Reefdale Investments Limited v Commissioner of Inland Revenue HC Wellington CP114/01, CP147/01

[2002] NZHC 89

IN THE HIGH COURT OF NEW ZEALAND
WELLINGTON REGISTRY CP114/01, CP147/01

IN THE MATTER of the Income Tax Act 1976 and the Income Tax Act 1994 and the Tax Administration Act 1994.

BETWEEN REEFDALE INVESTMENTS LIMITED
Plaintiff

VANYA HOLDINGS LIMITED
Plaintiff

AND COMMISSIONER OF INLAND REVENUE
Defendant

Date of hearing: 7 February 2002

Counsel: R J Cullen for Plaintiffs
J H Coleman for Defendant

Judgment date: 15 February 2002

JUDGMENT OF MASTER J C A THOMSON

[1] These are proceedings to challenge tax assessments by the Commissioner. Before me are applications for security for costs by the Commissioner of Inland Revenue against the plaintiffs who are Reefdale Investments Limited (“Reefdale”) and Vanya Holdings Limited (“Vanya”). Both Reefdale and Vanya admit they are insolvent. That means the threshold test required by R60 of the High Court Rules, namely that there is reason to believe the plaintiffs will be unable to pay the Commission’s costs if they are unsuccessful, has been satisfied. Once the threshold test has been met the Court has a discretion whether or not to order security and as to the amount. The litigation concerns an investment proposal offered by Salisbury Securities Finance Limited. As pleaded in the Statements of Claim, in summary:

(a) Investors were to purchase an option to acquire say $1 million of pinus radiata (in 1994 quantities) for $1 million in 10 years. If the 1994 value for the quantity of timber had increased in 10 years time, the investor could sell its contractual rights at a profit. If the 1994 value for the quantity of timber decreased in 10 years time, the investor’s rights would be effectively worthless, and the investor would be unlikely to exercise the option. If the investor was to choose to exercise its option, the counterparty could, at its option, decide to make a payment in money representing the value of the option or require the investor to pay $1 million and take delivery of the wood.

(b) Investors could insure against a loss of profit by paying a one off up-front premium, of $1 million for each $1 million of future contractual commitment. The guaranteed minimum sum insured for that $1 million of future contractual commitment, was $1 million compounded annually at 11% per annum for 10 years (ie $2.24 million). SSL was to arrange for a non-recourse loan (with interest accruing but not payable until the end of the investment) to the investor. The security to the lender was to be the insurance policy taken out by the borrower (investor), that was to be assigned to the lender.

[2] Mr Cullen for the plaintiffs makes the general submission that in taxation cases the Court should never order security because all tax payers regardless of their financial position should have the statutory unfettered right to challenge an assessment of tax by the Commissioner. He says an issue of public importance, or public interest, arises where, as here, claims of tax avoidance are made by the Commissioner. Mr Cullen argues that the effect of orders for security for costs against tax payers will mean indigent tax payers will be unable to challenge assessments. In these proceedings it will mean the Commissioner will move to collect the tax assessments against Vanya and Reefdale and they will consequently lose their tax losses.

[3] As a preliminary submission Mr Cullen mounts a challenge to R60(1)(b) on the ground that such rule (as far as taxpayers are concerned) is contrary to the New Zealand Bill of Rights Act 1990 and/ or is unconstitutional.

N.Z. Bill of Rights Act

[4] Mr Cullen says that R60 (1)(b) has to be applied to these plaintiffs as taxpayers, having regard to s 27(1) of the Act which establishes the necessity to apply the principles of natural justice which concept includes the right of access to the Courts. He submits that an order for security for costs will effectively deny these plaintiffs access to the Court to resolve this dispute. The answer to that submission, in my view, is that, in relation to R60, once the threshold test has been met, whether to make an order or not becomes one for the discretion of the Court, taking into account all the circumstances of the case. That means an order will not necessarily be made simply because these tax payers are admittedly impecunious. There is no predisposition one way or the other. The Court considers a number of well known factors before making up its mind whether to order security or no.

