Successful appeal by the Commissioner
2014 case note – construction of retail shopping centre and sale agreement – capital/revenue, supply.
Income Tax Act 2004, Income Tax Act 2007, Tax Administration Act 1994
In 1988, the taxpayer (a property developer) purchased a large block of land in Christchurch and began construction of a retail shopping centre on the site.
In 2003, before the development was fully complete, the taxpayer sold the centre to AMP. The agreement for sale and purchase between the taxpayer and AMP ("the Agreement") contained an "option" which required the taxpayer to use its best endeavours to lease and build the undeveloped part of the centre.
The sites to be constructed and completed were described as Future Development Sites ("the FDS") in the agreement.
Between 2004 and 2009, the taxpayer found tenants and procured unconditional agreements to lease. The taxpayer received "development payments" from AMP as the new tenants started paying rent.
The Taxation Review Authority ("TRA") found the following in its decision of 23 October 2013:
- The Agreement was a single, unitary contract for sale and purchase of the completed centre.
- The adjustment provisions of the Agreement clearly envisaged the completion of the development and were consistent with the disputant's position that the Agreement provided for the sale and purchase of the completed centre.
- The development option was not in fact an option that could be exercised. If the taxpayer failed to develop all of the proposed FDS units, it would be in breach of the obligation to use the best endeavours to develop the site.
- What was supplied was a capital asset as the Agreement was for a single indivisible supply of a completed shopping centre.
- FDS development payments were not taxable. No shortfall penalties were payable.
The TRA also rejected the alternative submission of the Commissioner of Inland Revenue ("the Commissioner") that the payments were taxable under s CB 3 of the Income Tax Act 2007 as derived from an undertaking entered into for the purpose of making a profit.
The Commissioner appealed the TRA's decision.
The Court allowed the Commissioner's appeal.
Two preliminary points
The Court began by considering two preliminary points: parole evidence; and the respondent's submission that the Commissioner had impermissibly shifted her grounds in the TRA, departing from her Statement of Position ("SOP").
In relation to the parole evidence issue, Kos J did not consider subjective declarations of the parties as to their intentions during pre-contractual negotiations relevant. His Honour did not consider them to be capable of providing objective guidance as to the intended meaning.
In respect to the second preliminary point, Kos J considered the Court of Appeal's decision in Commissioner of Inland Revenue v Zentrum Holdings Limited  1 NZLR 145 (CA) ("Zentrum"), determining that it was binding on the High Court. His Honour then noted that Vinelight Nominees Ltd v Commissioner of Inland Revenue  NZCA 655, (2013) 26 NZTC 21,055,distinguished between SOP and pleadings, finding that the Commissioner's SOP need only give an outline of the facts, evidence and propositions of law in sufficient "detail to fairly inform the disputant".
Kos J was satisfied that the Commissioner had done so here and that there was no place in the law for "arid literalism where clear meaning was conveyed despite form".
His Honour stated that even if that was not the case, the pleading would be permitted under s 138G(1) of the Tax Administration Act 1994 ("TAA") as response to the assertion made in the taxpayer's SOP.
One supply or two
The Court noted that a single transaction in a single contract may nonetheless contain two or more supplies for tax purposes. Some receipts may be capital, whereas others are income. Whether that is or not, is to be assessed in accordance with the principles stated in Wattie v Commissioner of Inland Revenue (1997) 18 NZTC 13,927 (CA) (upheld on appeal:  1 NZLR 529 (PC)).
Kos J held that the agreement in this case contains two distinct and separately identifiable supplies. The first is the transfer of land, payment for which is a capital receipt. The second is letting and construction services concerning the still undeveloped FDS land, now owned by a third party.
His Honour did not accept that the Agreement, properly construed, provides simply for the sale and purchase of a completed retail development.
In particular, his Honour did not consider that the clauses in the Agreement relied upon by the disputant provided a clear pointer to the Agreement containing a single indivisible supply; a completed shopping centre. The fact that the parties had used a broad label to describe what is being transacted did not necessarily characterise the whole of the transaction from a taxation perspective.
Kos J instead noted that several clauses in the Agreement showed the "functional and temporal" separation of the two supplies. His Honour disagreed with the TRA's findings in relation to these clauses, concluding as follows:
- The Agreement divided the consideration into two distinct sums: the purchase price and the development payments. Each clearly attributable to a different type of performance.
- The adjustment provisions were not a financial penalty for non-completion of the development and did not demonstrate that the taxpayer was compelled to deliver a completed shopping centre.
- The taxpayer would not be in breach of the agreement if it failed to complete development of the FDS sites, it was only obliged to use best endeavours to develop the FDS under the development option. (The Court adopted the approach to best endeavours clauses taken in Kingdon Development Ltd v Saiteys McMahon Property Ltd CIV-2007-404-3760, 17 October 2007 at , noting that the development option did not require the taxpayer to develop a site at its own cost in the event that neither the taxpayer nor AMP had been able to find tenants.)
- After the settlement of the sale of the land, when the development option took practical effect, the land no longer belonged to the taxpayer. It belonged to AMP. Therefore, all work to be done was on land belonging to AMP, not the taxpayer.
- The Agreement contemplated cancelling the development option separately from the principal agreement.
Kos J considered that the taxpayer, having chosen by its agreement to separate the form and timing of distinct obligations to supply, could not now re-amalgamate them because it better suited its taxation objectives. It could not have it both ways.
The Court also held that the TRA upheld the taxpayer's position in a "cogent and careful" decision. Therefore, the taxpayer's position, while wrong, was rationally arguable so shortfall penalties were not imposed.