GOVIND PRASAD SAHA V COMMISSIONER OF INLAND REVENUE CA CA617/2008

GOVIND PRASAD SAHA V COMMISSIONER OF INLAND REVENUE CA CA617/2008 13 March 2009IN THE COURT OF APPEAL OF NEW ZEALAND CA617/2008 [2009] NZCA 76BETWEEN GOVIND PRASAD SAHA Appellant AND COMMISSIONER OF INLAND REVENUE Respondent Hearing: 27 January 2009 Court: Chambers, O'Regan and Arnold JJ Counsel: G J Harley and R P Harley for Appellant M T Lennard and H Ryburn for Crown Judgment: 13 March 2009 at 2.30 pmJUDGMENT OF THE COURT A The appeal is dismissed. B The appellant must pay the respondent costs for a standard appeal on a band A basis, together with usual disbursements. We certify for two counsel. REASONS OF THE COURT(Given by Arnold J)Introduction[1] The appellant, Dr Saha, was a New Zealand partner in Ernst & Young (EYNZ). In 2000 EYNZ sold its consultancy business to a French company, Cap Gemini. This sale was part of a larger international transaction between the world-wide offices of Ernst & Young (EY International) and Cap Gemini. The then partners of EYNZ were paid by means of an allocation of shares in Cap Gemini. [2] Most of the value attributed to the sale related to the goodwill of the consultancy business. Accordingly, as part of the transaction Dr Saha and some other EYNZ partners were required to work for the business, which was to be operated by a wholly owned subsidiary of Cap Gemini, Cap Gemini Ernst & Young New Zealand Limited (CGE&YNZ), for five years from the date of settlement. In order to protect Cap Gemini's interests, the sale arrangement provided for the gradual release over a five-year period to the transferring EYNZ partners of their share entitlements in Cap Gemini. [3] Dr Saha commenced work with Cap Gemini, but became dissatisfied and left. On leaving he lost his entitlement to some of the Cap Gemini shares that had been allotted to him as part of the sale. A dispute arose between Dr Saha and the Commissioner of Inland Revenue (the Commissioner) as to how this should be treated under the Foreign Investment Fund rules (FIF rules), which it was accepted apply to the transaction. The FIF rules are found in Part C, subpart G of the Income Tax Act 1994 (the Act). [4] In the High Court, Simon France J found for the Commissioner: HC WN CIV 2007-485-701 23 September 2008. Dr Saha appeals against that decision.Factual background[5] There was no dispute about the background facts. Both parties accepted that the factual summary given by the Judge is accurate. Accordingly, the outline which follows is drawn from his judgment (at [5] – [19]).[6] EY International agreed that it would sell its consultancy business world- wide to Cap Gemini, subject to the proviso that individual national firms would have the option of participating or not in the sale. The distribution of the consideration for the sale (shares in Cap Gemini) was to depend on the outcome of the decisions of the various national firms. The partners of EYNZ decided to participate, and were allotted a total of 191,495 shares in Cap Gemini (referred to in the documents as transaction shares). Dr Saha was allotted 7566 transaction shares. [7] As most of the consideration for the sale related to the goodwill of the consultancy business, the sale transaction contained a number of features intended to protect Cap Gemini's interests: (a) EYNZ agreed to provide on-going support and not to establish a rival consultancy business for a period of five years. It also entered into non-solicitation and anti-poaching undertakings. (b) The EYNZ partners who were transferring to CGE&YNZ entered into:• an employment contract with CGE&YNZ;• a deed of covenant attaching various schedules which provided among other things for restrictive covenants and escrow arrangements. [8] The transferring partners undertook that, in certain specified eventualities, they would pay the "relevant amount" to Cap Gemini as liquidated damages (cl 2.1 of schedule 2 to the deed of covenant). The term "relevant amount" was defined to include "unreleased transaction shares" and "unreleased cash". Among the eventualities specified was the transferring partner voluntarily ceasing to be employed by CGE&YNZ (other than by way of retirement at the normal retiring age).[9] As we have said, in order to ensure that the partners transferring to CGE&YNZ did not simply "take the money and run", Cap Gemini provided that their transaction shares were to be released to them on a staged basis. The escrow arrangement gave effect to that. In essence, the arrangement was that the transaction shares were to be released to the transferring partners in fixed percentages in accordance with the following table (cl 5 of schedule 2):Release DatesClosing 1 April 2001 Second Anniversary of Closing Third Anniversary of Closing Fourth Anniversary of Closing Fourth Anniversary of Closing plus 300 daysPercentage amount of Transaction Shares released on each Release date25% 18.3% 18.3% 18.4% 10% 10%[10] However, the EYNZ partners (including the transferring partners) were entitled to sell their transaction shares in six tranches, initially at rather higher percentages, as