Wong v Commissioner of Inland Revenue
[2018] NZHC 2729
•19 October 2018
IN THE HIGH COURT OF NEW ZEALAND WELLINGTON REGISTRY
I TE KŌTI MATUA O AOTEAROA TE WHANGANUI-A-TARA ROHE
CIV-2017-485-679
[2018] NZHC 2729
UNDER Section 26 of the Taxation Review Authorities Act 1994 IN THE MATTER
of an appeal from a decision of the Taxation Review Authority in Wellington
BETWEEN
FRANCIS HUGH WONG
Appellant
AND
COMMISSIONER OF INLAND REVENUE
Defendant
Hearing: 26 February 2018 Appearances:
P S Davidson for Appellant
S J Leslie and I A Mara for Respondent
Judgment:
19 October 2018
JUDGMENT OF PETERS J
This judgment was delivered by Justice Peters on 19 October 2018 at 4.45 pm pursuant to r 11.5 of the High Court Rules
Registrar/Deputy Registrar Date: ...................................
Solicitors: Loo & Koo, Auckland
Crown Law, Wellington
Counsel: P S Davidson, Wellington
WONG v COMMISSIONER OF INLAND REVENUE [2018] NZHC 2729 [19 October 2018]
[1] The appellant, Mr Wong, appeals against a decision of Judge A Sinclair sitting as the Taxation Review Authority (“Authority”) given on 26 July 2017.1
[2] The decision concerned Mr Wong’s liability for income tax in the years ended 31 March 2013 and 2014 (“y/e 2013” and “y/e 2014”) and “shortfall penalties” imposed by the Commissioner of Inland Revenue (“Commissioner” and “IRD”).
[3] Mr Wong advanced a number of grounds in his notice of appeal, several of which would have made no difference to the outcome, even if correct. I address in this judgment only those grounds that are potentially material to the outcome.
Introduction
[4] Despite his obligations, and the letters, emails and formal notices that the Commissioner sent to him, Mr Wong did not file income tax returns for y/e 2013 and 2014. Given this default, and pursuant to s 106 Tax Administration Act 1994 (“TAA”), in November 2014 the Commissioner assessed the tax for which Mr Wong was liable. The Commissioner assessed Mr Wong as liable to pay $84,273.10 and
$39,549.65 for y/e 2013 and 2014 respectively, including penalties.
[5] The effect of the Commissioner’s assessments was that Mr Wong became liable to pay the tax assessed, absent his establishing that the assessments were excessive.2
[6] In the course of the next 18 months, Mr Wong filed a notice of proposed adjustment (“NOPA”); the Commissioner served a notice of response (“NOR”); the Commissioner filed a disclosure notice; and the parties exchanged statements of position (“SOP”).3 In the course of this process the Commissioner altered the assessment for y/e 2013 on account of depreciation recovered – in Mr Wong’s favour
– but the assessments were otherwise unchanged. Mr Wong also filed income tax
1 Wong v Commissioner of Inland Revenue [2017] NZTRA 04; appeal pursuant to Taxation Review Authorities Act 1994, s 26.
2 Tax Administration Act 1994, ss 106 and 149A.
3 The NOPA and NOR are dated 3 March and 29 April 2015 respectively.
returns for y/e 2013 and 2014, which were to the effect that his taxable income was
$951 in y/e 2013 and nil in y/e 2014.
[7] The matter then proceeded to adjudication before the IRD’s Disputes Review Unit, which upheld the assessments.
Challenge proceedings
[8] In July 2016, Mr Wong filed proceedings with the Authority challenging the assessments. To succeed in these proceedings, Mr Wong was required to persuade the Authority, on the balance of probabilities, that the assessments were wrong and by how much. Sections 149A(1) and (2) TAA provide:
149A Standard of proof and onus of proof
(1)The standard of proof in civil proceedings relating to the imposition of penalties is the balance of probabilities.
(2)The onus of proof in civil proceedings—
(a)relating to evasion or similar act to which section 141E applies or to obstruction rests with the Commissioner:
(b)relating to any other matter or thing rests with the taxpayer.
[9] Moreover, in Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue, the Supreme Court said:4
[171] Furthermore, when taxpayers challenge an assessment based on a reconstruction adopted by the Commissioner, the onus is on them to demonstrate, not only that the reconstruction was wrong, but also by how much it was wrong. Unless the taxpayer can demonstrate with reasonable clarity what the correct reconstruction ought to be, the Commissioner’s assessment based on his reconstruction must stand. This is settled law the
appellants have not shown that the Commissioner’s assessment based on his reconstruction was wrong. Even if they had shown that to be so, they have not shown on any reasonably clear basis to what extent it should be varied. ...