[5] The plaintiffs also rely on ss 6 and 9 of the Act. Section 6 requires legislation to be given a meaning that is consistent with the rights of freedom as set out in the Bill. The plaintiffs say R60(1)(b) should not be interpreted and applied in a way so as to drive the plaintiffs from the Court because of a requirement to provide security for costs. In my opinion the proper application of the Court’s discretion pursuant to R60 and the necessity to consider all the circumstances of the case will result in compliance with s 6 of the Act, if applicable. As to s 9, it provides that a person shall not be subjected to torture or to cruel, degrading, or disproportionately severe treatment or punishment. As to that, I simply reject the plaintiffs’ submission that a requirement to provide security for costs (in the circumstances here and for the sums sought) if ordered will constitute disproportionately severe treatment of the plaintiffs arising before there is a finding as to the merits of their claims. Indeed the need to resort to s 9 of the Act to bolster the argument I think is a good indicator of the fragility of the plaintiffs’ argument that R60 (1)(b) conflicts with the Act.

Rule 60(1)(b) is unconstitutional

[6] Mr Cullen submits that the requirement to provide security for costs, because of impecuniosity, constitutes a breach of a fundamental right (the right to access to the Court) and is therefore unconstitutional, and should not be ordered by the Court in the exercise of its discretion under R60 (1)(b). He says the comments of the Judges in the Court of Appeal in Shaw v CIR (1999) 3NZLR 154 left open the proposition that the Courts have the power to hold an Act of Parliament to be unlawful as being in breach of fundamental common law rights. As to that submission, all that need be said is that the Courts have yet to exercise such purported power in any case known to the Master and have up to now adhered to the convention that the Court’s function is to give effect to the intention of Parliament. Further, it seems to me that if this Court was to be emboldened enough to declare R60 unconstitutional, then the Court would still have resort to its inherent jurisdiction. From early times the New Zealand High Court recognised that to be so. In Williamson v Johnson (1889) 7NZLR 369, Williams J dealing with the then Supreme Court rules as to security for costs which it appears were similar to the present English High Court Rules, said at p 372:

“A particular class of cases is mentioned in which security may be claimed, but there are no other provisions in the rules. I do not, however, think that the Court is thereby prevented from exercising its general jurisdiction, and I am of opinion that where any special circumstances arise which make it right that security should be given, the Court can order security to be given.”

[7] Interestingly enough the English Courts, while recognising that the power to grant security for costs is derived from the inherent jurisdiction of the Court, have held that their rules are exhaustive and should not be extended (C T Bowring & Co (Insurance Ltd) v Corst & Partners Ltd (1994) 2 Lloyds Rep 567 (Condliffe v Hislop (1995), The Times, November 3. Those decisions would appear to be a recognition by the English Courts of Parliament’s supremacy and of its power to limit by legislation the inherent jurisdiction of the Courts at least in the area of security for costs. Indeed, it is to be noted that as a result of those judgments the security for costs rules in England have been extended to enable a defendant to seek an order against third parties. The point, however, is as I have said, that if the Court did determine that R60(1)(b) was unconstitutional, then it seems to me it could still resort to its inherent jurisdiction and order such security as it saw fit. Anyway I reject the submission that R60(1)(b) is unconstitutional. In doing so I take the same view as the Court of Appeal did in Shaw and say that an opposed run of the mill interlocutory chambers application arising from R60 should not be the occasion for the Master to contemplate revising conventions so fundamental to New Zealand’s constitutional structure. In that regard the affidavits of Messrs Quigley and Dewar filed for the plaintiff certainly do not persuade me to think otherwise.

The application itself

[8] In my view then the application for security is to be dealt with applying the usual principles. I accept Mr Coleman’s submission for the Commissioner, that costs in tax cases are now treated as being on an equal footing with any other civil commercial litigation. He tells me an order for security for costs was conceded in Abattis Properties Limited v Commissioner of Inland Revenue CP 102/01, 23 November 2001. Such approach was also adopted in Australia, in Money Tree Management Services Pty Limited v Deputy Commissioner of Taxation (no. 3) (2000) SASC 266. In Auckland Gas Company Limited v Commissioner of Inland Revenue (1990) 19 NZTC 15027, the Court of Appeal rejected the contention that the Commissioner should be treated differently from any other litigant as to costs in taxation cases.

[9] In saying that I acknowledge that if the dispute was to be heard by the Taxation Review Authority then s 16(3) of the Taxation Review Authorities Act 1994 says that no costs shall be awarded to or against the disputant of the Commissioner, except where s 22 of that Act applies. (That section would have no application here). The point however is that the plaintiffs had the choice of filing with the Taxation Review Authority or in the High Court. They have chosen here to file in this Court and thus, like any other litigant, they are liable to the jurisdiction of the High Court Rules. It may be there is still ability to transfer this proceeding to the Taxation Review Authority, but that has no bearing on these applications.

