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09 Jul 2014
Appeal Status

Nexus - section DA 1 of the Income Tax Act 2004

2014 case note - High Court upheld CIR's assessments disallowing the interest deductions as insufficient connection between deductions and income-earning process.

P L Brown Farms Limited v Commissioner of Inland Revenue [2014] NZHC 1601


The Commissioner of Inland Revenue ("the Commissioner") disallowed interest deductions claimed by the appellant, P L Brown Farms Limited, in the 2006 and 2007 income tax years. The Taxation Review Authority ("TRA") and now the High Court have upheld the Commissioner's assessments disallowing the interest deductions due to there being an insufficient connection between the deductions and the appellant's income-earning process.

Impact of decision

Whether there is sufficient nexus, between the income-earning process and the deductions claimed by a taxpayer, pursuant to section DA 1 of the of the Income Tax Act 2004 ("the Act"), is determined by considering the legal arrangements entered into, not by considering what other arrangements the parties might have entered into.


The appellant, P L Brown Farms Limited ("Farms"), appealed the decision of the TRA upholding the assessments made by the Commissioner and dismissing the appellant's challenge to those assessments (X Ltd (A Farming Company) v Commissioner of Inland Revenue [2013] NZTRA 2).


There are three relevant companies all ultimately owned by Mr and Mrs Brown. The Court, adopting the terms of the TRA, referred to the appellant as "Farms" and to the other two companies as "Sharemilking" and "Beef".

Farms (a qualifying company) borrowed from a bank on commercial terms and on-lent the borrowed funds to Sharemilking and Beef. One of the terms of this on-lending was that interest would be payable on demand, but in fact no interest was demanded from or paid by either Sharemilking or Beef.

The money was used by Sharemilking and Beef to purchase land now leased to Farms. The land purchase by Sharemilking included the purchase of shares in Fonterra.

Farms claimed deductions in the 2006 and 2007 income years for interest paid to the bank on the money borrowed and on-lent to Sharemilking and Beef. The Commissioner disallowed the deductions on the basis that the expenditure did not satisfy the general permission in section DA 1 of the Act, under which a deduction is allowed for expenditure incurred in deriving assessable income.



The appellant submitted that there was a nexus between the interest paid and its assessable income, because the borrowed money on which the interest was paid was used to acquire land that Farms used to carry on its farming business. The Court noted that had this been the case, there would have been an indisputable nexus between the interest expenditure claimed and the income-earning process carried out by Farms. However, the Court found that the land was actually purchased by Sharemilking and Beef and leased to Farms.

The Court noted that the arrangements actually entered into needed to be analysed to determine whether the arrangements established a nexus. The Court found that there was no evidence of any agreement between Farms and either Sharemilking or Beef that made the granting of the leases conditional on receipt by Sharemilking or Beef from Farms of the funds borrowed by Farms.

The Court also held that there was no evidence of any contract or other arrangement between Farms on one hand, and Sharemilking and Beef respectively on the other, to create a nexus between the borrowing and the acquisition of the land by Farms.

The Court held that, on the evidence, the ultimate controllers of all three companies had the ability to achieve, and did achieve, the outcome that the borrowed money was used to buy land which was then leased to Farms. Accordingly, the Court held that this was not a nexus in terms of section DA 1 of the Act.

Barter transaction

The appellant asserted that it received a reduced rental in exchange for interest-free loans and therefore a barter transaction existed. The Court was not satisfied, on the evidence, that there was any barter arrangement.

Fonterra shares

The appellant submitted that there is a nexus between the interest payments and the derivation of income because the funds borrowed by Farms were used in part by Sharemilking to purchase the Fonterra shares under which the milk produced by Farms was sold. The Court found that the money borrowed was not used by Farms to acquire the shares - the shares were acquired by Sharemilking.

The Court also held that there was no evidence that Farms derived any income as a direct result of the acquisition of the Fonterra shares, nor was there any evidence of the extent to which Farms or Sharemilking derived dividend income from the Fonterra shares.

Income Tax Act 2004