Negligent advice regarding a transfer of land attracting tax liabilities

Summary

This case is an appeal of the Court of Appeal decision in Roose v Duthie [2016] NZCA 600. It concerned a transfer of a property which attracted adverse tax consequences. The collective respondents sought damages from the collective appellants on the basis they were given negligent advice. The Court had to consider whether a cause of action accrued (because a tax liability arose) once the sale and purchase agreement became unconditional, or later, when it was settled. The Court held that, the loss (and therefore the cause of action) arose when the income from the transaction was derived. This occurred, in accordance with general principles of derivation, when the transfer was effected (at settlement date) on 2 May 2008. The Attorney-General was invited as intervener in these proceedings.

Impact

The Supreme Court is willing to involve the Attorney-General on matters of public relevance/importance when they are not a party to proceedings.

The Court confirmed the Commissioner of Inland Revenue’s (“the Commissioner”) current position on the derivation of income in land transactions.

Facts

The property in issue was acquired by Denise Developments Limited (“DDL”) in 2006. DDL subdivided the property into seven sections.

In early 2008, Ms Roose sought advice from Mr Duthie regarding the proposed transfer of the property from DDL to a trust. She claimed that Mr Duthie negligently advised her that such a transfer would not attract income tax and the sale would be zero rated for goods and services tax (“GST”) purposes.

A new trust was formed and DMR Development Limited (“DMR”) was incorporated to act as its trustee. On 14 April 2008 DDL and DMR entered into an agreement under which DDL was to sell, and DMR to purchase the property, for $1,950,000. The agreement provided that on settlement DMR would provide a deed of acknowledgment of debt for the purchase price under which demand for payment could not be made for five years. Settlement was to take place on 21 April 2008, but was later varied by agreement. Settlement was effected electronically on 2 May 2008.

As a result of an audit, the Commissioner determined that DDL’s taxable activity was property development, reassessed DDL’s income tax for the 2009 year and imposed a shortfall penalty.

The respondents contended that had Ms Roose been properly advised by Mr Duthie, DDL would not have transferred the land, and subsequently not incur an unnecessary tax liability as a result of the sale.

Decision

Toogood J, in the High Court had concluded that when DDL entered into the agreement on 14 April 2008 there was a commitment to a loss at that point (being either a tax liability or the costs associated to prevent that loss). Accordingly, the limitation period began to run from the moment.

Applying the decision in Thom v Davys Burton [2008] NZSC 65, [2009] 1 NZLR 437 (“Thom”) his Honour confirmed that the loss did not arise on transfer (2 May 2008) but when the parties entered into binding legal obligations.

The Court of Appeal allowed the appeal, distinguishing this case from Thom on the basis that this was a “no transaction” case. Briefly, the respondents would not have entered into the transaction but for the negligent advice. The Court concluded that DDL’s tax liability arose on 2 May 2008 when the transfer from DDL to DMR was registered. The Court identified that the cause of action accrued when the tax liability arose; damage could be anticipated, but had not been incurred until that point. The Court, referring to Mills v Commissioner of Inland Revenue (1985) 7 NZTC 5,025 (HC) (“Mills”), Gasparin v Commissioner of Taxation (1994) 50 FCR 73 (“Gasparin”) and Ruddenklau v Charlesworth [1925] NZLR 161 (HC) (“Ruddenklau”) considered the tax liability arose on transfer and dismissed the argument that the tax implications became inevitable once the agreement was entered into by the parties.

The Supreme Court observed that for the purposes of this case they were prepared to accept that disposal of the relevant land occurred when the Sale and Purchase Agreement went unconditional on 14 April 2008 (consistent with Mills).

Considering the principles of income derivation, the Supreme Court confirmed that under an unconditional contract for the sale of land, the vendor is entitled to seek specific performance. However, referring to Ruddenklau, the Court noted that a right to seek specific performance is not the same as the right to sue for the purchase price as a debt. The Supreme Court, relying on Gasparin, confirmed that income is derived at settlement when a debt accrues to the vendor (and not when the vendor is entitled to specific performance).

The appellants argued that the property was sold for less than market value and therefore s GC 1 applied. Consequently, s GC 1 deemed the vendor to have derived the market value (income) when disposal occurred. The Court considered that s GC 1(2) identifies the time at which market value is determined (at disposal) but not the timing of derivation of resulting income, which is determined by reference to the general principles of derivation.

Consequently, the Court found that a tax liability, and thus the cause of action, did not accrue until the date of settlement on 2 May 2008.

The Court also dismissed the argument that unwinding the agreement would have resulted in tax evasion, with severe penalties attached, on the basis that if the respondents had decided not to proceed to settlement, no income would have been derived and therefore no accrual of a liability to tax.

The Court made obiter comments on the nature of “wasted costs” but dismissed any advancement of the argument. The Court agreed with the approach of the Court of Appeal in regards to the “unwind costs” in that had a realisation of the true position occurred before 2 May 2008, there would have been no settlement and the liability would not have arisen.

Result

The appeal was dismissed. The appellants were ordered to pay the respondents costs of $25,000 and reasonable disbursements.