specified in the following table (cl 4 of schedule 2):Target DatesClosing 1 April 2001 Second Anniversary of Closing Third Anniversary of Closing Fourth Anniversary of Closing Fourth Anniversary of Closing plus 300 daysPercentage amount of Transaction Shares transferable in an OfferingMinimum: 25%: Maximum: 40% subject to market conditions Amount by which Offering on Closing falls short of 40% 18.3% 18.4% 10% 10%[11] To deal with the difficulty that transferring partners might have sold shares prior to their release date, cl 4.4 provided that cash proceeds from the sale of shares in excess of the released transaction shares would be held in escrow until the relevant release date, along with any unreleased (and unsold) transaction shares. Hence the liquidated damages provisions covered both unreleased transaction shares and unreleased cash. [12] Clause 6 of schedule 2 contained the forfeiture provisions. Relevantly cl 6.1 provided:6. Forfeiture6.1 in the event that the employment of the Accredited Consulting Partner by [CGE&YNZ] is terminated [because of voluntary cessation of employment] ... all of Unreleased Transaction Shares and the full amount of the Unreleased Cash held in the Consultant's Share Account and Consultant's Deposit Account at the Departure Date shall be released from the Consultant's Share Account and Consultant's Deposit Account pursuant to the Escrow Release Procedure and transferred as follows: (a) 50% of the Unreleased Transaction Shares and 50% of the full amount of Unreleased Cash shall be transferred to Cap Gemini or as it shall direct; (b) 50% to [CGE&YNZ], such shares and cash being destined for allocation to other employees of [CGE&YNZ] as Cap Gemini shall decide.[13] Dr Saha commenced employment with CGE&YNZ in mid-April 2000. Difficulties soon arose, however. Eventually Dr Saha entered a deed of settlement dated 31 May 2001 with Cap Gemini and CGE&YNZ and terminated his employment. The deed of settlement recorded that: (a) Dr Saha was employed by CGE&YNZ, had entered into a written employment contract with CGE&YNZ and a dispute had arisen between them as to the contract's interpretation. (b) Dr Saha and Cap Gemini were parties to the deed of covenant. (c) The parties had agreed to settle their dispute and all related matters. [14] The settlement deed then recorded that Dr Saha would resign from CGE&YNZ and that his last day of work would be 30 June 2001 (cl 1). Clause 4 provided:CGE&YNZ and Cap Gemini agree that 50% of Unreleased Transaction Shares (being 2095 shares) will not be forfeited. The remaining Unreleased Transaction Shares will be transferred to Cap Gemini or as it directs. The Deed of Covenant will remain in full force and effect.CGE&YNZ agreed to pay Dr Saha a specified sum (cl 5) and Dr Saha agreed that he would use his best endeavours to complete certain work prior to his departure on30 June 2001 (cl 7). The settlement deed also contained an "entire agreement" clause, which provided that the deed "supersedes all prior agreements and understandings between the parties with respect to the matters covered in [it]" (cl 10).Dr Saha's tax treatment of his Cap Gemini shareholding[15] Mr Frawley, a senior policy advisor with the Inland Revenue Department (IRD), gave evidence concerning the background and purpose of the FIF rules. He said that the FIF rules and the Controlled Foreign Company rules (CFC rules) were part of the International Tax regime. The purpose of this regime was "to implement the Income Tax Act's over-riding policy objective that New Zealand tax residents are taxed on their world-wide (i.e., New Zealand-sourced and foreign-sourced) income and non-residents are taxed on their New Zealand-sourced income." He said that "the CFC and FIF rules work by attributing a proportionate share of the income of a foreign entity (the CFC or FIF) to New Zealand residents who have interests in that entity. The result is that New Zealand residents are now taxed on a current basis on the foreign income earned indirectly through foreign entities as well as the foreign income earned directly." [16] Under the FIF rules, a taxpayer such as Dr Saha who holds an interest in a FIF may value his or her income (or loss) in one of four ways (there are some restrictions on the choice of method but they are irrelevant in the present case): (a) the accounting profits method; (b) the branch equivalent method; (c) the comparative value method; or (d) the deemed rate of return method. [17] In the present case, Dr Saha chose the comparative value method, as it is accepted he was entitled to do. This method is governed by s CG 18 of the Act. Itrequires that the taxpayer's FIF income be calculated as at the last day of the relevant income year in accordance with the following formula:(a + b) – (c + d) where- a is the market value of the interest as at the end of the income year (which value shall be nil to the extent that the interest is not then still held by the person as an interest subject to the comparative value method); and b is the aggregate of all the gains derived (including any withholding or other