Principles to be applied in exercising the Court’s discretion

[10] I deal with the usual matters considered by the Court in exercising its discretion under the Rule.

Merits of the Case

[11] The defendant submits that the plaintiffs’ case is without merit. While the Court cannot obviously come to a finite decision as to the merits, it is quite apparent from Mr Cullen’s submissions that the scheme devised by Salisbury involved a very complicated set up of arrangements, including dealing with the Niue Government and the taking out of an insurance policy. Of significance it seems to me is the fact Reefdale borrowed 95% of the insurance premium of $500,000, meaning it only contributed $25,000 and Leadenhall which is the unit trust, for which Vanya is the Trustee, borrowed 100% of the $2,700,000 premium it required. The Commissioner says the security for the loans was limited to the investors interest in the proceeds of the insurance policy and the timber option. The Commissioner considers that the investors are not truly at risk in respect of the “investment”. It is the Commissioner’s view that having contributed little, or no funds of their own, and having no on-going obligation to meet future costs of the arrangement, the plaintiffs are seeking to benefit from what are projected by the Commissioner to be huge tax losses.

[12] As I understand it, the plaintiffs contend that the position will not necessarily be as contended for by the Commissioner. They say the forestry option which is at the heart of the scheme, involves speculation on the movement in the value of timber over the 10 year term of the option. If over the 10 years timber prices increased over 1995 prices during the period of the option, the difference would be a profit to the option holder and taxable under New Zealand Income Tax Act. The insurance policy was simply, the plaintiffs say, designed to ensure that if prices declined over the period, and should the option be exercised, then the proceeds of the insurance policies would ensure that the plaintiffs would have the money to pay for the timber at 1995 prices. The plaintiffs’ claim is that in the event any insurance payments are made it would generate assessable income that would be applied to accumulated losses. The Commissioner disputes that. Without being in any position to come to any firm conclusion on the merits, it seems to me to be very telling that it appears from the second affidavit of Tracey Lloyd’s filed for the Commissioner that the “Timber Call Option Agreement” was effected with an Indonesian company that owns no forest or other assets, and is apparently prohibited by Indonesian law from dealing in timber. Furthermore, it must be of some significance that all other taxpayers involved in the scheme have conceded the correctness of the Commissioner’s assessments. Given the matters I have discussed, the plaintiffs’ prospects of success can certainly not be rated very highly, particularly in the light of the Commissioner’s assertion that the plaintiffs’ case is quite unmeritorious.

Impecuniosity caused by the defendant

[13] The plaintiffs do not claim that any conduct of the Commissioner caused or contributed to their impecuniosity.

Public interest

[14] Given that all other persons involved in the scheme have conceeded, I do not think any element of public interest arises.

Undue delay in applying for security

[15] That is not claimed by the plaintiffs and rightly so.

The possibility of others contributing

[16] That is an important issue here. It appears from the affidavit of Tracey Lloyd’s second affidavit that the scheme was offered to high net worth individuals and corporations. The first point to be made here is that the plaintiffs’ apparently have access to funds to meet solicitor and counsel’s costs in these proceedings as well as to pay for an expert economist. It appears that the beneficial owner of the Leadenhall Unit Trust (which owns Vanya) is a Mr Doke, the promoter of the scheme. The shareholders in Reefdale as shown in the balance sheet exhibited to Tracey Lloyd’s first affidavit appear to be three trusts and two companies. Their asset and liability situation has not been disclosed but one can readily infer that they would have the ability to contribute to any order for security for costs made against Reefdale, as would Mr Doke or his trusts. It is also I think likely that it would be the shareholders of the plaintiffs who would be the beneficiaries of the tax losses at the end of the day if the scheme runs its course.

[17] Balancing then all the factors I am required to consider, I am satisfied security should be ordered.

Quantum

[18] The plaintiffs made no challenge to the Commissioner’s assessment of quantum. They simply say they cannot pay. The Commissioner says the litigation will be complex and time consuming with witnesses required from overseas.

[19] Five million dollars of losses are at stake. One hundred and fifty thousand dollars is sought on the basis that the two proceedings are consolidated.

[20] Security is ordered for that sum against the plaintiffs jointly and both procedings are stayed until security in that sum is provided to the satisfaction of the Registrar.

[21] Costs reserved.