The Commissioner’s assessment must therefore stand.
[10] The Authority rejected Mr Wong’s arguments that the assessments were excessive and indeed varied the assessments adversely to Mr Wong. The effect of the variation was to deny Mr Wong deductions for expenses in respect of one of several
4 Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2 NZLR 289.
rental properties, this particular property being referred to as “Upland Road”. Mr Wong and his brother held/hold Upland Road on trust and the Authority agreed with the Commissioner that, as a result, Mr Wong personally was not entitled to deduct expenses that he had or might have incurred in respect of the property.
[11] Whether the Authority erred in varying the assessments as she did is in issue on this appeal, as are whether the Authority erred in:
(a)refusing Mr Wong a greater deduction for interest incurred in deriving assessable income; and
(b)upholding the Commissioner’s imposition of penalties.
[12] It is common ground that Mr Wong’s appeal to this Court is a general appeal, requiring me to come to my own view on the merits.
Background
[13] The Commissioner’s assessments were prepared by Mr Anderson, an investigator with the IRD. Having made numerous requests of Mr Wong for information and Mr Wong having failed to respond, Mr Anderson set about gathering information to make default assessments of Mr Wong’s liability.
[14] To this end, Mr Anderson sought information from the ASB, with whom Mr Wong banked; considered income tax and GST returns that Mr Wong had filed in previous periods; and undertook various Land Information New Zealand searches to ascertain whether Mr Wong was the owner of real property. The upshot of this information was that:
(a)Mr Wong, an accountant, was deriving income from working as a consultant and from rent on three properties (“properties”). No issue arises as to Mr Anderson’s calculation of Mr Wong’s income, subject to what I say below regarding income from Upland Road.
(b)The properties were situated in Victoria Avenue, and Ranfurly and Upland Roads, and Mr Wong had sold the property in Ranfurly Road in June 2012, so early on in y/e 2013.
(c)Mr Wong was indebted to the ASB. Mr Anderson assumed that some of this indebtedness would relate to the properties and that Mr Wong would be entitled to deduct interest incurred on that portion of the debt. Having allowed for the sale of the Ranfurly Road property, and on the information he had from the ASB, Mr Anderson estimated that Mr Wong would be entitled to deduct interest of $53,000 and $30,000 in y/e 2013 and 2014 respectively. The effect of the variation of the assessments to which I referred above, was to reduce those sums by approximately 50 per cent.
(d)Mr Anderson also estimated expenditure that Mr Wong would be entitled to deduct on account of the repairs, rates and insurance for the properties.
[15] In this way Mr Anderson arrived at the income tax for which Mr Wong was liable in each year. He then imposed a shortfall penalty of 40 per cent for gross carelessness, which he reduced by 50 per cent on account of Mr Wong’s compliance in earlier years. In short, the penalty imposed was 20 per cent of the income tax payable in each year.
Interest
[16] I turn now to Mr Wong’s appeal against the Authority’s refusal to increase the deduction he was permitted for interest generally.
[17] The evidence before the Authority was to the effect that the trustees had purchased Upland Road for $555,000 in 2002, and that Mr Wong and his partner (now deceased) had purchased Ranfurly Road in 2003 for $685,000 and Victoria Avenue for $842,000 in 2004. These sums totalled $2,082,000, all of which was borrowed from the ASB.
[18] The debt to the ASB was spread across several different loan accounts, including revolving credit facilities.
[19] The combined indebtedness of the trustees and Mr Wong personally as of 1 April 2012 was substantially more, being approximately $2.7 million, later reduced by approximately $547,000 on the sale of Ranfurly Road. Mr Wong accepted in evidence that the increase in indebtedness reflected his inability to meet his personal expenses from his income.
[20] Mr Wong’s first argument was that he was entitled to a deduction for all the interest charged on the total indebtedness outstanding, being interest of $115,023 in y/e 2013 and $95,744 in y/e 2014. The Authority rejected this claim, and it is not pursued on appeal.
[21] In the alternative, Mr Wong sought a deduction for interest of $88,574 for y/e 2013 and $72,765 for y/e 2014. The gist of this claim was that the total debt incurred on the acquisition of the properties remained outstanding and represented approximately 72 per cent or thereabouts of the total debt. The deduction for interest sought was the corresponding percentage of the interest paid on the total debt.
