COMMISSIONER OF INLAND REVENUE V DUNCAN CA CA186/06

COMMISSIONER OF INLAND REVENUE V DUNCAN CA CA186/06 13 June 2007IN THE COURT OF APPEAL OF NEW ZEALAND CA186/06 [2007] NZCA 235BETWEEN COMMISSIONER OF INLAND REVENUE Appellant AND PHILIP JOHN DUNCAN Respondent Hearing: 17 May 2007 Court: William Young P, Ellen France and Wilson JJ Counsel: A C Beck and S F Wellik for the Appellant G P Tyrrell for the Respondent Judgment: 13 June 2007 at 2pmJUDGMENT OF THE COURT A The appeal is allowed. B There is judgment for the Commissioner for the outstanding GST ($127,109.02) together with late payment penalties, interest and costs as may be determined or fixed in the District Court. C The award of costs made in the High Court in favour of Mr Duncan is set aside. D Costs in relation to the High Court appeal and this appeal are reserved.REASONS OF THE COURT(Given by William Young P)Introduction[1] Mr Philip Duncan was the sole trustee of the Duncan Family Trust, an entity which appears to have operated effectively as his alter ego. In February 1998, the Trust acquired land for the purposes of development and subsequently claimed input tax credits on associated outgoings. Mr Duncan was adjudicated bankrupt on 29 September 1998 but remained the trustee of the Trust. The development exercise continued and between 30 September 1999 and 30 November 2000 the Trust sold seven units. Appropriate GST returns were filed but the Trust never paid the output tax ($127,109.02) which fell due. The Trust is insolvent. It seems likely that all proceeds of the sales went to the Trust's financier. Mr Duncan eventually resigned as trustee on 18 June 2001 and was discharged from bankruptcy on 29 September 2001. [2] By reason of s 57(3) of the Goods and Services Tax Act 1986 (GST Act), Mr Duncan is personally liable for the output tax liability of the Trust unless released by s 114 of the Insolvency Act 1967 on the basis that the output tax liability of the Trust was provable in his bankruptcy under s 87(1) of that Act. [3] In proceedings brought by the Commissioner to recover the output tax and associated penalties, both the District Court and High Court have held in favour of Mr Duncan. [4] The Commissioner, having secured leave to do so from the High Court, now appeals to this Court. The appeal raises a single question: were the output tax liabilities provable in Mr Duncan's bankruptcy? Before we determine this question, we will briefly discuss: (a) The factual and GST context; (b) The terms of s 87(1) of the Insolvency Act;(c) The District Court judgment; and (d) The High Court judgment.The factual and GST context[5] The case has proceeded on the basis of a rather meagre agreed statement of facts which was supplemented by limited evidence given by Mr Duncan. In order to put the case in a comprehensible context, some reading between the lines is necessary. [6] It seems reasonable to infer that by the time the units came to be sold, the Trust did not have the contractual right to call on the financier for partial discharges of the mortgage on terms which would allow the Trust to retain sufficient of the proceeds of sale to enable it to pay output tax. In any event, the drift of the evidence suggested that the entire proceeds of sale were paid to the financier (leaving aside the meeting of certain sale expenses). [7] Had the financier exercised its power of sale as a mortgagee, it would have been required to account for output tax under ss 5 and 17 of GST Act. That this is so was established by Commissioner of Inland Revenue v Edgewater Motel Ltd [2003] 1 NZLR 425 (CA) which was later affirmed by the Privy Council in Commissioner of Inland Revenue v Edgewater Motel Ltd (Note) [2005] 3 NZLR 289 (PC). If Mr Duncan was concerned about his possible liability for output tax, he could have declined to enter into agreements for the sale of the units, leaving it to the financier to exercise its security rights. [8] There are two other ways in which Mr Duncan's potential liability for output tax as at the date of adjudication could have been avoided: (a) By selling the development as a going concern. If this had happened the sale would have been zero-rated with the result that the Trust (and Mr Duncan) would not have been subject to output tax liabilities when the units were eventually sold, or(b) By resigning as a trustee and notifying the Commissioner of this prior to the output tax liabilities coming to charge. If this had happened, Mr Duncan would have incurred no output tax liabilities.The terms of s 87 of the Insolvency Act[9] Section 87(1) of the Insolvency Act provides: all debts and liabilities, present or future, certain or contingent, to which the bankrupt is subject at the time of his adjudication, or to which he becomes subject before his discharge by reason of any obligation incurred before the time of his adjudication, shall be debts provable in bankruptcy.