BROWN v COMMISSIONER OF INLAND REVENUE [2014] NZHC 1600

BROWN v COMMISSIONER OF INLAND REVENUE [2014] NZHC 1600 [9 July 2014]IN THE HIGH COURT OF NEW ZEALANDWELLINGTON REGISTRYCIV-2013-485-3848[2014] NZHC 1600BETWEEN EAN INNES BROWNAppellantAND COMMISSIONER OF INLANDREVENUERespondentHearing: 3 June 2014Counsel: M T Lennard for AppellantS M Kinsler and I Mara for RespondentJudgment: 9 July 2014RESERVED JUDGMENT OF MACKENZIE JI direct that the delivery time of this judgment is4.30 pm on the 9th day of July 2014.Solicitors: Perkinson Law, Whangarei, for AppellantCrown Law, for Respondent[1] The appellant, who practices as a chartered accountant, claimed interest deductions in the 2005, 2006 and 2007 income years. The Commissioner disallowed the deductions on the basis that the appellant did not incur the interest expenditure and that there was not a sufficient nexus between the payments made by theappellant and the appellant's income earning process. The Commissioner alsoimposed shortfall penalties in those income years for a failure to take reasonable care. Those assessments were challenged before the Taxation Review Authority (TRA) and the assessments were upheld in a judgment delivered on 9 July 2013 by Judge A A Sinclair.1 The appellant appeals against that decision.[2] The detailed factual background is set out in the TRA decision and I need summarise it only briefly. The appellant practised as a chartered accountant througha company ("Accounting"). The appellant, his wife, and his business partner were the three directors. The trust ("Trust") was settled by the appellant in 2000. His wife and business partner were the trustees. In 2000 the Trust borrowed $420,000 from the bank and on-lent this to Accounting, which used the funds to purchase an accountancy practice. In 2004, Trust borrowed a further $250,000 from the bank and on-lent it to Accounting to acquire another accountancy practice. Accounting gave a guarantee of the Trust's indebtedness to the bank. The appellant and others gaveguarantees of Accounting's indebtedness to the bank.[3] Over the three relevant tax years, the taxpayer paid the bank the interest charged to the Trust on the loans, in total nearly $100,000. That is the deduction in issue on this appeal. The essential question is whether the payment by the appellant of the interest owed by the Trust meets the requirements of the general permission for deductibility in s DA 1 of the Income Tax Act 2004, which allows a deduction for expenditure incurred by a taxpayer in deriving the taxpayer's assessable income.[4] The essence of the appellant's submission is that there is a nexus between the expenditure and his assessable income, because when he made the payments he expected to be reimbursed. It is submitted that such reimbursement will be assessable income in his hands, and that the payments he made have a nexus with deriving that assessable income.1 X (Chartered Accountant) v Commissioner of Inland Revenue [2013] NZTRA 03.[5] The appellant relies upon a minute of the trustees dated 14 April 2004 whichrecords that "at the request of [the Bank] it is agreed [the appellant] will pay the interest and principal payments on the two loans ". The appellant said in evidence that he agreed to pay the principal and interest at the request of the trusteesand in consideration for the bank's continued cooperation as lender to the variousentities with which he and his wife were involved. It was submitted that this agreement formed the basis of a definitive commitment to pay the interest, and distinguishes this case from a mere volunteer who takes it upon himself without any agreement or obligation to pay the interest.[6] The Judge held that there was no written agreement between the Trust and the appellant recording the arrangement and that there was no agreement, written or oral, that the Trust would repay the taxpayer. In the light of that factual finding by the TRA, which is not challenged on this appeal, there is no contractual obligation on the Trust to pay the taxpayer the amount of the interest which he has paid on its behalf. The resolution of the trustees could not create a legally enforceable right on the part of the appellant to be reimbursed. The Judge's conclusion that there was nodefinitive commitment on the appellant to make the interest payments was correct, for the reasons she gave.[7] The taxpayer submits in the alternative that the Trust is liable to reimburse the taxpayer, either under ss 84 and 85 of the Judicature Act 1908 or under the common law right of indemnification which arises when a guarantor makes a payment on behalf of the principal debtor. The TRA also rejected this argument. Judge Sinclair said:2I do not accept on the facts of this case that the Trust became obliged under the contractual doctrine of indemnity and/or by restitutionary doctrines of contribution or reimbursement to repay the disputant. There is no right to indemnity as there was no default and the disputant was not liable as guarantor to make the payment. Likewise, there is no right to claim contribution because the disputant and the Trust are not co-sureties and the disputant has no obligation to contribute to the payment of the interest. Finally, the disputant has no right to claim reimbursement from the Trust because it is not a situation where he has been compelled by law to make the interest payments.2 At [34].