RON WEST MOTORS (OTAHUHU) LIMITED V THE COMMISSIONER OF INLAND REVENUE CA CA16/06

RON WEST MOTORS (OTAHUHU) LIMITED V THE COMMISSIONER OF INLAND REVENUE CA CA16/06 18 June 2007IN THE COURT OF APPEAL OF NEW ZEALAND CA16/06 [2007] NZCA 248BETWEEN RON WEST MOTORS (OTAHUHU) LIMITED Appellant AND THE COMMISSIONER OF INLAND REVENUE Respondent Hearing: 17 April 2007 Court: Hammond, O'Regan and Robertson JJ Counsel: S R G Judd for Appellant M J Ruffin and R J Wallace for Respondent Judgment: 18 June 2007 at 11 amJUDGMENT OF THE COURT A The appeal is dismissed. B We award costs to the Commissioner of $6,000 plus usual disbursements. REASONS OF THE COURT(Given by O'Regan J)Introduction[1] The appellant, Ron West Motors (Otahuhu) Ltd and its shareholders were parties to a tax avoidance arrangement devised by Mr J G Russell, which is known as the Russell template. The Commissioner issued assessments for the 1982, 1983 and 1984 years after making adjustments to the appellant's taxable income, to counteract the tax advantage it obtained from the tax avoidance arrangement, under s 99(3) of the Income Tax Act 1976 (the 1976 Act). These assessments were upheld by the Taxation Review Authority (TRA) (Case M109 (1990) 12 NZTC 2,690) and, on appeal, by the High Court (K J Cummings Ltd v Commissioner of Inland Revenue; Ron West Motors (Otahuhu) Ltd v Commissioner of Inland Revenue (1998) 18 NZTC 13,537). An appeal to this Court lapsed for want of prosecution and was treated as abandoned. [2] The Commissioner has also issued assessments against Mr Russell and parties associated with him for the relevant tax years. The appellant says these are assessments of the same income for which it has been assessed, thereby breaching s 99(4) of the 1976 Act. It wishes to pursue a new objection to its assessments for the tax years 1982, 1983 and 1984 on the sole ground of breach of s 99(4). It says it was unable to raise this ground in the original objection and appeals because the allegedly inconsistent assessments post-dated its objection. The appellant requested the Commissioner to accept a late notice of objection to its tax assessments for the tax years 1982, 1983 and 1984. The Commissioner declined. The appellant then sought judicial review of the Commissioner's decision not to accept a late notice of objection. The Commissioner applied to strike out the appellant's judicial review application. Simon France J granted the application and struck out the proceeding:Ron West Motors (Otahuhu) Ltd v Commissioner of Inland Revenue (2006) 22 NZTC 19, 748. The appellant appeals against that decision.Issues for determination[3] The Commissioner based his application to strike out on two complementary grounds, namely:(a) The Commissioner has no power to amend the assessments of the appellant for the tax years 1982, 1983 and 1984, and so was not in a position to accept the late notice of objection; (b) The proposed ground of objection, based on the inconsistency between the assessments of the appellant and later assessments was able to be pursued by the appellant during the initial objection process, and therefore could not be raised again. [4] The appellant contends that neither of these grounds is correct. In particular, it says: (a) The Commissioner is not lawfully prohibited from amending the assessments for the relevant tax years, and he therefore made an error of law in basing his decision on the premise that he was, in fact, prohibited from doing so; (b) The appellant was unable to pursue this ground of objection during its initial objection process, because it was limited to the grounds of its initial objection, which did not include any reference to subsequent and inconsistent assessments for the obvious reason that the subsequent assessments had not been made at the time the objection process commenced. [5] The same issues arise in relation to this appeal.Does the Commissioner have power to amend the assessments for the tax years 1982, 1983 and 1984?[6] In order to understand the parties' positions on this issue, it is necessary to give some context as to the operation of the Russell template, and the ways in which the Commissioner has responded to it.The Russell template[7] The appellant was a trading company carrying on business as a motor vehicle dealer. It and its shareholders, Ms West and Mr Radicich (the shareholders), participated in the Russell template tax avoidance scheme. The scheme was implemented by numerous other parties, and has been the subject of extensive litigation. The key steps in the implementation of the scheme are described below. [8] The first step was for the shareholders of the trading company (the appellant, in this case) to agree to sell their shares (or, more precisely, the beneficial interest in them) to a company controlled by Mr Russell (the parent company). This company became the new parent of the trading company and held its interests in the shares on trust for another Russell-controlled company, which had accumulated tax losses (the loss company). The purchase price was left outstanding and secured by a mortgage over the shares. The transaction was not intended to be a sale in any commercial sense. Under a management contract between the trading company, its shareholders and the relevant Russell entities which gave effect to the Russell template, the shareholders retained unfettered control over the business, notwithstanding the sale. The shareholders were also granted an option to repurchase the shares when the scheme had run its course. [9] The sale had two purposes, both of which were entirely tax