[10] As Chisholm J noted in the High Court, there are two limbs to this subsection: (a) First, there are "all debts and liabilities, present or future, certain or contingent, to which the bankrupt is subject at the time of his adjudication". Section 98 of the Insolvency Act requires the Official Assignee to estimate the value of "debts" and "liabilities" which are "contingent" or for some other reason do not "bear a certain value". If the Official Assignee considers that the value of such a liability or debt cannot be fairly estimated, he is to reject the proof. It is arguably implicit in s 98 that if the value of a debt or liability cannot be fairly estimated, it is not provable even though on the strict wording of the section, that consequence applies only if the Official Assignee has subjectively reached that conclusion. (b) Secondly there are "debts and liabilities" to which the bankrupt becomes subject before discharge "by reason of any obligation incurred before the time of his adjudication". [11] To the extent to which Mr Duncan relied on the first limb of s 87(1), and in particular the contention that at the date of his adjudication he had a contingent liability for output tax, there was scope for argument as to the application of s 98. On the other hand, if Mr Duncan could rely on the second limb, there was no need togo to s 98 as the liabilities for output tax which came to charge between September 1999 and November 2000 were certain and thus did not require an estimation process.The District Court judgment[12] The Commissioner sued Mr Duncan in the District Court at Christchurch for the output tax liabilities of the Trust, seeking to recover the unpaid GST (of $127,109.02) together with late payment penalties and interest. Mr Duncan defended the proceedings relying on ss 87(1) and 114 of the Insolvency Act. [13] In a judgment which he delivered on 3 February 2006, Judge Doherty held that at the date of Mr Duncan's adjudication, the relevant output tax liabilities were contingent liabilities for the purposes of s 87(1) as "tax would always have been payable; it was just a matter of when and how much": at [31]. [14] It seems clear that counsel who appeared for the Commissioner in the District Court did not put to the Judge the various ways in which Mr Duncan might have avoided liability for output tax (see [7] and [8] above).The High Court judgment[15] On appeal to the High Court, Chisholm J upheld the District Court judgment, albeit on a basis which differed from that favoured by Judge Doherty. [16] Chisholm J held that the prospective output tax liabilities of the Trust at the date of adjudication were not then contingent liabilities of Mr Duncan. He reached this conclusion in reliance on the following passage from the speech of Lord Reid inWinter & Others v Inland Revenue Commissioners [1961] 3 All ER 855 at 858 (HL):No doubt the words "liability" and "contingent liability" are more often used in connection with obligations arising from contract than with statutory obligations. But I cannot doubt that if a statute says that a person who has done something must pay tax, that tax is a "liability" of that person. If the amount of tax has been ascertained and it is immediately payable it is clearly a liability; if it is only payable on a certain future date it must be a liabilitywhich has "not matured at the date of the death" within the meaning of s. 50(1). If it is not yet certain whether or when tax will be payable or how much will be payable why should it not be a contingent liability under the same section. It is said that where there is a contract there is an existing obligation even if you must await events to see if anything ever becomes payable, but that there is no comparable obligation in a case like the present. But there appears to me to be a close similarity. To take the first stage, if I see a watch in a shop window and think of buying it, I am not under a contingent liability to pay the price: similarly if an Act says I must pay tax if I trade and make a profit, I am not before I begin trading under a contingent liability to pay tax in the event of my starting trading. In neither case have I committed myself to anything. But if I agree by contract to accept allowances on the footing that I will pay a sum if I later sell something above a certain price I have committed myself and I come under a contingent liability to pay in that event. This company did precisely that, but its obligation to pay arose not from contract but from statute. I find it difficult to see why that should make all the difference. (Emphasis added)[17] Chisholm J found in favour of Mr Duncan on the basis that the output tax liabilities which came to charge in the period September 1999–November 2000 arose out of obligations incurred before adjudication. He explained why he reached this