High Court considers a right to use land in context of depreciable intangible property

Summary

This case concerned an interest obtained under a settlement deed which amended an encumbrance over the taxpayer's land. The High Court rejected the taxpayer's argument that this interest was a right to use land pursuant to sch 14 of the Income Tax Act 2007 ("ITA") and was deductible as depreciable intangible property.    

Impact

The decision is useful guidance in considering whether a deduction can be allowed in respect of depreciable intangible property. Although the case only concerns a "right to use land" as listed in sch 14, the principles are applicable to depreciable intangible property generally.

Facts

This is a tax challenge by ANZCO Foods Limited ("ANZCO"), seeking to challenge assessments by the Commissioner of Inland Revenue ("the Commissioner") disallowing deductions claimed for depreciation. The deductions were based on a payment to allow ANZCO to undertake meat processing and freezing activities at a plant previously owned by a rival meat processing company, AFFCO New Zealand Limited ("AFFCO").

The payment arose from a negotiated settlement to vary an encumbrance on land purchased by ANZCO. This encumbrance restricted ANZCO from using the land to slaughter, freeze, cool, and further process meat products. ANZCO treated the result of settlement with AFFCO as conferring upon it a right to use land and sought to depreciate that item under the ITA.

AFFCO closed and sold off a number of its properties during the 1990s. One of the properties, a meat processing plant located in Waitara, was sold to a third party and included an encumbrance/limitation in the sale and purchase agreement.

This encumbrance stated that the purchaser will not use the property for "slaughtering, processing, cooling or freezing of lamb, sheep, Bobby calves, cattle or goats for a period of twenty (20) years from the possession date". The sale and purchase agreement required the third party purchaser to secure the performance of this covenant by the purchaser and its successors in title.

ANZCO purchased the Waitara property from the third party in February 2004.  ANZCO did not consider that its activities at the plant were caught under the encumbrance. AFFCO disagreed and issued proceedings seeking an injunction to prevent the land being used for the purpose of processing or manufacturing meat products. 

AFFCO was successful in their proceedings in the High Court (AFFCO New Zealand Ltd v ANZCO Foods Waitara Ltd HC Wellington CIV-2004-985-499, 23 August 2004) and partially successful in the Court of Appeal (ANZCO Foods Waitara Ltd v AFFCO New Zealand Ltd [2006] 3 NZLR 351 (CA)). ANZCO applied for leave to appeal to the Supreme Court; however, a settlement was reached in July 2005 whereby ANZCO agreed to pay $5,600,000 plus GST to use the property and the words "further processing, cooling or freezing" were deleted from the terms of the encumbrance.

ANZCO treated the agreement as constituting the purchase of a "right to use" land under sch 14 of the ITA which was then spread as a deduction under s EA 3 ITA.

The Commissioner disagreed that the payment made by ANZCO to AFFCO under the settlement deed was depreciable intangible property and disallowed the deduction.

ANZCO'S position

ANZCO submitted it acquired a chose in action which was an item of intangible property. Further, this was an item of depreciable property as described in sections EE 6 to EE 8 of the ITA and the rights or interests it acquired from the settlement also fell within the definition of depreciable intangible property in s EE 62 of the ITA. The right to use land is listed as an item of depreciable property in sch 14 of the ITA and this is what ANZCO contend they receive under the settlement.

The Commissioner's position

The Commissioner submitted that all ANZCO secured as a result of the settlement was its release from the restriction on the use of its own property. The removal of the encumbrance reinstated rights that attached to its ownership of the land. In so doing the capital value of the land was enhanced. The value of the rights obtained would not depreciate over subsequent years. The payment made by ANZCO was therefore capital in nature and not capable of being the subject of any deduction.

The Commissioner argued the interest obtained by ANZCO was not a right to use land within sch 14. Furthermore, ANZCO obtained reinstated rights of ownership that do not decline in value as required by s EE 6(1) ITA and also the  rights did not constitute separate "property" distinct from the ownership of the land.

Decision

What did ANZCO obtain as a result of its settlement with AFFCO?

Mander J considered that on the face of it a "right to use" the Waitara property was granted by the settlement deed. However, having considered the case law on this point (Mills v Dowdall [1983] NZLR 154 (CA) at 159; Re Securitibank Ltd (No 2) [1978] 2 NZLR 136 (CA); Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2 NZLR 289 and Buckley & Young Ltd v Commissioner of Inland Revenue [1978] 2 NZLR 485 (CA)), he concluded that "right to use" descriptor used in the terms of the contract cannot by itself be determinative. Rather, it is the legal character of the transaction that is actually entered into and the legal steps which are followed which are decisive.

The legal character of the transaction is to be ascertained by careful consideration of the contractual arrangements entered into. AFFCO did not hold or own any rights to use the Waitara property. The restriction contained in the original 1999 sale and purchase agreement did not equate to any retention by AFFCO of a right to use the property in any way. Rather, the covenant was negative in nature, restricting the use to which the Waitara property could be put.

Mander J considered the Court of Appeal's analysis from the earlier ANZCO v AFFCO litigation confirmed that when AFFCO entered into the sale and purchase agreement with the third party in 1999, it did not retain any subset of rights attaching to the fee simple estate. What rights acquired to prevent the use of the land for certain purposes were distinct from that bundle of rights and in particular from the right to use the land.

