High Court confirms tax avoidance and opening of time bar on basis of returns being wilfully misleading
2016 case note - High Court confirms tax avoidance and opening of time bar on basis of returns being wilfully misleading - Abusive Tax Shortfall Penalty.
Great North Motor Company Limited (“Great North”) commenced challenge proceedings against the Commissioner of Inland Revenue (“Commissioner”) in respect of the Commissioner’s assessments in the income tax periods 31 March 1996 to 2011. The High Court upheld the Commissioner’s assessments.
Great North was incorporated on 21 October 1959 and until 7 February 1992 was called Zupps Motors Ltd. It operated a used car yard. 99.99 percent of the plaintiff’s shares are held by Glen Eden Holdings Ltd (“Glen Eden”). Glen Eden is wholly owned by Commercial Management Ltd (“Commercial Management”). Commercial Management is wholly owned by Commercial Administration Ltd (“Commercial Administration”) and Commercial Administration is wholly owned by Glen Eden. The remaining 0.01 percent of Great North is owned by Downsview Nominees Ltd (“Downsview”) and Downsview is wholly owned by Commercial Administration. The Court noted that Great North’s ownership “may be fairly described as circular”.
Mr John George Russell was the sole director of Glen Eden, Commercial Management and Commercial Administration as well as accountant and secretary to all three companies.
Mr Radisich and his companies are longstanding clients of Mr Russell and Mr Radisich is a former shareholder of Great North (he held 98.4 percent of the shares until September 1998). All shares in Great North are held on trust for Mr Radisich’s benefit.
On 20 August 1993, Great North issued a debenture to Glen Eden in return for Glen Eden advancing $380,277 to Great North. This sum was repayable “on demand”; meaning Great North was liable to repay the advance in full at any time. Interest was payable at any rate specified by Glen Eden, but only when Glen Eden actually demanded payment of interest. In the absence of Glen Eden stipulating an interest rate, the default rate was 28 percent per annum. Under the debenture, Great North was entitled to make repayments of principal at any time. At that time, Great North was insolvent. It had ceased trading on 10 December 1993, some four months after Glen Eden had injected the funding. The Court considered it likely however that these funds were used to repay a creditor (Ron West Ltd, of which 99.99 per cent of the shares were owned by Mr Radisich and the remaining 0.01 percent by Downsview).
On 14 July 1994, Mr Russell wrote to the Commissioner saying Great North had no assets or income and thus no funds to pay PAYE tax deductions from 31 March 1991. Mr Russell corresponded similarly on 21 March 1995. Great North was placed in liquidation, in the intervening period, on 1 September 1994.
On 20 April and 28 June 1995, Mr Russell filed income tax returns for Great North for that year. The returns asserted that Great North had made combined losses of $1,785,076.12. Great North was removed from the companies register on 8 May 1996. However, it was restored to the register on 1 July 1997 on application by Glen Eden and Mr Russell.
On 23 December 1997 Mr Russell wrote two letters to the Commissioner outlining objections to the Commissioner’s 1991 to 1995 determinations. In April 1998, Great North instituted judicial review proceedings against the Commissioner in relation to these determinations. However, Great North did not recommence business and was again placed in liquidation on 24 June 1998. Glen Eden (the shareholder) abandoned its judicial review proceedings in September 1998.
On 25 May 2005 Kensington Developments Ltd (“KDL”) acquired 14 debentures from Glen Eden, including that issued by Great North to Glen Eden in 1993.
KDL was incorporated in 1979 but has been in receivership since 30 June 1994. Mr Russell has been its receiver from July 1994 and sole director from 1 April 2008. The Court considered it was unlikely KDL paid anything to acquire the debentures yet Great North now owed KDL (by virtue of the transfer) $5.9 million under the debenture. On 26 May 2005, Mr Russell appointed himself receiver of Great North. On 29 May 2005, Great North was struck off the companies register.
In July 2005 Mr Russell filed tax returns on behalf of Great North even though the company had been removed from the register two months earlier. The returns were for the tax years ending 31 March 1996 to 31 March 2005 inclusive and claimed expenditure and associated losses made up of the interest payable on Great North’s debenture since inception (which by 2005 had reached $7,206,855.66).