view in this way:[34] It is significant that both the word "liability" and the word"obligation" are used in the second limb and Parliament must have intended that they would carry different meanings. According to the New Shorter Oxford English Dictionary the word "obligation" means:"the action of constraining oneself by promise or contract to a particular course of action; a mutually binding agreement. Also, the course of action etc. to which one commits oneself, a formal promise".Significantly this definition does not limit the word to something that is legally binding. In my opinion the structure of s87(1) makes it tolerably clear that the word "obligation" was intended to indicate a less formal commitment than the word "liability". Read as a whole the subsection seems to contemplate that when an obligation arising before bankruptcy matures into a debt or liability after bankruptcy but before discharge it will be provable. [35] Now I turn to the evidence to determine whether Mr Duncan was subject to an "obligation" in terms of s87(1) before his adjudication. Unfortunately the evidence, including the agreed statement of facts, is extremely cryptic. [36] On Mr Duncan's uncontested evidence (paragraph 9 of his brief) input tax on the land and building costs was claimed prior to the date of his adjudication. It must follow that the finance had been uplifted and thefinancial package relating to the development (referred to in paragraph 5 of the brief) was in place before Mr Duncan was adjudicated bankrupt. Under that package "a number of purchase agreements" relating to units had to be in place and upon sale the net proceeds of the units had to be paid to the financier until the full amount owing to the financier had been repaid. Thus the evidence indicates that from the outset the trust was committed to the unit sales by the financing package. It was therefore inevitable that sooner or later there would be liability for GST output tax. [37] Given that situation it would appear that the GST liability to which Mr Duncan became subject before his discharge was incurred by reason of the obligations that were in place before Mr Duncan was discharged from bankruptcy. As the Judge said: " tax would always have been payable; it was just a matter of when and how much". Had the obligation not matured into a debt or liability before Mr Duncan's discharge, s87(1) could not have applied. But it did mature before his discharge. This seems to be the very type of situation contemplated by the second limb of s87(1) where an obligation entered into before bankruptcy has matured into a debt or liability before discharge. Under those circumstances Parliament has decreed that it should constitute a provable debt. (Italics in original)[18] In the High Court, counsel for the Commissioner identified to the Judge the points set out in [8] above. The Judge, however, dismissed their significance. [19] As to the possibility that the development might have been sold as a going concern, the Judge said this:[38] In my view that is not a plausible proposition because it is incompatible with the uncontested evidence before the District Court. The only inference that can be safely drawn is that by the time of Mr Duncan's adjudication the trust was well and truly committed by the financing arrangements to the sale of individual units. If the Commissioner wished to mount an argument to the contrary he should have attempted to establish some evidential foundation. As it is, there is none.[20] As to the possibility that Mr Duncan could have avoided liability by resigning the Judge said:[39] Again this argument runs into evidential problems. It is based on the premise that Mr Duncan could have resigned. Given the evidence I do not think that I am in a position to safety draw that inference. My reluctance reflects the uncontested evidence about the financial package. As far as I can see Mr Duncan was the sole trustee and the trust seems to have been regarded as "his" trust. Under those circumstances it would not have been surprising or unusual if the package committed Mr Duncan to the development and his trusteeship until borrowings were repaid. There is no evidence about the extent of the borrowings but it can probably be inferred that they were very substantial. Apart from that, I do not have any evidenceabout the trust deed or any provisions concerning retirement. The fact that Mr Duncan did not retire until after the units had been sold could be significant. Whatever the position I am not prepared to speculate about Mr Duncan's ability to resign as a trustee or about his ability to obtain a Court order under s46 of the Trustee Act 1956. [40] Another factor also counts against the Commissioner's second argument. As Mr James pointed out, the whole basis of the Commissioner's claim against Mr Duncan is that Mr Duncan in fact remained a trustee until after the units had been sold and the GST liability had arisen. By suggesting that Mr Duncan could have resigned the Commissioner seems to be wanting it both ways. It seems to me that this is a situation where the Court is entitled to take into account what actually happened, namely, that Mr Duncan remained a trustee, and that it should avoid being sidetracked by (at best) a theoretical possibility that we know did not eventuate. Indeed, the second limb in s87(1) has been structured in a way that requires events to be traced beyond adjudication to the point when the debt or liability arises (provided, of course, that it arises before adjudication).Were the output tax liabilities provable in Mr Duncan's bankruptcy?