tax payable by the fund in a country or territory outside New Zealand in respect of that gain, allowable as a credit to the person under section LC1) by the person during the income year with respect to the interest; and c is the market value of the interest as at the end of the preceding income year (which value shall be nil to the extent that the interest was not then held by the person as an interest subject to the comparative value method); and d is the aggregate of all expenditure incurred by or on behalf of the person in acquiring the whole or any part of the interest during the income year, [18] In accordance with this formula, Dr Saha returned a loss of $1,210,651 in relation to his transaction shares in the 2001 income year, which the Commissioner accepted. Mr Frawley explained the calculation in the following way: (a) Dr Saha had no Cap Gemini shares at the start of the income year. Accordingly "c" in the formula was nil. (b) Then during the course of the income year, Dr Saha acquired 7,566 Cap Gemini shares as part of the sale transaction. At the time of acquisition these were worth $462.27 each, or a total of $3,497,552. This became "d" in the formula. (c) During the income year, Dr Saha sold 2,301 shares for a total price of $848,709. This became "b" in the formula.(d) At the end of the year, Dr Saha retained 5,265 shares, which had a market price of $273.16 each, for a total market value of $1,438,192. This became "a" in the formula. (e) Consequently the value of Dr Saha's income or loss in accordance with the FIF rules was ($1,438,192 + $848,709) – (0 + $3,497,552) = – $1,210,651, i.e., a loss in that amount. [19] For the 2002 income year, having left his employment with CGE&YNZ, Dr Saha calculated that he had a loss under the FIF rules of $894,950. The calculation was as follows: (a) At the beginning of the income year Dr Saha held Cap Gemini shares worth $1,438,192 in total. That was "c" in the formula. (b) Dr Saha acquired no further shares during the income year. Therefore "d" in the formula was nil. (c) Dr Saha disposed of 767 shares during the course of the year, for a total price of $124,280, and forfeited 2,095 shares when he left CGE&YNZ. Dr Saha claimed that the 2,095 shares had a nil value, so that "b" in the formula was simply $124,280. (d) At the end of the income year, Dr Saha still held 2,403 shares, which had a total market value of $418,962. This was "a" in the formula. (e) Consequently Dr Saha said he incurred a loss for the 2002 income year, as follows: ($418,962 + $124,280) – ($1,438,192 + 0) = - $894,950. [20] By contrast, the Commissioner said that the 2,095 shares referred to in [19](c) above had a value of $602,938, so that "b" should be $727,218. Consequently the proper calculation of Dr Saha's loss was as follows: ($418,962 + $727,218) – ($1,438,192 + 0) = –$292,012.[21] This then is the dispute between the parties – was the loss $894,950 as Dr Saha claimed or $292,012 as the Commissioner claimed?Commissioner's assessment[22] In an adjudication report dated 1 March 2007 the Commissioner identified two alternative lines of analysis, both leading to the same result in terms of the formula in s CG 18. The first relied on s CG 23(5). That subsection provides:CG 23(5) [Deemed disposition at market value] For the purposes of this Act, where at any time in an income year a person disposes of any property which is, with respect to the period immediately before disposition, an interest of the person in a fund with respect to which the person uses the comparative value method or the deemed rate of return method, for no consideration or for consideration which is less than the market value of the property at the time, the person shall be deemed to have derived from the disposition consideration equal to the market value of the property at the time.[23] The Commissioner said that the forfeiture of the 2,095 transaction shares was clearly a "disposition" for the purposes of s CG 23(5). On the assumption that there was no actual gain to Dr Saha as a result of the forfeiture, the effect of s CG 23(5) was that Dr Saha was deemed to have derived consideration equal to the market value of the shares at the time of disposition. This value had to be carried through into "b" in the s CG 18 formula. [24] The Commissioner's second line of analysis relied on s CG 14(2), which provides:CG 14(2) [Non-monetary gain] For the purposes of the FIF rules, where any gain is derived in kind and not in money, the amount of the gain shall be equal to the market value of the gain derived in kind, measured as at the time derived.