Director's liability for asset stripping under section HD 15

Summary

The Taxation Review Authority (“the Authority”) upheld the Commissioner of Inland Revenue’s (“the Commissioner”) assessment of a director as agent for companies pursuant to s HD 15 of the Income Tax Act 2007 (“ITA”). In finding the director liable, the Authority considered arrangements had been entered into which resulted in the companies not meeting their tax liability to the Commissioner. The Authority also considered a number of issues in relation to the director’s bankruptcy and ultimately concluded that the director had no standing to bring the tax challenge, as the challenge vests in the Official Assignee.

Impact

This is a significant case as it considers a director’s liability as agent for a company under the asset stripping provisions under s HD 15 of the ITA (and s 61 of the Goods and Services Tax Act 1985 (“GSTA”)).

Facts

The disputant commenced challenge proceedings after he was assessed under s 61 of the GSTA as agent for three companies, AB 1 Limited, AB 3 Limited and AB Ventures Limited (“the Companies”), which were placed into liquidation on 30 June 2010 for goods and services tax (“GST”) liabilities totalling $1,779,568.

The matter initially came before the Authority on 31 October 2012 following which, further matters were raised and eventually heard on 24 August 2015.

Property Limited was incorporated in 1997 and acted as the GST group representative member under s 55 of the GSTA for a number of companies that were part of the Property Group of Companies (“the GST Group”). The disputant was managing director of Property Limited until the company was liquidated in July 2010. The Companies were included in the GST Group and the disputant was also the managing director of the Companies.

By April 2008, Property Limited and a number of its subsidiaries had substantial outstanding liabilities to creditors. Property Limited was also owed significant amounts by some of its subsidiary companies including AB 1 Limited, AB 3 Limited and AB Ventures Limited. The directors of Property Limited decided to sell certain assets of its subsidiaries to generate funds to pay the debts of Property Limited. The disputant negotiated the agreements for sale and purchase of the assets.

In July 2006, Property Limited provided a financial guarantee to a finance company in relation to the indebtedness of the largest subsidiary in the GST Group. In July 2008 the subsidiary was placed in receivership.

After taking legal advice, the disputant and other directors decided to incorporate PQR Holdings Limited (“PQR”) and for that company to acquire shares in certain subsidiaries of Property Limited and to acquire, by way of assignment, the intercompany debts owed by those subsidiaries to Property Limited. PQR was incorporated on 1 August 2008. The disputant was its sole director.

On 4 August 2008, Property Limited and PQR entered into a Deed of Assignment assigning debts. To secure these debts, the Companies granted mortgages over the land contained in the various certificates of title that were subject to the sale and purchase agreements. On 6 August 2008, GST invoices were issued by the solicitors acting for the Companies. Each of the sale and purchase agreements settled on 14 August 2008.

The disputant in his capacity as managing director of each of the Companies, Property Limited and PQR made the decision to apply the net proceeds to pay the inter-company debts, which had been assigned to PQR. He subsequently used those funds to pay certain debts of Property Limited and some of its subsidiaries.

On 23 October 2008, Property Limited and PQR entered into a deed titled “Agreement” signed by the disputant as director of Property Limited and as director of PQR. After the net proceeds had been paid to PQR there were no remaining funds or assets left in the Companies to pay the GST liabilities.

The Companies failed to comply with statutory demands served on them by the Commissioner. In June 2010, the High Court made orders putting each of the Companies into liquidation.

On 25 August 2009, the disputant was assessed as agent. In 2010 the disputant was subsequently adjudicated bankrupt and the present challenge proceedings were issued by the disputant in May 2011.

Decision

Jurisdiction

Regarding the extent of the Authority’s jurisdiction, Judge Sinclair initially considered and dismissed a number of the disputant’s arguments contending that the Authority has no power to make orders. Judge Sinclair then concluded that the disputant, as an un-discharged bankrupt, had no standing to bring the challenge.

Effect of s 76 of the Insolvency Act 2006

Judge Sinclair agreed with the Commissioner that a tax challenge is not a proceeding to recover a debt that would be halted by s 76 of the Insolvency Act 2006 (“IA 2006”) and noted a similar view taken in Case H85 (1985) 8 NZTC 592 at 596. For that reason s 76 of the IA 2006 was not relevant to this case.

Contingent debt prior to adjudication

Judge Sinclair referred to Allen v Commissioner of Inland Revenue (2004) 21 NZTC 18,718 (CA) at [58] regarding assessments remaining valid until set aside by a court of competent jurisdiction, which is supported by the clear policy that underpins s 109 of the Tax Administration Act 1994 (“TAA”).

Her Honour agreed with the Commissioner that the TAA contemplates a tax debt being an actual debt despite a challenge to the underlying assessment being on foot.

Position on bankruptcy

Judge Sinclair considered that there was no merit in the disputant’s argument that a further contingency arose on bankruptcy. The disputant argued that as the Commissioner’s proof of debt had not been accepted or rejected by the Official Assignee (as no funds were available for distribution), no debt survived the adjudication of bankruptcy.