[21] We are satisfied that, for the purposes of s 87(1), Mr Duncan's potential liability for output tax was not, as at the date of his adjudication, a contingent liability. This is for the reasons given by Lord Reid in Winter as adopted by Chisholm J in the High Court. At the date of adjudication Mr Duncan was under no commitment to pay the output tax liabilities which later came to charge. There was thus no contingent liability as to output tax. This conclusion makes it unnecessary to consider whether: (a) A contingent liability for output tax at the date of adjudication would have been capable of fair estimation under s 98; and, if not (b) Whether it matters that this issue had not be the subject of assessment by the Official Assignee. [22] However, we are unable to agree with Chisholm J that the second limb of s 87(1) applies. [23] In our view that first and second limbs of s 87(1) must be read together. Mr Duncan can only rely on the second limb if the output tax liabilities which came to charge while he was bankrupt were "debts and liabilities" to which he becamesubject "by reason of any obligation incurred before the time of his adjudication". In our view the section requires that the relevant debt or liability be to the party to whom the pre-adjudication obligation was owed. As a consequence the output tax liabilities were not provable in Mr Duncan's bankruptcy. [24] Although the conclusion which we have just expressed disposes of the appeal, there are two related points which we should make. [25] Mr Tyrrell maintained that the result contended for by the Commissioner was unfair to Mr Duncan because he may be made bankrupt a second time for reasons that have their origin in events which occurred before his first adjudication. In effect he invoked the "clean slate" principle which is reflected in the Insolvency Act, a consideration which plainly weighed with Chisholm J. But while we accept the clean slate principle, we do not see it as applicable here. When the output tax liabilities were incurred, Mr Duncan was bankrupt and the Trust was apparently insolvent. Mr Duncan was not required to carry on the business of the Trust in such a way as to incur liabilities for output tax which the Trust could not meet. We have already indicated in [7] and [8] above the options which were legally open to Mr Duncan. We accept that the sale of the development as a going concern may have been unrealistic. But Mr Duncan could have resigned as a trustee or he could have simply left the development in the hands of the financier which would have been liable for output tax as it sold the units. Given that he elected to continue to trade through the Trust after his adjudication, there seems to us to be no injustice in holding that he must meet the associated liabilities. [26] The related point relates to the very limited contextual evidence which was placed before the District Court. To some extent (albeit not on the fundamental issue in the case) we have been required to draw common sense inferences from the exiguous material we have. In this respect it is important to recognise that the Insolvency Act argument which Mr Duncan relied on was an affirmative defence. It was for him to show that the relevant liabilities were provable in his bankruptcy rather than for the Commissioner to establish that they were not provable. So if the broad view which Chisholm J took of the second limb of s 87(1) was correct, it was still for Mr Duncan to show that at the date of his adjudication, he had an"obligation" to enter into the sales which triggered his GST liabilities. This he failed to do.Result[27] The appeal is allowed. There is judgment for the Commissioner for the outstanding GST ($127,109.02) together with late payment penalties, interest and costs as may be determined or fixed in the District Court. The award of costs made in the High Court in favour of Mr Duncan is set aside. We reserve the costs of this appeal and the costs in the High Court, as we have been told that Mr Duncan has applied for Legal Aid.Solicitors: Crown Law Office, Wellington for the Appellant Saunders & Co, Christchurch for the Respondent