related. The first was to make the trading company part of a group of companies controlled by Mr Russell, some of which had tax losses. This enabled Mr Russell to take advantage of the group relief provisions in s 191 of the 1976 Act. The second was to create a debt to the shareholders from an entity associated with Mr Russell which could be satisfied out of the profits of the appellant. [10] The next step was for the trading company to agree to pay its net profits, half- yearly, to the loss company. This was called an administration charge. It was income in the hands of the loss company, but group relief under s 191 was relied upon to avoid tax. In reality, the administration charge was partly a conduit for the money which was to be returned to the shareholders, and partly a fee payable to Mr Russell for the use of the scheme. The proportion was calculated by reference tothe amount of tax saved. In addition, the company paid a consultancy fee representing five percent of the administration charge to another Russell company. [11] The third step was for the parent company to pay the shareholders their part of the administration charge. This was designated an instalment of the purchase price for the shares. The amount of the purchase price was calculated not by reference to the value of the trading company, but to enable the scheme to mop up a given number of years of expected net profit. When that had been accomplished, the shareholders could exercise their option to repurchase the trading company and carry on as if nothing had happened. Alternatively, the Russell parent company could agree to prior release of that option for a sum which would create a sufficient new capital debt to enable the scheme to start up again. [12] The objective of the template was to convert the profits of the trading company, which would otherwise be taxable in its hands or the hands of its shareholders if distributed, to a tax-free capital payment to the shareholders.The Commissioner's response: Tracks A, B, C, D and E.[13] In the present case, the Commissioner assessed the appellant (the trading company), disallowing the deduction it had claimed for the administration charge and consultancy fee, and assessing it on that income. This approach has become known as the Track A method of assessment. Although in the present case the operation of the scheme did not leave the appellant penniless, and the appellant did, in fact, pay some tax to the Commissioner, this was not typical. In most cases, the trading companies (ie the company in the same position as the appellant in this case) were insolvent shells by the time the Inland Revenue Department sought to enforce judgments resulting from Track A assessments. This occurred because the assets of the trading companies had been sold back to the original shareholders as provided for in the management contracts, leaving the trading company with no assets. [14] The Commissioner then changed his approach in many cases. He restored the trading company's deduction for the administration charge (but not the consulting fee) and then reconstructed the administration charge as income of theoriginal vendor shareholders, assessing them accordingly. This method of assessment became known as Track B. This Court recently dealt with a number of appeals involving Track B assessments: Wire Supplies Ltd v Commissioner of Inland Revenue [2007] NZCA 244. [15] Subsequently, the Commissioner has issued Track C, D and E assessments. Track C assesses the administration charge against the Russell parent companies, Track D assesses the consultancy fee against Mr Russell personally, and Track E assesses certain income against Mr Russell personally. Counsel for the Commissioner, Mr Ruffin, informed us that the Commissioner does not intend to pursue the Track C or D assessments, but does intend to pursue Track E assessments. It appears, however, that the Track C assessment of the Russell parent company in the present case has not been formally withdrawn, and this is the basis on which the present case was pursued. Even if the Track C and D assessments are withdrawn, however, the same issue will arise in relation to the Track E assessments, which the appellant says tax the same income as has been attributed to it by the Commissioner for the purposes of the Track A assessments for the relevant years. The Commissioner denies this.Section 99(4)[16] Section 99(4) of the 1976 Act is designed to prevent double taxation of those involved in a tax avoidance scheme. It provides:Where any income is included in the assessable income of any person pursuant to [s 99(3)] then, for the purposes of this Act, that income shall be deemed to have been derived by that person and shall be deemed not to have been derived by any other person.