Intention or purpose of one or more trustees attributable to trust as a whole
2013 case note – intention/purpose of some trustees - whether amounts derived on disposal of properties income - GST, shortfall penalties, gross carelessness.
The decision by the Taxation Review Authority ("TRA") held that two of the three trustees, Mr and Mrs B, had the intention or purpose to sell when each of the relevant properties was acquired. This intention or purpose was attributable to the Trust as a whole, despite the third trustee asserting that she had no such purpose or intention.
The TRA also held that the Trust's activities amounted to a business of erecting buildings and a taxable activity for goods and services tax ("GST") purposes. Accordingly, the trustees of the Trust were found to be jointly and severally liable to pay income tax and GST output tax on the sale proceeds from seven properties. The TRA also found that shortfall penalties for gross carelessness applied.
Impact of decision
The TRA's decision that the intentions or purposes of some, but not all, of the trustees of a trust can be attributed to the Trust as a whole, is an important one. It appears to confirm the approach taken in CIR v Boanas (2008) 23 NZTC 22,046 (HC) in relation to the intentions of partners in a partnership. It is worth noting that the TRA also considered that from a broader perspective, it would result in "an extraordinary outcome if a trust can simply ignore the unanimous trustee requirement in its day to day operation and then be able to take advantage of that requirement when considering its tax obligations". Such a comment also appears to echo the Court of Appeal's sentiments in Commissioner of Inland Revenue v Newmarket Trustees Ltd  NZCA 351;  NZLR 207.
The disputants are the trustees of the B Family Trust ("the Trust"). The Trust was settled on 9 October 1996 by Mr and Mrs B, who were also appointed as trustees and were the primary beneficiaries of the Trust. Mr and Mrs B's solicitor, Ms X, was also a professional trustee for the majority of the periods in dispute.
Over a 12-year period between September 1996 and September 2008, the Trust bought and sold 11 properties. Ten of those properties were purchased as vacant sections and the Trust had houses built on nine of those ten properties. Mr and Mrs B lived in each of the newly built houses for between two and ten months before selling them, with the exception of the tenth property, which they occupied for two and a half years.
Following an audit, the Commissioner issued default assessments to the Trust for income tax and GST on the sale proceeds from seven of the 11 properties. This was on the basis that:
- the properties were bought with the purpose or intention of resale; and/or
- the Trust was in the business of erecting buildings; and
- the buying, improving, and selling of the seven properties constituted a taxable activity for GST purposes.
The Trust was also assessed for shortfall penalties on the basis that it had been grossly careless in taking its tax position or, alternatively, failed to take reasonable care.
The trustees disputed the Commissioner's assessments and filed a challenge proceeding in the TRA.
Attributing purpose or intention to the Trust
The disputant submitted that for the purposes of section CD 1(2)(a) of the Income Tax Act 1994 and 2004 ("the ITA"), the intention or purpose of sale must be attributable to the Trust as a whole, not just to individual trustees. Therefore, where intention or purpose is not unanimous, it cannot be regarded as an intention or purpose of the Trust. If just one of the trustees did not have the intention or purpose to sell when the relevant properties were acquired, it could not be concluded that the Trust as a whole had the intention or purpose to sell either. The disputant referred to the fact that the Deed of Trust required the decisions of the trustees to be made unanimously in support of this proposition.
The Commissioner contended that if Mr and Mrs B, acting in their capacities as trustees, had the intention or purpose of resale, the fact that Ms X may have had other intentions or purposes did not defeat the application of section CD 1(2)(a) of the ITA.
In finding for the Commissioner, the TRA agreed with the Commissioner's submission, that section CD 1(2)(a) of the ITA specifically provides that the intention or purpose to sell need only be one of a number of intentions and purposes and does not need to be the dominant intention or purpose. The TRA also accepted the Commissioner's submission that it does not necessarily follow that Trustees had to be unanimous as to their intention for the future use of that land. There may be situations where trustees have different intentions. The TRA also considered that even if that approach was not correct, Ms X knew that Mr and Mrs B were entering into agreements for the sale and purchase of land. Ms X allowed her co-trustees to enter into these transactions and she was therefore estopped from denying that she approved the decisions of Mr and Mrs B. The Commissioner also contended that Mr and Mrs B were acting on behalf of the Trust when they purchased and sold Trust land and that it was clear from the evidence that Ms X was aware of her co-trustees' activities. As a consequence, all the trustees were bound by the decisions and actions of Mr and Mrs B.