Disputant’s standing to bring these proceedings

Judge Sinclair looked at the status of the bankrupt’s property following adjudication and citing s 101 of the IA 2006 where it is defined as meaning “property of every kind, whether tangible or intangible, real or personal, corporeal or incorporeal, and includes rights, interests, and claims of every kind relation to property however they arise”.

Her Honour stated she was satisfied that the right of the disputant to issue challenge proceedings passed to the Official Assignee on the disputant’s bankruptcy pursuant to s 101(1) of the IA 2006.

Judge Sinclair held that it was apparent that the Official Assignee did not assign or otherwise consent to the disputant issuing challenge proceedings. Furthermore, Her Honour held that the right to issue these challenge proceedings vested in the Official Assignee and the disputant has no standing to bring these proceedings.

Section 61 of the GSTA and s HD 15 of the ITA

In the event that the Authority was wrong on the standing issue, Judge Sinclair went on to consider the application of s 61 of the GSTA. Her Honour held that the requirements of s 61 of the GSTA were met and that the Commissioner was correct in treating the disputant as an agent of the Companies and in assessing him as jointly and severally liable for the Companies’ respective GST liabilities.

Was an “arrangement” entered into?

Judge Sinclair considered both the definition of “arrangement” in s YA1 of the ITA and the meaning of “arrangement” considered in Ben Nevis Forestry Ventures Limited v Commissioner of Inland Revenue ([2009] 2 NZLR 289, 331 at [105]).

The disputant contended in the present case that there was no relevant arrangement because the payments:

1. discharged debts owing to PQR which existed prior to any alleged arrangement being entered into; 
2. were the result of a unilateral decision by the disputant to prefer the debts rather than to pay the funds to the disputant.

Payment of pre-existing debts

Her Honour agreed with the Commissioner that while the Companies had pre-existing debts, which they owed to Property Limited, they did not have pre-existing debts owing to PQR. Those debts arose only after the debts had been assigned to PQR as part of the Arrangement.

Unilateral decision

Judge Sinclair considered Peterson v Commissioner of Inland Revenue [2012] 1 NZLR 450 (CA) at [43] and [50] where the Privy Council had considered whether an arrangement requires a consensus or meeting of the minds between the parties involved. The Judge noted that the Court of Appeal in Russell v Commissioner of Inland Revenue [2012] NZCA 128, (2012) 25 NZTC 201,120 had held that there was still an arrangement where one taxpayer acted unilaterally in circumstances where he controlled all of the entities and was the architect of the overall plan [101].

Her Honour held the disputant is the director and consequently controlling mind of all the relevant companies involved in the various transactions making up the arrangement. Her Honour also held that the transactions were closely connected; they all occurred over a relatively short period and formed part of an overall plan. She went on to find that the disputant also played an active role in the implementation of various transactions.

Judge Sinclair found that for the purposes of s 61 of the GSTA, an arrangement was entered into involving each of the Companies and consisting of transactions collectively referred to as the “arrangement”.

Was it an effect of the arrangement that each company cannot meet a tax liability? 

Judge Sinclair adopted the approach in Auckland Harbour Board v Commissioner of Inland Revenue (1999) 19 NZTC 15,433 at 15,451 where Richardson P had stated that the word “effect” had its standard meaning of “the end accomplished or achieved”, and that the word “effect” should be similarly interpreted in s 61 of the GSTA.

Her Honour stated that the sale of the properties converted the Companies’ assets from one form to another. The net sale proceeds were then stripped from the Companies under the arrangement. After the transactions that made up the arrangement had been completed, the Companies were unable to satisfy their GST liabilities. Judge Sinclair agreed with the Commissioner’s submission that this was the effect of the arrangement.

Is it reasonable to conclude that a purpose of the arrangement is that a company cannot meet a tax liability?

Her Honour noted that s HD 15(1)(c)(1) of the ITA uses the indefinite article “a purpose of the arrangement” and that accordingly, if any purpose of the arrangement was to have the effect of depleting the assets of the company, that purpose is sufficient.

Judge Sinclair noted that the principles relevant to determining the purpose of an arrangement have not been considered by any Court in respect of s 61 of the GSTA and applied the approach of the Supreme Court in Glenharrow Holdings Limited v Commissioner of Inland Revenue [2008] NZSC 116, [2009] 2 NZLR 359 when dealing with an arrangement in the avoidance context.

Her Honour stated that viewed objectively it is reasonable to conclude that a purpose of the arrangement in this case was the effect that the Companies cannot meet their respective GST liability.

Is it reasonable to conclude that if the disputant made reasonable enquiries he could have anticipated at the time that the GST liability would or would likely be required to be met?

Judge Sinclair held that it is reasonable to conclude if the disputant as director of the Companies at the time of the arrangement had made reasonable enquiries he would have anticipated that the GST liabilities arising would, or would likely, be required to be met.