[17] The appellant wishes to pursue a fresh objection to the Track A assessments against it on the basis that the later Track C assessment is an assessment of the same income. It wishes to argue that the advent of the assessment of the Russell parent company under Track C means that the income attributed to the Russell parent company is deemed not to have been derived by the appellant, and that the Commissioner must cancel or amend the Track A assessment to remedy the breach of s 99(4).History of the inconsistent tracks argument[18] In the original objection filed by the appellant, the issue arose as to the conflict between Track A and Track B assessments. This issue had also arisen in theMiller litigation, which dealt with objections to assessments of shareholders made on a Track B basis, where the Commissioner had previously assessed the relevant trading companies. [19] In Miller v Commissioner of Inland Revenue (No 2) (1997) 18 NZTC 13,127 at 13,134, the High Court ruled that where a Track A assessment had been made, the taxpayer's objection had been disallowed and the taxpayer requested that a case be stated for the TRA, the Commissioner was prevented from issuing a new Track B assessment. In the present case that meant the Commissioner had to allow the appellant's objection proceedings to proceed, and could not change this approach and tax the shareholders, Ms West and Mr Radicich, for the relevant tax years under Track B. [20] Although the issue was not pursued on appeal in Miller, this Court ruled that the point at which the Track A assessment could not be changed was the point at which the case was actually stated for the TRA, not the point at which the taxpayer requested a case stated as the High Court had found: Miller v Commissioner of Inland Revenue [1999] 1 NZLR 275 at 293. The Privy Council agreed with this Court's view: Miller v Commissioner of Inland Revenue [2001] 3 NZLR 316 at [34]. [21] The net effect of this was that in the present case, because the Track A assessments for the relevant years had gone past the point of a case being stated, the Commissioner was bound by the Track A assessments and could not switch to Track B. However, for later years, where the Track A assessments had not become subject to a case stated to the TRA, the Commissioner could issue Track B assessments, but if he did so, he would then become bound to cancel or amend the Track A assessments to avoid double taxation in breach of s 99(4). [22] While that was a good outcome for Ms West and Mr Radicich, because it protected them against Track B assessments in the relevant years, it meant that theTrack A assessment against the appellant stood. The appellant made various arguments in the High Court based on the apparent inconsistency between Track A and Track B assessments, and these were dealt with by Baragwanath J by simply cross-referring to his decision in Miller (at 13,549). The effect of that was that Baragwanath J determined that, on the facts of the present case, the Commissioner was prevented from issuing a subsequent Track B assessment which was inconsistent with the Track A assessment of the appellant, but the Track A assessment was not affected by the subsequent Track B assessment, which the Commissioner was bound to withdraw. [23] What the appellant now seeks to do is to mount a similar argument as to the inconsistency between the Track A assessment and the Track C assessment. A very similar argument was made by the appellants in the Wire Supplies appeal, though in that case the argument was focused on the apparent inconsistency between Track B assessments and Track C assessments. In the Wire Supplies appeal, this Court determined that the Track B assessments were unaffected by subsequent, allegedly inconsistent, Track C assessments. The Court applied by analogy the principle established in BASF NZ Ltd v Commissioner of Inland Revenue (1995) 17 NZTC 12,136. In that respect, the Court adopted a similar approach to that which had been adopted by Baragwanath J in Miller, as modified by the decision of this Court and that of the Privy Council in Miller. The conclusion of this Court in Wire Supplies is summarised at [128] - [130] as follows:[128] We believe it is appropriate to apply the BASF principle by analogy in cases involving the potential application of s 99(4) to provide a proper basis for consideration of potentially inconsistent assessments. There needs to be a way of ensuring that the Commissioner cannot continue to change ground on the party to whom tax avoidance income will be assessed, while at the same time recognising that, once the Commissioner has become committed to a particular party or parties, s 99(4) must operate to protect other potential assessees for the same income. In our view the application of the BASF principle on the basis that it was applied in the Miller litigation as between Track A and Track B assessees provides a workable solution which ensures that once objection proceedings have been started they can proceed to finality without being left in a perpetual state of uncertainty, and at the same time giving effect to s 99(4). [129] This means that where a Track C assessment is made in circumstances where a Track B assessment is already before the TRA, the party who may seek to invoke an inconsistency argument based on s 99(4) is the Track C assessee, but not the Track B assessee. This is consistent withthe decisions of all courts in Miller, as well as reflecting the reality that the Track B assessee is limited in the grounds of its objection to those which appeared in the objection itself, which cannot have included the possibility of an inconsistent Track C assessment that did not exist at the time of the objection. If, on the other hand, the Commissioner makes a Track C assessment which is inconsistent with a Track B assessment that has not become the subject of a case stated, then the Commissioner will be required to amend the Track B assessment to remove any inconsistency with the Track C assessment. [130] This approach leads to a bright line rule which determines whether an earlier or a later assessment derives the benefit of s 99(4) in the event of inconsistency. It is consistent with the approach taken in the Miller litigation and it prevents a situation arising where no Track A or B assessments can be determined until the final outcome of proceedings dealing with Track C, D and E. Given the competing interests of the Track B assessee and the Track C assessee, it is hard to see how that could be done other than in proceedings involving both, though there is no provision for that in the legislation. All of this recognises that, while the foundation of the BASF principle is the protection of the interests of taxpayers, it also has the effect of recognising that the courts must adopt procedures to ensure that objections to assessments can be resolved in an orderly manner, and that later assessments taken on a different basis from earlier assessments should not be permitted once the fate of the earlier assessment is in the hands of the court system.