Legal expenditure allowed if meets "principal purpose" test

Summary

The High Court found that the trustees of the Mangaheia and Te Mata Property Trusts were entitled to deduct GST input tax credits in relation to legal services acquired for litigation proceedings. Legal services acquired by the trustees were acquired for the principal purpose of making taxable supplies. The High Court also found that the "principal purpose" test has to be met before GST on services and supplies can be claimed as an input tax under section 3A(1)(a) of the Goods and Services Tax Act 1985 ("GST Act").

Impact of decision

The High Court has clarified the law in regard to the meaning of section 3A of the GST Act. If there is sufficient nexus between the services acquired and the making of the taxable supplies, the services will have been obtained for the principal purpose of making taxable supplies.  

Each case requires a factual inquiry and the "principal purpose" test has to be met before the GST on services and supplies can be claimed as an input tax credit.

Whilst not overturning the Taxation Review Authority's findings of fact, the High Court has confirmed the Commissioner's view that section 3A(1)(a) of the GST Act is more than just a "filter" and stated the law in a fashion not inconsistent with the Commissioner's view that section 3A(1)(a) is to be read in conjunction with section 21 of the GST Act.

For clarity, the Commissioner's position is not that accounting and valuation fees were (and often are) allowed because they do not amount to large sums.

The Commissioner will not appeal this decision.

Facts

The trustees of the two disputant trusts claimed GST input tax credits for fees for legal services arising out of protracted litigation concerning a number of trusts. The Commissioner disallowed the claims and the disputants successfully challenged that in the Taxation Review Authority; TRA Nos 67/05 and 70/05.

The Commissioner appealed against the decision of the Taxation Review Authority that the Commissioner acted incorrectly in disallowing the two disputant trusts GST input tax credits claimed by the trustees for legal fees.

The Commissioner brought this appeal on the basis of the following:

• The Authority was incorrect in finding that the legal services acquired and the fees paid by the trusts were acquired for the principal purpose of making taxable supplies.
• The Authority erred in law by reading down the "principal purpose" test required under section 3A of the GST Act.
• The Authority's approach to the "principal purpose" test was flawed and it was incorrect to say that section 3A(1)(a) of the GST Act operates as a "filter" between the making of taxable supplies and exempt supplies.

Decision

Whether the Authority erred in law by reading down the principal purpose test under section 3A of the GST Act 1985

The High Court found that considering whether there is sufficient nexus is an eminently sensible way of approaching the principal purpose test because:

• ... if there is an insufficient nexus between the acquisition of goods or services in the making of taxable supplies, then logically it could not follow that the goods or services were acquired for the principal purpose of making taxable supplies. [23]

This nexus must be a question of fact. One way of approaching the factual inquiry whether the services were acquired for the principal purpose of making taxable supplies is to ask whether there is a sufficient nexus between the services acquired and the making of the taxable supplies. If the principal purpose was something other than the making of taxable supplies then the conclusion should be there was insufficient nexus.

Inherent in the definition of a taxable supply is that it must be in the course or furtherance of the taxable activity.

In terms of claiming for a business expenditure, the reference to "making taxable supplies" is to be read widely. There is no requirement that the specific expenditures on which input tax credits are claimed need to be directly linked to the specific resulting products. This would be contrary to the overall balancing out effect which the legislation seeks to achieve; see Glenharrow Holdings v Commissioner of Inland Revenue [2009] 2 NZLR 359

On the finding of the Taxation Review Authority that section 3A of the GST Act is a filter, the Court found that:

• The reference to there being a "filter" was not entirely apt. The principal purpose test has to be met before the GST on services and supplies can be claimed as input tax. [36]

The High Court found that the Taxation Review Authority's reference to section 3A of the GST Act as a "filter" is ambiguous, but reading the decision as a whole, there is no doubt that the Authority's decision does not involve any departure from the ordinary meaning of the words "principal purpose".

Whether the legal services acquired (and fees paid) by the trusts were for the principal purpose of making taxable supplies

It is not appropriate that a presumptive approach that virtually anything a trustee, and thus the trust, does intra vires might meet the "principal purpose" test. There may be circumstances where the "principal purpose" threshold is not met even though a trustee is acting intra vires. Every case is a factual inquiry and in the case of the trusts, regard had to be given to the terms of the trust deed, the taxable activity and the exact nature of the trustee's actions so as to establish on the facts whether the "principal purpose" test has been satisfied.

The High Court found that the Authority did address the need for some nexus between the expenditure on legal fees and the taxable activity of the two trusts.

The Authority was aware of the statutory requirement to apply the exact wording of section 3A of the GST Act and, as a whole, the Authority's decision did not depart from the ordinary meaning of the words "principal purpose".

The Court found that the Authority was correct on the facts and the law, and the two trusts were entitled to claim the GST input tax credits for fees for legal services acquired by the trusts for the purpose of the litigation. The High Court dismissed the Commissioner's appeal.