[25] On this analysis, Dr Saha was treated as having derived a gain in kind from the disposition, which had to be measured by reference to the market value of the shares. As with the first alternative, this value had to be carried through into "b" in the s CG 18 formula.The High Court's approach[26] It is clear that the argument in the High Court focussed on the first of the two lines of analysis just outlined. Simon France J proceeded on the basis that the disposal of the 2,095 shares did not produce an actual gain for Dr Saha: at [33]. He treated the forfeiture as an adjustment to the original purchase price: at [48] and [51]. Having concluded that there was a disposal of the 2,095 shares in the 2002 income year for nil consideration the Judge held that s CG 23(5) deemed that disposal to be at market value: at [51]. The Judge's analysis was influenced by the fact that Dr Saha had chosen in the 2001 income year to treat himself as having acquired the full number of his transaction shares (7,566), which gave rise, he considered, to a need for symmetry of treatment: at [55] – [56]. [27] In the result, then, Simon France J upheld the Commissioner's assessment.Our evaluation[28] Before us Dr Harley argued that the forfeiture of the 2,095 shares to Cap Gemini operated as an adjustment to the original purchase price paid by Cap Gemini. He submitted that Dr Saha had not made a gift to Cap Gemini. Rather, he had incurred a loss of $602,938 on the disposal. What had been an agreed price for the sale transaction had been altered downwards. In terms of s CG 23(5), there was consideration – a detriment flowing from Dr Saha to Cap Gemini. [29] Mr Lennard for the Commissioner also focussed his submissions on s CG 23(5), and supported Simon France J's analysis. [30] However, in the course of argument we became concerned that the parties were analysing what had occurred by reference to the deed of covenant, and in particular the forfeiture provisions in cl 6.1 of schedule 2, rather than by reference to the settlement deed. That deed effected a new contractual arrangement between the parties. Analytically, it replaced the deed of covenant and the attached schedules: see cl 10 of the settlement deed. But, having done so, it effectively reinstated the terms of the deed of covenant by saying that the deed "remained in full force andeffect": cl 4 of the settlement deed (quoted at [14] above). By this the parties must have meant "remained in full force and effect except in so far as this Deed otherwise provides". We say this because the settlement deed did vary what would have been the position under the deed of covenant. So, whereas cl 6.1 of the deed of covenant provided for the forfeiture of all unreleased transaction shares, the settlement deed provided that Dr Saha could retain half of the unreleased transaction shares: see cl 4 of the settlement deed. [31] As a matter of logic, we consider that the focus must be on the settlement deed. It recorded various agreements to end the employment dispute between the parties. Dr Saha was to resign on a specified date, and agreed to use his best endeavours to complete and bill certain work prior to that date. He was required to transfer half of his unreleased transaction shares to Cap Gemini. For its part, Cap Gemini agreed to make a termination payment to Dr Saha and to allow him to retain half of his unreleased transaction shares. Cap Gemini also agreed to release Dr Saha from his employment obligations. As we have said, the deed was expressed to supersede all previous agreements and understandings between the parties in respect of the matters that it covered. It wiped the slate clean. The fact that it provided that the deed of covenant remained in full force and effect does not alter the analysis. It simply means that the parties made a new bargain and in doing so incorporated the deed of covenant, as modified. [32] What is the result of this in terms of the FIF rules? The consequence is, in our view, that the second line of analysis advanced by the Commissioner in his adjudication report is correct. When the parties agreed the settlement deed each gave consideration. As part of his side of the bargain, Dr Saha agreed to relinquish half of his unreleased transaction shares. (That is, he did not forfeit them under cl 6.1 of schedule 2 but agreed to transfer them as part of an overall settlement of his employment dispute.) In return he received certain benefits such as the freedom to undertake other employment. In our view, then, it is not correct to say that Dr Saha obtained no gain from the transfer of the shares to Cap Gemini. Rather, he received a gain, but it was a gain in kind and not in money.[33] Accordingly we consider that the position is covered by s CG 14(2). Under that provision the amount of the gain is to be "the market value of the gain derived in kind". We have before us no valuation evidence going to that, but if the market value of the gain derived in kind is less than the market value of the shares at the time of disposition, the latter market value must be adopted, in accordance with s CG 23(5). On that basis, the market value of the 2,095 shares was $602,938 and that figure must be included in "b" in the formula in s CG 18. [34] In the result, then, we reach the same outcome as Simon France J, albeit by a different route.Decision[35] We dismiss the appeal. The appellant must pay costs to the Commissioner for a standard appeal on a band A basis, plus usual disbursements. We certify for two counsel.Solicitors: Quigg Partners, Wellington for Appellant Crown Law Office, Wellington for Respondent