On 13 July 2006 Mr Russell filed Great North’s return for that year (with losses of $8,875,561.97). Computer generated determinations were automatically issued allowing the claimed expenditure and losses. From 11 October 2005, the Commissioner issued re-assessments disallowing the expenditure and losses.
The Court considered it “almost certain” that Mr Russell had anticipated the Commissioner’s re-assessments as:
- On 27 August 2010 Mr Russell and Glen Eden applied to reinstate Great North to the companies register, and it was reinstated from 8 October 2010;
- On 5 January 2011 Mr Russell filed tax returns for 2007–2009; and
- On 10 January 2011 in response to a letter from the Commissioner, Mr Russell informed the Commissioner that her re-assessments were time-barred because of the operation of s 330 of the Companies Act 1993.
Over 2011 and 2012 Mr Russell filed Great North’s tax returns for the 2010–2011 years. On 7 April 2011, the Commissioner commenced an investigation into Great North’s returns and sought information from Mr Russell. The parties continued corresponding into 2012.
On 4 September 2012 KDL transferred (at least some of) its interest in the debenture to Timberton Investment Ltd (“Timberton”). Timberton is wholly owned by Mr Radisich. Mr Russell signed the deed of assignment as receivers for both Great North and KDL. Timberton paid KDL a total of $600,000 (albeit the Court noted that Mr Russell had accepted this was paid to use up Great North’s tax losses). Great North agreed to pay contributory interest as necessary at a rate of 10 percent per annum. Timberton acquired Great North’s tax losses at a rate of 15 cents per dollar of loss.
In 2014, the Commissioner concluded that Great North had engaged in tax avoidance and s 108(2) of the Tax Administration Act 1994 (“TAA”) permitted re-assessments to be made.
Before considering each issue in turn, the Court firstly noted that Mr Russell’s evidence was unpersuasive.
The Court confirmed that the specific provisions were satisfied but found that the arrangement was a tax avoidance arrangement.
The Court considered that Great North had issued debentures to Glen Eden when it knew it was insolvent, the debenture terms reinforced the artificiality of the arrangement and the debenture was later transferred to KDL without consideration. The Court noted that the ownership of the relevant entities was circular and there was no genuine economic consequence for Great North or KDL or even Timberton.
The Court considered that the arrangement was artificial and contrived with creditors being replaced to alter the incidence of tax. The Court concluded that Parliament would not have contemplated the deduction of interest as a business-related expense in this way.
Time bar: s 108 of the TAA
The Court concluded that for the purposes of s 108(2) of the TAA, Mr Russell knew the returns he completed and filed on behalf of Great North were misleading on the basis that, either, he had actual knowledge the arrangement constituted tax avoidance or that it was highly likely tax avoidance (and therefore subjectively reckless).
The Court found that the tax position taken by Great North was unacceptable and abusive and was therefore satisfied that the Commissioner did not err in imposing shortfall penalties for an abusive tax position.
Time bar: s 330 of the Companies Act 1993
The Court considered that it is clear from s 15 of the Companies Act 1993 that once removed from the register a company does not exist in law. However, the Court accepted that s 330 of the Companies Act 1993 (as demonstrated by the relevant case law) provides that the actions of a deregistered company are not treated as nullities upon the company’s restoration to the register. Accordingly a return can be retrospectively validated.
However, the Court considered that validation does not backdate the return to the time of filing:
- Until restoration there is no taxpayer with whom the Commissioner can deal and therefore until restored, the deregistered company cannot defend itself by complying with the applicable statutory time period;
- Sections 328(6) and 329(4) of the Companies Act 1993 seek to ensure that neither the restored company nor any other person is unfairly affected by the company’s removal from the register and that s 330 should be read alongside those powers; and
- Section 108 strikes a balance between the finality of taxpayer affairs and the effective maintenance of the tax base and “unbridled retrospective validation” of a tax return under s 330 of the Companies Act 1993 could imperil s 108 of the TAA. The Court said that, if it was a live issue, it would have concluded that the time bar commenced only when Great North was restored to the register on 8 October 2010.
Companies Act 1993; Income Tax Act 2007; Tax Administration Act 1994