[24] Applying the decision of this Court in Wire Supplies to the facts of the present case, the advent of the Track C assessments (or, for that matter, Track D or Track E assessments) potentially contravening s 99(4) may provide a basis for challenging the Track C, D or E assessments: that will be a matter to be decided in the context of the challenge proceedings relating to those assessments. But the later assessments have no impact on the Track A assessments in this case, and the Commissioner is not permitted to amend or cancel the Track A assessments. In other words, if s 99(4) is engaged in the present case, that is a problem which affects the Track C (or D or E) assessments but not the Track A assessments against the appellant.The appellant's argument[25] The appellant's argument can be summarised as follows: (a) The Commissioner has power under s 126 of the Tax Administration Act 1994 (the 1994 Act), to allow a taxpayer to make a late objection. This is clear from s 126(2), which says that any objection madeoutside the fourteen day time limit specified under s 126(1) shall be effective 'unless the Commissioner accepts the same and gives notice to the objector accordingly'. (b) The decision of the High Court in Gisborne Mills Limited v Commissioner of Inland Revenue (1989) 11 NZTC 6,194 makes it clear that the discretion given to the Commissioner by s 126(2) must be exercised lawfully, which requires the Commissioner to weigh the circumstances leading to the request for late objection. If the Commissioner did not do so, his decision, or his failure to make a decision, was reviewable by the Court. The Gisborne Mills case concerned s 30(2) of the 1976 Act, but that provision is identical to s 126(2) of the 1994 Act. (c) In the present case, the Commissioner declined to allow a late objection on the basis that he did not have power to amend the Track A assessment of the appellant. The appellant contends that is incorrect, and that the Commissioner has therefore made a reviewable error of law. (d) The Commissioner is able to reopen the Track A assessment because: (i) Section 23 of the 1976 Act gives the Commissioner a wide power to amend an assessment "from time to time and at any time". Section 113 of the 1994 Act is in similar terms; (ii) Section 27 of the 1976 Act and s 109 of the 1994 Act provide that the method of contesting an assessment is through the statutory objection or challenge procedure. However, those sections do not limit the Commissioner's power to amend assessments. Thus the power to amend survives even the completion of objection or challenge proceedings if the amendment relates to a matter which has not been dealt with in the objection or challenge proceedings;(iii) The Courts have placed a gloss on the broad power in s 23 (and s 113) in the BASF decision. However, that decision should not be applied in the present case because it is designed to protect taxpayers' interests, and should not be used in a way which prejudices the interests of the Track A assessee (the appellant) in this case; (iv) If the BASF decision does not limit the Commissioner's ability to amend or cancel the Track A assessment, then there is no other limitation on his power to do so and he was incorrect to determine that he did not have power to do so in this case. (e) Simon France J did not decide whether the Commissioner was in error or not. Instead, he determined at [18] that the late objection could not succeed. The Judge said that the Commissioner could either still amend the Track A assessment, in which case he was not allowed to issue a concurrent Track C assessment, or he could not amend the Track A assessment, in which case the complaint of inconsistency lay with the Track C assessee. (f) This addressed the wrong question, because it focused on whether a late objection would be successful, rather than on the question as to whether the Commissioner had properly exercised his discretion whether or not to allow a late objection. (g) Because, on the appellant's argument, the Commissioner did have power to reopen the Track A assessment, the basis on which the Commissioner exercised his discretion was flawed, and the Court should direct him to consider the matter afresh, on a legally correct basis.Discussion[26] The appellant's case founders at steps (c) and (d). This Court has now determined that the Commissioner cannot reopen an assessment once the objection is in the hands of the TRA: Wire Supplies at [130]. The Commissioner cannot therefore amend the Track A assessment in this case. We note for completeness that the High Court Judge followed the observation recorded in (e) above with a statement that he had no doubt that the correct position was that the Commissioner cannot now amend the Track A assessment. So he also reached this conclusion, though he decided the present case before this Court's decision in Wire Supplies. The Commissioner refused to allow the appellant's proposed late objection because the Commissioner's inability to reopen the Track A assessment on the grounds of inconsistency with the Track C assessment made the objection futile. [27] We are satisfied that the Commissioner was not in error in the way he exercised his discretion not to accept the late objection. The application to review the Commissioner's discretion on this ground cannot succeed, and it was appropriate to strike it out.Could the appellant have pursued the present ground of objection during the initial objection process?