Taxation Review Authority determines allowable expenditure on rental properties and treatment of trust income and expenses
2017 case note - disputant's ability to claim interest expenditure on funds borrowed to purchase properties for commercial rental - deductions, shortfall penalties.
This case concerned the disputant’s ability to claim interest expenditure on funds borrowed to purchase properties for commercial rental in the 2013 and 2014 income years (“years in dispute”). The disputant is a chartered accountant and operates a consultancy business from his residential address. The disputant’s rental and consultancy income went into his various revolving credit accounts. Business and personal expenditure were paid by the disputant from personal credits cards and from funds in the revolving credit accounts.
The Commissioner of Inland Revenue (“the Commissioner”) raised default assessments for the years in dispute, which were challenged by the disputant in the Taxation Review Authority (“the Authority”). As the disputant was unable to discharge his onus in showing how the Commissioner’s assessments were wrong, the Authority, in finding for the Commissioner, made revised assessments disallowing certain losses.
This decision confirms, as per Buckley v Young Ltd v Commissioner of Inland Revenue  2 NZLR 485 (CA) at 498, that the onus of proof rests on the taxpayer to show that the Commissioner’s assessments are wrong and by how much they are wrong. The ability to accrue, carry forward and apply tax losses falls within the broad definition of a “tax shortfall” pursuant to s 3 of the Tax Administration Act 1994 (“TAA”), being a tax benefit, credit or advantage of any type or description whatever benefiting the taxpayer or another person. There is no provision enabling a trust to either pass on losses or for a beneficiary to claim any kind of deduction for expenses incurred by that trust.
Three rental properties purchased by the disputant were identified by the Commissioner and were the subject of her investigation. The first property was purchased by the disputant in 2002 (“the White Road property”) in the name of the MF Trust of which the disputant and his brother are trustees and the disputant and his daughter are beneficiaries. In September 2003 the disputant and his then partner purchased a rental property (“the Green Road property”). In August 2004, the disputant and his partner purchased another rental property (“the Brown Avenue property”). The total cost of the properties was $2,082,000. Funding for the properties was largely obtained by loan and credit facilities from XY Bank.
The disputant claimed the interest on the borrowings for the Green Road property for only a small part of the 2013 income year. The disputant claimed interest in respect of the Brown Avenue and White Road property for both tax years in dispute.
The Authority found for the Commissioner on all points. Pursuant to s 138P of the TAA, the Authority made revised income tax assessments for the years in dispute (including shortfall penalties for gross carelessness). The Authority’s findings on each of the listed issues above are addressed in summary below.
Issue 1: Interest deductions
The Authority found that based on the disputant’s 2007 to 2011 tax returns he had an annual cash deficit of over $50,000 and was satisfied that some of the bank borrowings were used to fund personal living expenses. In the absence of sufficient evidence, the Authority found that the disputant had not discharged his onus of showing that the bank interest claimed as a deduction in each year was paid on capital utilised in earning assessable income in those periods.
Issue 2: White Road Property
The disputant contended that as he returned the rental income from this property as his own income, deductions in relation to the property should be allowed. In support of this proposition, the disputant gave evidence that the insurance invoices and rates assessments were in his and his brother’s names, as trustees of the MF Trust, and paid by the disputant using his credit cards. However, the Authority noted that the balances on the credit cards were then paid from the MF Trust’s bank account. The Authority was not satisfied that these accounts were paid by the disputant.
The Authority was also not satisfied for the purposes of s DA 1 of the Income Tax Act 2007 (“ITA”) that the disputant derived the rental income other than as a beneficiary of the MF Trust (ss HC 5, HC 6 and HC 7of the ITA). Accordingly, the Authority found it appropriate to amend the default assessments removing the deductions allowed in the default assessments for bank interest, insurance and rates relating to this property.
Issue 3: Depreciation
The disputant claimed depreciation for furniture and fittings, motor vehicles, carpet, stove, waste master and computers for the years in dispute. The Authority noted that there was no separate schedule detailing the individual items and/or other documents evidencing that these items were purchased for the rental properties and not for the disputant’s own residence. The Authority accepted the Commissioner’s reduced allowances for depreciation for each of the years in dispute.
Issue 4: Shortfall Penalties
The disputant contended that no tax shortfall arose because once his accumulated losses were taken into account, he had no taxable income in either of the years in dispute. The question before the Authority was whether the tax position taken by the disputant, in not filing tax returns by the due date, “overstate[d] a tax benefit, credit or advantage of any type or description whatever by or benefitting…the disputant or another person. (Italics added).” (TRA Case 09/16 at )
On this point, the Authority concluded that the ability to accrue and carry forward tax losses thereby reducing the amount of tax payable on income earned in subsequent years is plainly a tax advantage to any taxpayer. The Authority was therefore satisfied that the disputant had taken a tax position that resulted in a tax shortfall in each of the years in dispute.
Taking into account the disputant’s accountancy background, experience as a consultant advising business clients and his failure to file returns by the due date after repeated requests to do so, the Authority found that his conduct was a deliberate breach of his tax obligations. The Authority found that the Commissioner had properly imposed shortfall penalties for gross carelessness for the tax years in dispute reduced by 50% for previous behaviour.
Issue 5: Amended Assessments
The Authority concluded that the Commissioner did the best she could in assessing the disputant’s taxable income when she prepared the default assessments based on the limited information she had at the time. However, the Authority held that as a consequence of the further information ascertained during the course of the proceeding as to the ownership of the White Road property, it was appropriate to adjust the assessments to remove deductions previously allowed in relation to that property. The Authority subsequently made revised assessments for the years in dispute pursuant to s 138P of the TAA.
This decision is subject to an appeal filed in the High Court.
Tax Administration Act 1994 and Income Tax Act 2007