Decisions on application of CA 1(2) - common law interest and income under ordinary concepts

All references are to the Income Tax Act 2007, unless otherwise stated.

Question

We have been asked whether the Commissioner accepts, as a broader principle, all the reasoning in the High Court decisions CIR v Buis and Burston (2005) 22 NZTC 19,278 on the application of section CA 1(2) (income under ordinary concepts) to so-called "common law interest" payments. [Common law interest payments are payments which might be described as akin to "interest" but are not connected with lending eg, late payment "interest" for settlement of a contract, "interest" awarded as part of a damages claim.]

In Buis and Burston France J held that section CD 5 of the Income Tax Act 1994 (now section CA 1(2)) could not apply to tax common law interest payments, because interest could be taxed only under the provision dealing with interest so defined (section CE 1 of the Income Tax Act 1994 (now section CC 4(1)). In his Honour's view, common law interest payments were not taxable because they did not come within the definition of "interest" in section OB 1 of the Income Tax Act 1994 (now section YA 1).

Answer

While the Commissioner decided not to appeal the decisions in the Buis and Burston cases, he does not accept the correctness of this aspect of the decisions as a generally applicable principle. The Commissioner intends to have the matter considered further by the courts when an opportunity arises in the future.

Explanation

CIR v Buis and Burston concerned the taxation of payments received by the taxpayers under section 72 of the Accident Rehabilitation and Compensation Insurance Act 1992 (interest paid in relation to the late payment of earnings related compensation). The Commissioner sought to tax those payments as income under ordinary concepts.

The Commissioner and the taxpayers accepted that the payments did not fall within the definition of "interest", which applies only to payments arising from "money lent" (also a defined term).

In the High Court, France J found that the payments were not income, being in the nature of a penalty imposed on the Accident Compensation Corporation. The Commissioner accepts this aspect of the decision.

However, his Honour also concluded that the payments could not be income under ordinary concepts in any event as the payments were in the nature of interest and interest could be taxed only under the provision dealing with interest as defined (section CE 1 of the Income Tax Act 1994 (now section CC 4(1)). In France J's opinion, section CD 5 of the Income Tax Act 1994 (now section CA 1(2)) must be read subject to section CE 1 of the Income Tax Act 1994 and could not be used to tax any interest payments that did not fall within the general interest provision.

The Commissioner does not agree with this aspect of the decision. Section YA 1 defines "interest" as being a payment made to a person by another person for money lent. The Income Tax Act did not originally define "interest". However, in 1983 a definition was inserted by section 3(1) of the Income Tax Amendment Act (No 4) 1983. This definition was inserted to ensure that certain money market transactions that were in the nature of loans, but that in law were not classed as money-lending, would be taxed: Marac Life Assurance Ltd v CIR (1986) 8 NZTC 5,086. The definition was not a codification of the taxation of all forms of interest.

In many instances payments which might be described as akin to "interest" under common law or ordinary concepts are not connected with "money lent" - late payment "interest" for settlement of a contract being a common example. "Interest as damages" where the damages are a reflection of a loss of profits is another. In the Commissioner's view the inclusion of a definition of "interest" in respect of money lent was not intended by Parliament to have excluded from taxation amounts that are akin to interest and are income under ordinary concepts.

The Commissioner considers that the Act must be read in its entirety and section CC 4(1) must be read as applying to situations falling within the definition of "money lent"; leaving those transactions that do not fit within that definition to be governed under the general charge of income under ordinary concepts: section CA 1(2). In those cases, it would be necessary to consider the true nature of the payment in the hands of the recipient to determine whether it is income and therefore taxable: IRC v Ballantine (1924) 8 TC 595 and Riches v Westminster Bank Limited [1947] 1 All ER 469.