[28] Our decision on the first ground of appeal makes it strictly unnecessary for us to deal with this aspect of the appeal. We do, however, briefly summarise the view we have reached. [29] The appellant contends that the objection to the Track A assessment against it on the basis of inconsistency with the later Track C assessment is a new matter which was not in issue, and could not have been in issue at the time of its initial objection to the Track A assessment. In short, the appellant argues that s 36 of the Inland Revenue Department Act 1974 had the effect of limiting the appellant's initial objection to the Track A assessment to the grounds which it set out in its initial objection. The grounds could not include the inconsistency with the later Track Cassessments because the Track C assessments had not been made at the time the objection was made. [30] Counsel for the Commissioner said that the High Court appeal in relation to the appellant's initial objection dealt with the inconsistency of Track A and Track B assessments, which essentially raises the same point as is now being raised in relation to Track C, and also dealt with the existence of the Track C assessments themselves. He produced the submissions of the then counsel for the appellant (called "Contentions of Appellant") which were presented to Baragwanath J during the hearing of the High Court appeal. One of the "contentions", Contention 11, specifically deals with the issues arising from the inconsistency of Track A and Track B assessments. The argument that the subsequent Track B assessments triggered a need to cancel the Track A assessment of the appellant was dealt with. [31] The progress of the appellant's High Court appeal coincided with the progress of the Miller litigation, including both the judicial review proceedings and the objection proceedings by the Miller appellants, who were both Track A and Track B assessees in relation to Russell template transactions. After Baragwanath J had issued his judgments in the Miller litigation, an application for recall of those judgments was made on the basis (among other things) that the later Track C assessments required that the judgments be recalled. Baragwanath J declined to recall his judgments in the Miller litigation: Miller v Commissioner of Inland Revenue HC AK M103/93 26 September 1997. But he deferred his decision in the appellant's High Court appeal until after the Miller recall judgment had been issued. Baragwanath J recorded this at the beginning of his judgment in the appellant's appeal at 13,539, and concluded "Insofar as the issues are the same I adopt the account and conclusions the subject of the Miller decisions, which apply mutatis mutandis to this case". The Judge then dealt with the contentions advanced by counsel for the appellant, which included contentions relating to the impermissible use of Track A and B assessments. [32] The complex intertwining of the Miller litigation with the appellant's High Court appeal makes it difficult to conclude with certainty that the impact of the Track C assessment was properly before the Court and conclusively dealt with. Theintertwining arose from the fact that the Russell template transactions in issue in the present appellant's appeal and in the Miller litigation were essentially the same, counsel representing the appellant was also representing the Miller appellants, the same counsel was representing the Commissioner in both cases and Baragwanath J was dealing with the Miller cases and the appellant's appeal. In that environment, the restrictions on the scope of objection under s 36 did not appear to be strictly adhered to, and the focus was on dealing with issues affecting Russell template cases as and when they arose. [33] The most that can be said on this aspect of the case is that the Track A/Track B issues were directly confronted in the present case, and that the Track C issues were obliquely referred to and dealt with by cross reference to the recall judgment of Baragwanath J in the Miller litigation. This would not be sufficient, in itself, to lead us to conclude that the point which the appellant now wishes to raise in its intended fresh objection has been conclusively dealt with. However, the Track A/Track B issue, dealt with in the Miller litigation, is essentially the same as the issue which the appellant now wishes to raise. Additionally, the Track C assessments were clearly identified by the Judge in his consideration of the appellant's appeal. These factors lead us to conclude that there would be no unfairness in not allowing the present proceedings to proceed further.Result[34] As the Commissioner was not legally wrong in the grounds on which he declined to allow a fresh objection, we conclude that the High Court Judge was right to strike out the judicial review application. We therefore dismiss the appeal. We award costs to the Commissioner of $6,000 plus usual disbursements.Solicitors: Quay Law, Auckland for Appellant Meredith Connell, Auckland for Respondent