[22] The Authority rejected this alternative claim. Judge Sinclair was not satisfied that all of the original debt of $2,082,000 remained outstanding. The problem the Judge saw was that a number of the loan accounts in respect of which Mr Wong claimed interest expenses were revolving credit facilities. Mr Wong had drawn on, and credited, these accounts on many occasions and over a number of years. Mr Wong had transferred funds between accounts to meet his various commitments. He had used the funds to pay both business and personal expenses. It was not possible therefore, to use Mr Wong’s suggested approach to ensure a correct assessment of what bank interest had been used to generate rental income.
[23] The Judge held it was for Mr Wong to prove the debt and to prove the interest actually paid on it, failing which the assessments would stand. It is clear from her decision that the Judge considered Mr Wong’s evidence fell short of what was required to demonstrate the assessments were wrong and by how much.
Discussion
[24] A taxpayer is entitled to a deduction for expenditure, including interest incurred, in deriving assessable income. This appears from:5
DA 1 General permission
Nexus with income
(1)A person is allowed a deduction for an amount of expenditure ... to the extent to which the expenditure or loss is—
(a)incurred by them in deriving—
(i)their assessable income; or
...
General permission
(2)Subsection (1) is called the general permission.
...
[25] Section DB 6 Income Tax Act 2007 is specifically concerned with a deduction for interest incurred and provides:
DB 6 Interest: not capital expenditure
Deduction
(1)A person is allowed a deduction for interest incurred.
...
Link with subpart DA
(4)... The general permission must still be satisfied and the other general limitations still apply.
[26] The need to satisfy the general permission in respect of a deduction for interest incurred requires the taxpayer to establish the underlying capital sum or debt has been employed to derive assessable income for the taxpayer.6
5 Income Tax Act 2007, s DA 1.
6 Pacific Rendezvous Ltd v Commissioner of Inland Revenue [1986] 2 NZLR 567 (CA) at 572.
[27] As I see it, the sale of Ranfurly Road would mean all debt related to the acquisition of that property, some $685,000, should be excluded. Even if Mr Wong did not repay all of that debt on the sale of the property, the balance ceased to be relevant on Mr Wong’s alternative approach.
[28] It would then be necessary to exclude that part of the debt attributable to the acquisition of Upland Road, being $555,000. This is because I agree with the Authority that Mr Wong was not entitled to deduct expenses in respect of that property (see below).
[29] That would leave Mr Wong seeking a deduction in respect of interest on loan(s) attributable to the acquisition of Victoria Avenue in 2004. Mr Wong would be required to prove the principal of those loans that remained outstanding, and the interest paid on them.
[30] However, Mr Wong did not put his case on this basis, whether before the Authority or before me. If the entire purchase price of Victoria Avenue, $842,000, remained outstanding, I agree with Ms Davidson, counsel for Mr Wong, that the interest payable thereon would have exceeded that allowed in the assessment, probably by some margin. But Mr Wong would first need to prove the underlying premise, that is that the entire sum of $842,000 remained outstanding, and the actual interest paid thereon.
[31] It follows that I am not persuaded the Authority erred in rejecting Mr Wong’s claim that he was entitled to the deductions for interest that he sought.
Upland Road
[32] The issue which arises as regards Upland Road is whether Mr Wong would be entitled to deduct expenses that he paid in respect of the property, that is that the general permission was satisfied in respect of these expenses.
[33] This is because, as I have said, Mr Wong holds the property with his brother as trustees of the Madeline Francesca Family Trust (“trustees” and “trust”), the beneficiaries of which include Mr Wong and his daughter.
[34] Despite having made provision in the assessments for deductions in respect of the Upland Road property, the Commissioner submitted to the Authority that, in fact, Mr Wong was not entitled to any deductions. The Authority accepted this submission, and revised the assessments.
[35] Mr Wong challenges this decision on appeal but, if unsuccessful, submitted the Commissioner “can’t have it both ways”, ie that Mr Wong should not be liable for tax on the income from the property but at the same time be denied deductions for expenses.
Discussion
[36] I preface what follows by recording that none of the records that might be expected to be available regarding the trust were in evidence before the Authority, that is no copy of the trust deed, resolutions, minute books or financial statements. Moreover, Mr Anderson’s evidence was that the trustees had not filed a tax return since 2001.
Income
[37] The rent paid on the Upland Road property was deposited directly into Mr Wong’s personal bank account. Mr Wong returned this income in his income tax returns in years prior to y/e 2013 and y/e 2014. Mr Anderson likewise included the rent in assessing Mr Wong’s income for y/e 2013 and y/e 2014.
[38] The income derived from Upland Road belonged to the trustees as owners of the property. Ms Davidson submitted that in fact there had been an error in making the arrangements to let the property and that is why the income had been paid to Mr Wong. Regardless, and however the payments to Mr Wong came about, the trustees owned the property and the income was theirs. There can be no dispute about that point.
