High Court finds for Commissioner on tax avoidance and imposes an abusive tax position shortfall penalty
2016 case note – High Court found taxpayer engaged in an arrangement that had a tax avoidance purpose or effect and CIR correct to disallow GST refund.
Tale Holdings Limited ("Tale") entered into an arrangement to purchase a property development ("Delta") from Te Anau Lakeside Estates Limited ("Te Anau") facing liquidation action. Under the arrangement the purchase price was set according to the amount owed under Te Anau's mortgage. Tale took the property subject to the mortgage and paid no money to Te Anau. Tale claimed a goods and services tax ("GST") input tax deduction for the tax fraction of the purchase price and Te Anau did not pay any GST output tax. The Court held that:
- Tale was engaged in an arrangement that had a tax avoidance purpose or effect that was not merely incidental;
- The Commissioner of Inland Revenue ("the Commissioner") was correct to disallow the whole of the GST refund sought by Tale; and
- The Commissioner’s assessment of a shortfall penalty was correct.
The black letter law position in this case was determined under the GST legislation prior to 1 April 2011 (after which date transactions between GST-registered parties involving land, or in which land is a component, are mandatorily zero-rated). On black letter law the taxpayer was allowed the GST input claim, but the High Court upheld the voiding of the arrangement as tax avoidance.
Tale acquired a land subdivision called Delta from Te Anau. Tale did not pay any money for Delta. Instead, Tale acquired Delta on the basis it would accept liability for a debt of approximately $8.5 million, which Te Anau owed the bank. At the time, the rateable value of Delta was approximately $4.2 million and its market value was approximately $3.2 million.
Tale claimed a GST refund of $936,629 based upon the "purchase price" of Delta and Te Anau did not pay any output tax on the sale of Delta to Tale.
The Commissioner concluded Tale was engaged in a tax avoidance arrangement and also imposed an abusive tax position shortfall penalty (ATP shortfall penalty) of 100 per cent, reduced by 50 per cent for previous good behaviour in accordance with s 141FB of the Tax Administration Act 1994 (TAA), of the GST refund denied to Tale.
Was there an arrangement for the purposes of s 76 of the Goods and Services Tax Act 1985 ("GST Act")?
Tale argued that the Commissioner identified in her submissions two new steps in the arrangement (compared to in her Statement of Position) and that the inability of the Commissioner to accurately identify what the alleged arrangement was pointed to the fact that there was no agreement which could be identified as constituting an arrangement.
The Court considered that although the Commissioner should be as precise as possible when identifying what constitutes an arrangement (in the dispute process documents), the Commissioner’s statutory obligations do not extend to providing the taxpayer with an extensive analysis of the facts and law she relies upon; rather the Commissioner must provide a concise statement of the key facts and the law in sufficient detail to inform of the grounds of the proposed adjustment (TAA, s 89F(2)(b).
The Court noted that aspects of the Commissioner’s case about what constituted the arrangement had evolved, there were five key elements that remained since the time the Commissioner issued her Notice of Proposed Adjustment ("NOPA") that satisfied the definition of "arrangement."
Did the arrangement have a tax avoidance purpose or effect?
In order to identify whether the arrangement in this case had a tax avoidance purpose or effect, the Court first focussed on the objectives of the GST regime, and then upon the effect and purpose of the arrangement.
The Court found particular relevance in two features of the GST regime: (1) that transactions will be driven by market forces; and (2) that over time there will be a netting off of the GST components of sales and purchases - the Act does not contemplate a taxpayer claiming GST input tax credits when there is no possibility of output tax being paid over time.
In determining the purpose of the arrangement, the Court focused on the artificiality of the purchase price, the fact that Tale did not pay anything for Delta and that the transaction was unlikely to result in GST being paid.
As to the artificiality of the purchase price, the Court noted that Tale did not obtain an independent valuation of Delta to determine if the purchase price was consistent with the market value.
The Court noted that the assumptions made by Tale’s witnesses regarding the value of Delta at the time of purchase were very optimistic and Tale did not call any independent evidence to support those assumptions or to challenge the conclusions of the expert called by the Commissioner concerning the market value of Delta at the time of purchase. The Court found that the expert’s assessment of the market value of Delta at $3,200,000 at the time Tale acquired it was accurate.
The Court was satisfied that the transaction at the heart of the arrangement was not a normal commercial transaction because the shareholders of Tale did not provide any equity and had no capital at risk and because Tale acquired Delta at a price which was set by reference to Te Anau’s debt to the bank, not the market value of the land in question.
The Court also considered that because Tale would be unlikely to sell Delta at a price greater than the amount required to pay the bank mortgage in full, Tale would only ever be able to pay output tax on the sale of Delta to the extent that the bank would allow. This would result in Tale claiming and recovering an input tax deduction and not paying the output tax that would normally be expected to be present where transactions are governed by ordinary market forces. This is exactly what transpired. Allowing Tale to obtain a GST refund for the acquisition of Delta in such circumstances defeats the revenue collection purpose of the GST Act and does not result in netting off of inputs and outputs over time.
The Court accordingly held that the arrangement in this case was designed to alter the incidence of GST in a way which could not have been within the contemplation of Parliament. As a result, the arrangement clearly had a tax avoidance purpose or effect.
Did the arrangement have a tax avoidance purpose or effect which was not merely incidental?
The Court held that the tax avoidance purpose or effect of this arrangement was more than merely incidental because:
- Tale acknowledged that it was part of the plan it engaged in that it would receive a GST refund, which was to be applied to the debt owed to the bank;
- Tale accepted that obtaining the GST refund was a key objective in itself. The refund was likely to be its most significant source of revenue, at least in the initial state of development and sales by Tale; and
- The GST refund sought was based on a contrived and artificial price that had no resemblance to the true market value of Delta which involved the suspension of ordinary market forces.
Was it wrong for the Commissioner to disallow the entire GST refund sought by Tale?
Tale suggested that if the transaction had an inflated value then the Commissioner was required to reconstruct the transaction and assign an appropriate value to it in order to calculate the GST refund to which Tale was entitled. However, the Commissioner did not undertake an adjustment under s 76(3) of the GST Act. The onus was accordingly on Tale to demonstrate that the transaction could not have been zero-rated and that commercial objectives were connected to the arrangement.
The Court held that although Tale had not been registered for GST at the time of sale and there was no agreement in writing that the supply was of a going concern, the sale by Te Anau to Tale was in all other respects of a going concern which was able to be zero-rated for GST purposes. There was no reason why Tale could not have achieved its alleged commercial objectives by entering into the arrangement in a way that was tax neutral and did not involve tax avoidance.
Was the Commissioner’s assessment of a shortfall penalty correct?
The Court considered that there were similarities between this arrangement and the one in Glenharrow Holdings Ltd v Commissioner of Inland Revenue  NZSC 116,  2 NZLR 359. In both cases the purchaser was a shell company, the price was not paid in economic terms, the price "paid" was inflated and GST was not paid by the vendor. The Court concluded that at the time Tale took its tax position there was significant Supreme Court case law which strongly indicated the position being taken by Tale was not, when viewed objectively, likely to be correct. The Commissioner was therefore correct when she assessed Tale as being liable for an Abusive Tax Position shortfall penalty under s 141D of the TAA.
Tax Administration Act 1994 ss 141D, 141FB and Goods and Services Tax Act 1985 ss 9, 11, 76