending it.
In respect of the costs claimed for counsel travelling to Auckland and being accommodated there, we accept that tax litigation is a specialist area of law. The Commissioner is based in Wellington and had instructed the Revenue team at Crown Law in relation to these proceedings. It was reasonable in the circumstances, given their expertise and experience, to use them at each stage of the proceeding. In any event, as was said by Clifford J in Commerce Commission v Bay of Plenty Electricity Ltd:[28]
[50] I must also comment that in a very small country such as New Zealand, I find the concept of “out of town” counsel – particularly in this commercial area – as being somewhat outdated. Without wishing to raise further market definition issues, I would have thought the market for legal services at this level was a national one. On that basis, the costs of travel and accommodation are disbursements reasonably incurred and payable as such, unless for some very unusual reason the decision to retain counsel of choice could be seen as being particularly unreasonable. An example of such unreasonableness might arise where that decision was itself properly seen as a cost raising exercise.
[28]Commerce Commission v Bay of Plenty Electricity Ltd HC Wellington CIV-2001-485-917, 4 December 2008.
In our view, this reasoning applies with equal force to the present situation and these disbursements were reasonably incurred in defending the proceedings in the High Court. There is no basis on which the decision to order these disbursements as recoverable from the appellant has been shown to be in error.
Outcome
The appeal is dismissed.
Costs
The appellant must pay the respondent costs for a standard appeal on a band A basis and usual disbursements.
Solicitors:
Crown Law Office, Wellington for the Respondent
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