High Court upholds TRA’s finding that no management services were provided by Honk Land Limited to Honk Land Trust

Summary 

The High Court dismissed Honk Land Trustees Limited's appeal. Ellis J agreed with the Taxation Review Authority ("TRA") that no services were provided by Honk Land Limited ("HLL") to Honk Land Trust ("Trust").

Impact 

This decision confirms the judgment of the TRA, and in particular the correctness of its factual finding that the management services were not actually provided by HLL to the Trust. There was no need for the High Court to consider whether or not the payment of the fee formed part of or constituted a void tax avoidance arrangement that was appropriately reconstructed by the Commissioner of Inland Revenue ("the Commissioner") but the High Court indicated (such indication is obiter) that it was.

Background

This case is an appeal by Honk Land Trustees Limited ("HLT") of the TRA's decision confirming an assessment made by the Commissioner disallowing a $1,116,000 income tax deduction HLT claimed in the 2005 income year. The deduction related to a management fee that, in its capacity as the corporate trustee of the Trust, HLT had paid to a related entity, HLL.

The TRA found that the management fee was not deductible because it did not relate to any relevant services actually provided by HLL and (alternatively) that it was a contrivance designed to enable the Trust to avoid the payment of tax. The TRA also upheld the imposition of a 50% shortfall penalty for taking an abusive tax position. 

Facts

The Trust was established by deed dated 27 September 2002. The settlor was Mr David Andrew Tauber, who is also a discretionary beneficiary of the Trust. Mr Tauber is, or was in 2005, the controlling mind of a number of companies and other entities that were beneficially owned by the Trust (through HLT) and which collectively comprised a wider business enterprise. HLT directly owned Honk Group Limited which, in turn, directly and indirectly owned various other companies, including HLL.  

In the 2005 tax year:

1. the Trust earned income from commercial rentals, dividends and interest income from associated entities;
2. two of the three Auckland commercial properties owned by the Trust were sold;
3. HLL owned two commercial buildings in Takapuna worth $20 million with a rent roll in excess of $2 million.

The financial statements of the Trust for the 2005 year recorded management fees totalling $1,152,824 as an expense to the Trust which comprised:

1. $1,116,000 charged by HLL; and
2. $36,824 charged by Basin Ridge Management Ltd, Mr Tauber's management company.

The effect of the $1,116,000 management fee expense was:

1. the Trust claimed a deduction resulting in it having no tax to pay on its income; and
2. HLL offset the payment it received against its existing losses with the result it paid no tax on the management fee income.

Decision

The High Court considered the fundamental question raised by the appeal was whether the management services were in fact provided by HLL to the Trust at all. If they were not, then all other grounds of appeal necessarily fail.

Management Fees

The High Court agreed with the TRA's finding that there was no record of services provided and the fee was not fixed by reference to the costs incurred but simply by reference to the Trust's total income. The High Court considered the TRA's analysis of Mr Tauber's evidence was correct, highlighting the undisputed absence of any written management agreement between the Trust and HLL or any other supporting documentation. Furthermore, various other undisputed factors collectively formed a more than adequate basis for the TRA to draw the conclusions it did. 

The High Court considered that Mr Tauber's evidence was, in a number of important ways, implausible, contradictory, vague and equivocal. The High Court cited examples from the transcript of the TRA hearing, pointing out the various inconsistencies. 

The High Court considered it was difficult not to agree with the Commissioner that, in reality, the management fee was a rather unsophisticated ex post facto contrivance designed solely to effect the transfer of the precise amount of taxable income upon which the Trust would otherwise have had to pay tax. 

The High Court found that the TRA was correct to find that no management services were provided by HLL to the Trust. As a result, the High Court did not consider it necessary to consider the legal aspects of the appeal.

Shortfall penalties

On applying shortfall penalties, the High Court considered:

1. Whether, viewed objectively, claiming the deduction was about as likely as not to be correct and, if not;
2. Whether the deduction was claimed with a dominant purpose of avoiding tax.

The High Court agreed with the Commissioner's view that it is obvious that no deduction can be claimed by a taxpayer for the cost of services which have not been provided to it. Therefore, HLT's tax position was not about as likely as not to be correct. 

The High Court discussed a dominant purpose of avoiding tax, referring to Alesco New Zealand Limited v Commissioner of Inland Revenue ([2013] NZCA 40, [2013] 2 NZLR 175), concluding, as the management services were not in fact provided to the Trust by HLL, the only purpose of the fee can have been to avoid tax by moving profits out of the Trust to HLL.