[39] Given that, but given that the income was paid directly to Mr Wong, the trustees must be assumed to have allocated the income – their income – to Mr Wong as a beneficiary of the trust. As the Authority said, such an allocation would have the effect
of rendering the income “beneficiary income” in Mr Wong’s hands.7 As a consequence, it was correct to include the rent from Upland Road in assessing Mr Wong’s income.
Expenses
[40]Turning now to the expenses, the trustees purchased Upland Road in 2002 for
$555,000. Part of the purchase price was funded by a term loan of $480,000 from ASB to Mr Wong personally (“term loan”), with repayment guaranteed by the trustees.8
[41] There is no evidence as to the basis on which Mr Wong made the $480,000 available to the trustees. In any event, Mr Wong’s evidence, and it was not disputed, was that he paid the interest due on the term loan to the ASB.
[42] The trustees funded the balance of the purchase price of $75,000 by borrowing that sum from ASB, on a revolving credit facility (“revolving loan”). Mr Wong guaranteed repayment in his personal capacity. The trustees paid the (modest) interest due on the $75,000.
[43] Mr Wong was entitled to deduct for any expenses he incurred, interest or otherwise, in respect of Upland Road if he incurred that expenditure in deriving his assessable income.9
[44] The Commissioner’s submission to the Authority was that Mr Wong had not so incurred the expenditure and so was not entitled to the deductions claimed. The Authority agreed and that was correct for the following reasons.
[45] As I have said, there is no dispute that Mr Wong was liable to the bank for the interest due on the term loan and that he paid that interest. However, he was only
7 Income Tax Act 2007, ss HC 5 to HC 7.
8 That the loan was made to Mr Wong personally is obvious on the face of the loan document, notwithstanding Mr Anderson’s repeated refusal to accept this when Ms Davidson cross-examined him. See the evidence of Mr M Anderson given before the Authority at 158-163.
9 Income Tax Act 2007, ss DA 1 and DB 6.
entitled to a deduction in respect of that interest expense if he incurred it in deriving his assessable income.
[46] I agree with the Authority that this would require Mr Wong to prove that he had agreed with the trustees that they would return or allocate income to him if he paid the interest on the loan. This would tie his receipt of the income to his payment of the interest to the ASB. But there was no such agreement and, absent that, Mr Wong is not permitted to deduct the expense.
[47] In relation to the revolving loan, the Commissioner submitted that Mr Wong did not incur any expenditure because the trustees paid the interest due. However, Ms Davidson submitted that Mr Wong had incurred the expense because he was liable both personally and as a trustee for the interest.10 But being liable for a sum is not necessarily to “incur” it as an expense. The trustees were entitled to a deduction for the interest they paid, not Mr Wong.
[48] For the same reasons as those relating to the term loan, Mr Wong was not entitled to deduct for any expenses relating to insurance and rates. It was for the trustees to pay these expenses as the owners of the property. Ms Davidson made the point that each trustee would have been severally liable to pay the rates assessed on the property, and Mr Wong may well have been liable on invoices the insurer rendered to him. Again, however, Mr Wong cannot claim a deduction on these sums because the required nexus between the incurring of the expenditure on the one hand, and Mr Wong’s assessable income, as opposed to the trustees’, is absent.
[49] Finally, I record that matters in respect of the insurance and rates expenses were further complicated by evidence suggesting that the trustees had reimbursed Mr Wong for these items. Ms Davidson submitted to me this was not so, that Mr Wong had paid the invoiced amounts, and that, to the extent the trustees had reimbursed him, Mr Wong had put them in funds to do so. The Authority was not persuaded as to this and it is unnecessary for me to address the point, given the view I take of the issue.
10 Loan Agreement dated 23 October 2002 at 3.
Penalties
[50] The Commissioner imposed shortfall penalties against Mr Wong for gross carelessness. The empowering provisions of the Act relating to shortfall penalties are ss 141AA–141K. For example, s 141A concerns a taxpayer who does not take reasonable care in taking a tax position. Section 141B concerns a taxpayer who takes an “unacceptable” tax position, as defined. Section 141C applies to a taxpayer who is grossly careless in taking a tax position, as the Commissioner contends was the case with Mr Wong.
[51] As I have said at [15], the penalty payable under s 141C is no more than 40 per cent of the “tax shortfall”, a definition which I discuss below. In Mr Wong’s case, the Commissioner reduced this penalty by half to 20 per cent for previous compliant behaviour.11 The resulting shortfall penalties were $5,099.22 for y/e 2013 and
$3,295.81 for y/e 2014.
