Contractor not a party to a sham
2010 case note - Judge held that disputant was not claiming income tax deductions or GST inputs for invoices knowing them to be false - deductibility, agent.
Tax Administration Act 1994, Income Tax Acts 2004 and 2007, Goods and Services Tax Act 1985, and Income Tax (Withholding Payments) Regulations 1979
Judge Barber held that the disputant was not claiming income tax deductions (or GST inputs) in respect of invoices knowing them to be false. His Honour allowed leave for the parties to make submissions on the legal issue of deductibility (including whether GST inputs can be based on false invoices). However, he considered that the false invoices were costs incurred by the disputant in good faith in seeking to derive assessable income so that they are deductible in the usual way.
Impact of decision
This decision is limited to its facts.
The disputant (an orchardist and contracting company) challenged the Commissioner's reassessments of its GST, PAYE and income tax for 2006 and 2007.
The Commissioner alleged that the disputant had used false invoices from subcontractors to claim income tax deductions, GST inputs and to avoid paying PAYE on salaries paid in cash.
It was accepted by the disputant that five of its subcontractors were involved in a fraudulent invoice writing scheme. However, the disputant claimed that one of its ex-employees was running a secret and separate business operation using the invoice writing companies without the disputant's knowledge.
The Commissioner alleged that the disputant (via its proprietor Mr J) was well aware of its involvement in the fraudulent invoice writing scheme and was attempting to use its ex-employee as a scapegoat.
Judge Barber held that he could not be satisfied, on the balance of probabilities, that the disputant (through its proprietor Mr J) knew that the invoices upon which the disputant had claimed income tax deductions and GST inputs were false. In terms of the reasoning of Richardson J in NZI Bank v Euro-National Corporation Ltd, Judge Barber held that because the invoices were not a sham to which the disputant was a party, the legal effect of the invoices was to be respected.
The Commissioner argued that Mr J had actual knowledge of the sham and was the directing mind of the disputant. A principal is not bound by an agent's knowledge of fraud; but where a person who may properly be classified as the "directing mind of the company" has actual knowledge, the principal company will be liable: El Ajou v Dollar Land Holdings Plc  2 ER 685. His Honour held that the level of proof led for the Commissioner was insufficient for him to find as a fact that Mr J was a knowing participant in the "fraudulent invoice writing scam".
His Honour considered that the disputant had paid out on invoices which it believed were genuine because its proprietor Mr J was duped by an ex-employee. His Honour considered this to be expenditure incurred in the course of the disputant's business even though some of the invoices were false. His Honour allowed leave for the parties to make submissions on the legal issue of deductibility (including, whether GST inputs can be based on false invoices). Nevertheless, His Honour considered that the false invoices are costs incurred by the disputant in good faith in seeking to derive assessable income so that they are deductible in the usual way.
His Honour was uncertain whether the Commissioner still relied on his first ground for disallowing the income tax deductions, GST inputs and for increasing PAYE as being due to insufficient documentation and information. His Honour said that he would reconvene the hearing on that aspect if necessary however, his view was that there was sufficient documentation and information to comply with the discretions available to the Commissioner.