His Honour considered that the amendment of the encumbrance by removing a restriction on existing rights which formed part of the fee simple estate held by ANZCO was not to be equated with a conveyance or grant of rights held or enjoyed by AFFCO. Underscoring this finding is the fact the restriction was limited to a finite period after which the covenant expired. Upon that event triggering, no "right to use land" passed to the land owner, rather the contractual restriction (the "chose in action") secured by the encumbrance would extinguish.

His Honour identified an inconsistency with ANZCO's argument that it held intangible property, being a "chose in action". This was because in the hands of the owner of the land, the chose in action upon which the claim for depreciation is dependent no longer exists. The property owner's rights are no longer encumbered and the chose in action, the right to enforce that aspect of the contract, evaporates. The intangible property of the type contended for by ANZCO therefore only exists as a separate item of property in the hands of AFFCO or another third party.

Mander J concluded that what ANZCO obtained from the settlement was not a "right to use land" but the removal of a contractual restriction over its existing rights of use.

Did what ANZCO obtain constitute intangible depreciable property under the Act?

Was a "right to use land" as that term is to be interpreted in schedule 14 of the ITA acquired by ANZCO as a result of the settlement?

Schedule 14 of the ITA lists "the right to use land" as an item of depreciable intangible property. ANZCO argued this term should bear its plain and natural meaning and this is what they obtained under the settlement. The Commissioner argued the rights or interests acquired did not fall within the Schedule.

Mander J, noting principles relevant to the interpretation of tax statutes, went on to consider sch 14 in the immediate and general legislative context. His Honour also cited the Simkin Trust cases (Trustees of the Simkin Trust v Commisioner of Inland Revenue [2003] 2 NZLR 315 (CA) and Trustees in the CB Simkin Trust v Commissioner of Inland Revenue [2004] UKPC 55, (2005) 22 NZTC 19,001) which provide a detailed analysis of (what is now) sch 14. One of the principles emerging from this was that sch 14 must be interpreted consistently with the criterion that the property must have a finite useful life and that it would in normal circumstances be expected to decline in value over time.

His Honour considered that requirement may be viewed as an amalgam of the criterion in s EE 62(2)(b) and the qualifying description of depreciable property in s EE 6(1), but that ultimately the effect is the same; intangible depreciable property cannot include property that does not have a limited useful life. Mander J went on to conclude that the rights obtained by ANZCO were the reinstated rights of ownership and did not have a finite life span.

Was the "right to use land" depreciable property under section EE 6(1) of the ITA?

Mander J considered that even if he were to proceed on the basis the interest or right conveyed under the settlement deed was capable of constituting a right to use land under sch 14, ANZCO must still satisfy the requirement of s EE 6(3)(b) that the intangible property was depreciable property under subs (1). In order to be depreciable, the item of intangible property must be property that in normal circumstances might reasonably be expected to decline in value while it is used or available for use in deriving assessable income or in carrying on a business for such purpose.

Mander J found that it was apparent that ANZCO was unable to satisfy the test because what was conveyed to ANZCO under the settlement deed was the restoration of inherent rights of ownership. The encumbrance held by AFFCO was for a limited period. However, once that period expired, ANZCO's full ownership rights would revive in perpetuity. ANZCO effectively bought out the restriction which prevented the use of its ownership rights which in normal circumstances would not be expected to decline in value. The reinstated rights of ANZCO to undertake further processing, cooling and freezing at the Waitara plant would continue to run with its ownership.

It was important to draw a distinction between what AFFCO held and what ANZCO received. The worth of the restrictive covenant declined over time, but it does not follow the value of the right to use the land reduced. ANZCO argued that what was conveyed to it was a right to use land but it relied on the value of the restriction on its use of the land in the hands of a competitor to meet the statutory requirement that the intangible property depreciated over time. This highlighted that what ANZCO acquired as a result of the settlement was not a right to use land but the discharge of a limitation over a right it already held as the owner of the fee simple state.

Conclusion

Mander J concluded that what ANZCO obtained pursuant to the settlement deed was a variation of the encumbrance which secured a contractual restriction on the landowner's rights of ownership. AFFCO had no actual right to use the Waitara land to convey to ANZCO.

His Honour considered that the meaning of a "right to use land" as listed in sch 14 as depreciable intangible property does not extend to include rights which form part of the ownership of the fee simple estate. The rights to use the land which became available to ANZCO as a result of the settlement do not have finite useful life over which they will depreciate. As a consequence, the payment made by ANZCO to obtain the variation of the encumbrance in order to access those rights reflects the increased capital value of the property in the hands of the owner.

While the value of the restriction in AFFCO's hands as a competitor of ANZCO reduced as the period of the covenant diminished, the value of the rights to use the land which were restricted by the covenant would not diminish over time in the hands of the landowner. There could be no expectation that such property rights would decline in value while being used to derive assessable income. In the absence of the value of the rights to use the land declining, such intangible property does not qualify as depreciable property under the Act.

Although the settlement deed may describe the transaction in terms of AFFCO granting to ANZCO the right to use the Waitara property in a particular way, the true contractual nature of the settlement was that the ambit of the encumbrance was simply reduced. At that point there was no basis upon which the previously encumbered rights could reasonably be expected to decline in value.