[52] The issue before the Authority was whether the Commissioner had power to impose these penalties. There was no dispute that Mr Wong had been grossly careless. The question was whether there was a “tax shortfall” for the two income years. Tax shortfall is defined as follows:12
tax shortfall, for a return period, means—
(a)the difference between the tax effect of a taxpayer’s tax position for the return period and the correct tax position for that period, when the taxpayer’s tax position—
(i)results in too little tax paid or payable by the taxpayer or another person:
(ii)overstates a tax benefit, credit, or advantage of any type or description whatever by or benefiting the taxpayer or another person; …
…
[53] By the beginning of y/e 2013, Mr Wong had accumulated tax losses of more than $700,000. These losses were large enough to offset Mr Wong’s liability for tax
11 Tax Administration Act 1994, s 141FB.
12 Tax Administration Act 1994, s 3.
in y/e 2013 and 2014. As such, Mr Wong’s failure to file returns did not result in a tax shortfall in terms of (a)(i) of the definition.
[54] Rather, the issue was whether Mr Wong had overstated “a tax … advantage of any type or description whatever” within the meaning of (a)(ii) of the definition.
[55] Before the Authority, Ms Davidson submitted that tax losses were merely the result of expenses exceeding income and did not constitute a “benefit, credit or advantage of any type or description”. Ms Davidson invited the Authority to construe these words narrowly.
[56] The Authority did not accept this submission on the grounds that, had Mr Wong filed returns stating his correct tax position, his accumulated losses would have been reduced by the amount of his net income in y/e 2013 and y/e 2014.
[57] The Authority considered the words “a tax … advantage of any type or description whatever” sufficiently broad to encompass a failure to reduce a pre- existing loss. The effect of Mr Wong’s failure to file his returns was that loss was overstated. If this were not an advantage, a taxpayer with a pre-existing loss would not suffer a sanction for failing to calculate his or her tax liability. The Commissioner submitted that could not have been Parliament’s intention, and the Authority agreed.
[58] Then the Authority determined that Mr Wong’s failure to file his returns had resulted in an advantage, that is an overstatement of his losses, sufficient to satisfy (a)(ii) of the definition of “tax shortfall”.
[59] The Authority determined that the shortfall was equivalent to Mr Wong’s liability for income tax in each of the years in question. As its revisions to the assessments had increased the amount of income tax Mr Wong owed, so the shortfall and the shortfall penalties increased to $12,353.61 for y/e 2013 and $7,852.23 for y/e 2014.
[60] Ms Davidson likewise submitted to me that Mr Wong’s tax loss was not an advantage within the definition of “tax shortfall”, on the basis in [55] above, although
Ms Davidson accepted that a tax loss could be considered an advantage in some situations, such as where companies in a group were able to group or “pool” losses.
[61] Ms Davidson also submitted that Mr Wong’s accumulated tax losses leading into y/e 2013 and y/e 2014 could not be overstated as a result of his failure to file returns. That may be so, but the issue is what tax advantage Mr Wong held at the end of these periods, not at the start of them.
Discussion
[62] The Authority’s decision is correct for the reasons it gave. If it were not so, a taxpayer with an accumulated loss could not be penalised for failing to file a return, assuming the taxpayer would continue to carry forward a loss (but a smaller one) to the next year. The purpose of the penalty provisions is to encourage a taxpayer to comply with his or her obligation to file a return. The Commissioner has the same interest in receiving that return, and thus knowing the taxpayer’s true tax position, whether he or she is in a loss or profit-making position.
[63] As counsel for the Commissioner submitted, this is confirmed by s 141(12)(b). Section 141 governs the calculation of tax shortfalls and to the extent relevant provides:
141 Tax shortfalls
(1)Tax shortfalls are to be calculated by the Commissioner in accordance with this section.
…
(12)The tax effect of a tax position taken by a taxpayer in a return period is to be calculated having regard to—
(a)the marginal rate or rates of tax applicable to the taxpayer during the return period; and
(b)where the taxpayer has no tax to pay in the return period, the rate of tax or lowest marginal rate of tax that would apply to the taxpayer during the return period, if the taxpayer had tax to pay.
[64] As the Commissioner submitted, this provision makes it clear that a shortfall may still arise if a taxpayer has no tax to pay. For these reasons, it was open to the Commissioner to impose the penalties she did.
Result
[65]The Authority’s decision is correct in all respects. I dismiss this appeal.
[66] I expect the parties will be able to agree costs but they may submit memoranda if not.
Peters J
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