GST avoidance arrangement unsuccessful
2006 case note - taxpayer obtained GST refunds on the purchase of real estate on very long settlement terms - tax avoidance, Ch'elle Properties, shortfall penalty.
Goods and Services Act 1985
A case similar to Ch'elle Properties where the taxpayer obtained GST refunds on the purchase of real estate on very long settlement terms. Ch'elle Properties was not directly applied to the arrangement but was influential and a Shortfall Penalty confirmed.
This case was about obtaining GST input tax refunds on real estate transactions with unusually long settlement periods (in this case over 35 years). It is broadly similar to Ch'elle Properties  3 NZLR 274.
The disputant was incorporated in 17 July 2001. The company was registered for GST in October 2001 on an invoice basis.
Mr C was a property developer and sole director of B Ltd. B Limited entered into agreements for sale and purchase of seven residential properties in Tokoroa, to two companies (collectively T Limited). The two companies were owned by another company which, in turn, was a 50% shareholder in B Limited.
The properties were purchased for $140,000 by T Ltd and each was on-sold to the disputant for $220,000 in October 2001 with deferred settlement until dates varying between June and October 2037.
A deposit of $10 was payable on execution of the agreements and the balance payable on 14 December 2001 "or such later dates as may be agreed upon by the vendor". It appears that the balances of the deposits payable for those agreements have not been paid.
T Limited was never able to give legal title to the disputant as the legal ownership remained with B Limited. T Limited issued seven tax invoices on 30 October 2001. The disputant filed a GST return for the period ending 30 October 2001 which showed $1,540,000 of inputs and nil outputs. The Commissioner declined to pay a refund.
The true value of the properties was questionable due to the mortgagee sale in May 2003, where the properties were sold for $39,000 (equating to $5,571 each). An explanation of this huge discrepancy was that "the properties were ransacked prior to the mortgagee sale". The unquestionable outcome of the sale is that it is highly unlikely that the properties would have been available for the deferred settlement 37 years hence.
Section 76 tax avoidance
The Judge declined to apply Ch'elle Properties to this case citing the amended statutory provisions.[par 22]
However, he said that he had no doubt that the arrangements in this case were designed and intended to exploit the anomaly which the Courts have decided (e.g Nicholls v The Commissioner of Inland Revenue (1999) 19 NZTC 15,233) results from a mismatch between registration on a payments basis vis a vis an invoice basis. [par 26]
The Judge referred to Section 19 of the Act (Accounting basis);
- Subject to sections 19A to 19D, every registered person must account for tax payable on an invoice basis for the purpose of section 20
Prior to 10 October 2000, s. 19(1) was only subject to ss.19A-19C. Section 19D was enacted from 10 October 2000. At the relevant date it provided:
- The requirement by a person making a supply for consideration in excess of $225,000 to be registered on an invoice basis for that supply
- It only applies to agreements for sale and purchase which are not "short term" as defined in s.OB1 of the Income Tax Act 1994 (one Year and one day for the amended s. 19D);
- It catches taxpayers who make more than one relevant supply and the sum of the supplies is more that $225,00; if the Commissioner considers that the person ,making the supplies did so to avoid subs.(1).
The Judge held the opinion that T Limited was used as a vehicle to carry out the arrangements. [par 29]
The Judge after considering the criteria of s. 76 Tax Avoidance was of the view that there was clearly a series of contracts backed by a plan of understanding. His Honour cites Challenge to state:
"a scheme of arrangement which complies with the specific provisions of a taxing statute may nevertheless fall foul of the anti-avoidance provisions" [par 41]
The fact that the series of transactions was carefully structured to meet the requirements of s. 19(D) does not affect any of the foregoing considerations. He used the words of Rodney Hansen J,
"The tension between the commercial and juristic character of the arrangement is stretched to breaking point. It conforms to the letter of the Act while departing from its fundamental objectives. It has therefore the purpose and effect of defeating the intent and application of the Act." (at p.285 of Ch'elle) [par 45 of TRA judgment]
He held that the scheme offended s. 76 and was void to the Commissioner. The Commissioner was correct in refusing to refund the input credit as filed. [par 46]
Penalties for taking an abusive tax position
The Judge referred to Mr C's related activities, in which he said that Mr C had been the guiding mind of three similar schemes. Each of the schemes are attempts to finance substantial purchases of real estate using the GST inputs and lengthy deferred settlements creating a mismatch between registration on an invoice basis and registration on a payments basis. Each scheme uses the device on long periods of deferred settlement and dubious price escalation mechanisms which inflate the value of the inputs claimed. [par 50]
His Honour focused on the knowledge of Mr C and his associated companies as relevant to the disputant's tax position. This was because His Honour concluded on the evidence that disputant was "closely aware of the detail of the Ch'elle scheme and its chilly reception by the Commissioner" [par 53]
His Honour had no difficulty accepting that the shortfall penalty was properly applied in this case. [par 63]
Mr C was perfectly aware at the time of these transactions that from December 1999, schemes of this nature were under a cloud. The Judge said,
"For somebody who represents himself to have (and has in these proceedings demonstrated) a sound grasp of the relevant law and practice it was highly imprudent of him to continue these schemes as has in this case. It was equally imprudent of the disputant in this case knowing what its principal did to associate itself with such schemes of arrangement." [par 64]
In the Judge's decision he expressed his opinion that the amount of shortfall penalty applied by the Commissioner was not excessive, and having regard to the circumstances, he was surprised that the Commissioner kept it at the 50% of the maximum permitted. [par 66]