[8] The Judge was clearly right to hold that the appellant has no right to indemnity from the Trust for the interest paid. A prerequisite to the application of ss 84 and 85 of the Judicature Act is that the person seeking to invoke the rightsconferred is "surety for the debt or duty of another", or "liable with another for any debt or duty". The appellant was not a guarantor of the Trust's indebtedness to the bank. Accounting had guaranteed the Trust's indebtedness to the bank. Thetaxpayer had guaranteed Accounting's indebtedness to the bank. Accounting incurred no indebtedness to the bank in respect of interest payable by the Trust to the bank. It could have incurred such indebtedness only if the bank had demanded payment under its guarantee. The bank did not. The claim that the taxpayer has a right of indemnity from the Trust must fail.[9] Because there is no contract between the taxpayer and the Trust requiring the Trust to reimburse the taxpayer, and because the Trust is not required under any statutory or common law right of indemnity to reimburse the taxpayer, any reimbursement by the Trust will be entirely voluntary. In those circumstances, it cannot be said that the payments made by the appellant were incurred by him in deriving future assessable income by way of reimbursement. The absence of any legal obligation to reimburse arising from the incurring of the expenditure means that there is no nexus between the expenditure and the potential for assessable income by reimbursement.[10] That conclusion makes it unnecessary for me to consider whether, even if there was a legal obligation on the Trust to repay the appellant the interest paid by him, the expectation of reimbursement would meet the test in s DA 1. Counsel for the appellant did not cite any authority which supports the proposition that, in circumstances where a particular item of expenditure does not have any other nexus with the derivation of any other assessable income, the existence of a right to be reimbursed that item of expenditure by another is sufficient to make both the payment and the subsequent reimbursement part of the income earning process. In the absence of authority, I would be reluctant to reach that conclusion. It is however unnecessary for me to express a view, because the lack of a right of reimbursement means that the question does not arise in this case. The appellant's submission thatthe interest is deductible must fail.[11] The Authority held that a shortfall penalty was payable because the taxpayer did not take reasonable care in taking the tax position which he did when claiming a deduction for the amounts paid to the bank. On this, the Judge said:3The disputant is a partner in a firm of chartered accountants and is a member of the New Zealand Institute of Chartered Accountants. As an accountant, he was involved at relevant times in preparing and/or reviewing financial accounts and income tax returns for clients. In doing this work the disputant is obliged to maintain competency standards and otherwise comply with appropriate technical and professional standards. In his evidence before theAuthority the disputant stated that he gave tax advice to clients. The firm's website also refers to his areas of expertise as including: "tax minimisation,succession planning and restructuring businesses". As well, the disputantwas a businessman with extensive farming interests. I agree with theCommissioner's submission that the disputant could be expected to have hada high level of knowledge and experience regarding business transactions and the tax legislation relating to interest deductibility.The disputant says that if he was wrong to make the deductions then that error arose from an error of law where he had a reasonable argument supporting his stance. The disputant did not produce any evidence as to the steps which he took to ascertain the correct tax position. As an accountant, he was in a position to research the law on interest deductibility and to take advice (including legal advice as to the operation of the various guarantees in place). Taking the above matters into account I accept the Commissioner'scontention that the disputant has not acted as a reasonable person would have in the same circumstances.[12] I agree entirely with the Judge. Her conclusions on the imposition of a shortfall penalty were correct, for the reasons she gave. There is nothing that I need to add.[13] The amount of the penalty under s 141A of the Tax Administration Act 1994 for not taking reasonable care is 20 per cent of the resulting tax shortfall. The Judge held that this was reduced by 50 per cent under s 141FB(2) of that Act. She held that s 141I of that Act, which applies when a tax shortfall is temporary, did not apply. She rejected a submission that the shortfall is temporary because it will be reversed when the Trust reimburses the appellant. That finding is clearly right. There is no right of reimbursement.3 At [40]-[41].[14] The appeal is dismissed. The respondent is entitled to costs, which I fix on a 2B basis._________________________A D MacKenzie J