Share transactions not taxable
2007 case note - Taxpayers' share trading activities held to be on capital account – 'in business', 'dealing' and 'purpose of disposal'.
Income Tax Act 1994 & Income Tax Act 1976
Summary
Taxpayers' share trading activities held to be on capital account.
Facts
This was an appeal from the High Court. The TRA case is Case W43 (2004) 21 NZTC 11,403 and the High Court as King v The Commissioner of Inland Revenue (2006) 22 NZTC 19,691. An attempt by the taxpayer to recall the High Court judgment is reported at Estate of King v The Commissioner of Inland Revenue (2006) 22NZTC 20,040. Judicial review proceedings were also part of this matter and are reported (at the High Court) as Dowell v The Commissioner of Inland Revenue (2006) 22 NZTC 19,681.
The taxpayers are a family with offshore investments, the management of which was left entirely to their broker in England. The only instruction the broker had was to achieve a return of £1,800 per month to the family (£600 each). The taxpayers had no interest in how this was achieved.
In late 1984 the investments were placed into a company based in Jersey. The family purportedly sold their investments to the company and advanced a loan to the company to pay for the investments, which was to be repaid at £1,800 per month. The investments were held in three "accounts" which were never to be mingled and the expenses of which could only be paid from the "account" to which it related. There was an administration agreement which effectively retained control of the funds in the hands of the family.
Considerable buying and selling of shares occurred in the relevant period (1989 to 1990 income tax years) but there was no change in the arrangements before and after the investments were moved into the company.
The Taxation Review Authority ("TRA") concluded that there was no taxable income from the share activity as there was no agency between the sharebroker and the family, the broker was not in business and the onus was on the Commissioner to prove the broker's intentions at each transaction. The TRA did conclude the company held the shares as bare trustee for the family.
The Commissioner appealed the TRA decision regarding the share business or trading and the onus of proof issue. The taxpayers appealed the finding that there was a bare trust. On appeal to the High Court, the Commissioner was successful and the taxpayers unsuccessful.
The taxpayers appealed to the Court of Appeal.
In addition, the taxpayers sought to appeal the High Court's refusal to recall its substantive judgment in the tax case. The taxpayers argued that the Commissioner had in fact conceded his appeals in the course of the hearings and therefore should not have succeeded before the High Court. The taxpayers sought, unsuccessfully, recall of those decisions.
Finally, the taxpayer sought a judicial review. The assessments were made relying upon the Income Tax Act 1994 whereas the correct Act should have been the Income Tax Act 1976. The taxpayers sought, by judicial review, a declaration that the assessments were nullities and were void. This was unsuccessful at the High Court and the taxpayers appealed to the Court of Appeal
Decision
The Court of Appeal dismissed the appeals in the judicial review and recall application. In the judicial review the Court considered that section YB5(4) applied and answered the case, thus the taxpayer's arguments the assessments were nullities had no merit.[par 116-121]. In respect of the recall appeal the appeal was described as "misguided" (as the Court doubted there was an oral judgment) and "pointless" as the substantive judgment was under appeal anyway: the recall appeal was "nonsensical" [par 125]
The Court allowed the tax appeal. Addressing each ground:
Share Dealing (first limb s 65(2)(e) ITA 1976): After reviewing the relevant cases and the peculiar facts of this case, the Court concluded:
[66] Our conclusion is that this matter is very finely balanced. On the one hand, there was a reasonable high frequency and continuity of effort. Certainly, this was not a case of haphazard or unsystematic buying and selling. Rather, the portfolios were, in [taxpayer's witness'] words "actively managed". On the other hand, there are explanations, other than trading, for a considerable number of the transactions and for their timing. Furthermore, the overall approach was, as [taxpayers' counsel] suggested, a fairly conservative one with a focus on the preservation of capital.
[67] Given the matter is finely balanced in these circumstances we consider that before taking a different view from the TRA, it was incumbent on the Judge to be satisfied that the TRA was wrong in its factual findings. We do not consider that this test was met....
In Business (section 65(2)(a) and Grieve): The Court noted the TRA's view that there was considerable overlap of this test with the share dealing test [69] and after reviewing the relevant cases and facts of this case the Court concluded:
[78] Essentially for the reasons we have given in relation to the first limb of section 65(2)(e), we do not consider there was a basis for the High Court to take a different view from that in the TRA in this issue. The nature of the activity was investment. The scale and nature of the activity across the portfolios was not such as to meet the test for a business when the transactions are analysed taking into account [the taxpayer's witness'] explanation for them. It cannot be said the taxpayers' intention was to conduct a business.
Finally the Court considered whether the shares were acquired for the purpose of resale (section 65(2)(e) second limb). The parties accepted that this was a subjective test to be determined by reference to each individual instance of share acquisition [89]. However, in the absence of finding of fact on individual transactions (which the Court of Appeal would not usually make) and the Commissioner's decision not to seek the matter be remitted back to the TRA for it to make such findings of fact, the Court concluded the second limb of section 65(2)(e) was not met [90].
A minor issue in the tax case was whether the Jersey-company which held the portfolios was a bare trustee for the taxpayers. The Court of Appeal agreed with the TRA and High Court that it was [91-114].