The TRA concluded that in the circumstances, the intention of Mr and Mrs B could be attributed to the Trust.
Were the amounts derived on the disposal of the seven properties income?
Purpose or intention of sale
While the Commissioner contended that the Trust had acquired the relevant properties with the purpose or intention of sale, the Trust argued that when each of the relevant properties was acquired, the Trust had not intended to sell them. Instead, the Trust asserted that the intention was that each property would become Mr and Mrs B's long-term family home (as beneficiaries). Mr and Mrs B then gave evidence that shortly after each house was completed, unforeseen events occurred that required them to sell.
After considering the evidence, the TRA held that the Trust failed to prove on the balance of probability that, at the time of acquisition of each of the properties, the Trust did not have at least one intention or purpose of sale. The TRA found that Mr and Mrs B were not credible witnesses and that their alternative explanations for why each property had to be sold lacked credibility and were not supported by any contemporaneous documentation or evidence.
Business of erecting buildings
The Trust contended that it was not in the business of erecting buildings. This was on the basis that not only were the Trust's activities not carried out in a coherent and organised way, but that the Trust also lacked the necessary intention to make a profit. It was argued that the Trust did not have a coherent business plan nor did it maintain business records. In addition, it was argued that even if Mr and Mrs B had an intention to make a profit, that intention was not shared by Ms X and therefore the requisite intention to profit could not be attributed to the Trust as a whole.
Despite accepting that the Trust had not maintained business records, the TRA nonetheless held that the Trust's activities of purchasing sections, building houses and selling them on, were carried out in a coherent and organised way. For the reasons discussed earlier, the TRA disagreed with the Trust's "unanimous intention" argument, finding that the Trust as a whole had an intention to profit. For reasons covered in the TRA's analysis of the intention/ purpose/issue, the TRA also found that the relevant properties had been acquired for the purpose of the business of erecting buildings, and that in any case, the properties were disposed of within the applicable 10-year period after each house was completed.
Exemption for residential land
The TRA held that the "residential exemption" in section CD 1(3) of the ITA would only apply if a dwelling was used "primarily and principally" as a residence, and only if the taxpayer is not engaged in a regular pattern of acquiring and disposing or acquiring and erecting buildings (see Case K21 (1988) 10 NZTC 218 (TRA); Case M102 (1990) 12 NZTC 2,634 (TRA) and Parry v Commissioner of Inland Revenue (1984) 6 NZTC 61,820 (HC)).
The TRA agreed with the Commissioner's contention that the occupation of each property (with the exception of property five which was sold before being built on) was incidental to the more significant purpose of sale and as such the properties were not occupied "primarily or principally" as residences. The TRA also held that section CD 1(3) did not apply because the Trust was engaged in the acquisition of sections, construction of dwelling houses and subsequent sales to such an extent that a regular pattern of was established.
Is the Trust liable to account for GST output tax?
In line with the TRA's finding that the Trust was engaged in the business of erecting dwelling houses on the properties, the TRA also found that the Trust's activities of buying land, building houses and on-selling the developed properties constituted a taxable activity. As a consequence, the Trust was deemed to have been registered for GST and required to account for GST output tax on the sale proceeds from the properties.
The TRA did not accept the Trust's argument that the activities of buying, building and selling occurred simply as a series of "one off" transactions, and that the activities occurred on an intermittent basis.
The TRA found that in view of the large number of sections that the Trust had purchased, improved and sold, there was a high risk of a tax shortfall occurring. The scale and duration of the activities undertaken by the trustees meant that the risk was an obvious and serious one. Because a reasonable person in the circumstances of the trustees would have foreseen the risk, the TRA concluded that shortfall penalties for gross carelessness had to apply.
Income Tax Act 1994 and 2004, Tax Administration Act 1994, Goods and Services Tax Act 1985