M R FORESTRY (NO.1) TRUST LIMITED AND ANOR V THE COMMISSIONER OF INLAND REVENUE HC WN CIV 2006-485-21

M R FORESTRY (NO.1) TRUST LIMITED AND ANOR V THE COMMISSIONER OF INLAND REVENUE HC WN CIV 2006-485-21 6 July 2006IN THE HIGH COURT OF NEW ZEALAND WELLINGTON REGISTRY CIV 2006-485-21UNDER the Declaratory Judgments Act 1908 IN THE MATTER OF of the Tax Administration Act 1994 BETWEEN M R FORESTRY (NO.1) TRUST LIMITED First Plaintiff AND M R FORESTRY (NO.2) TRUST LIMITED Second Plaintiff AND THE COMMISSIONER OF INLAND REVENUE Defendant Hearing: 28 June 2006 Appearances: B A Scott and J McCaughan for the Plaintiffs J H Coleman and K Whitiskic for the Defendant Judgment: 6 July 2006 at 10amJUDGMENT OF MILLER J Introduction[1] An administrative dispute over tax losses claimed as deductions in the taxpayers' 2000 and 2002 returns ended abruptly when, in September 2003, the Commissioner forgot to file notices of response to the taxpayers' notices of proposed adjustment. Because he was then deemed to accept the proposed adjustments, the Commissioner later issued assessments allowing the disputed losses. He promptly issued amended assessments disallowing them, so asserting that the first disputeprocess and resulting assessments did not affect his statutory discretion to amend an assessment at any time where he thinks it necessary to ensure its correctness. [2] The taxpayers say the Commissioner erred in law because he was bound by the assessments that resulted from the earlier disputes process. They want to invoke the same procedure for the amended assessments, expecting that the Commissioner will refer the assessments to the Adjudications Unit within the Inland Revenue Department for reconsideration. They issued notices of proposed adjustment. The Commissioner issued notices of response so that he was not again deemed to accept the adjustments, but he refuses to co-operate further. He claims the taxpayers are attacking the exercise of his discretion to issue amended assessments, and says the Tax Administration Act 1994 does not allow them to do so. [3] In this declaratory judgment action, the taxpayers seek a declaration to the effect that the Commissioner must complete the disputes procedure.Factual background[4] The taxpayers are trusts associated with a Wellington family. They are participants in what has become known as the Trinity scheme, which involved a Douglas fir forest in Southland. Expenses associated with taxpayers' investments in the forest were claimed as deductions against their income from other sources. InAccent Management Limited v CIR (2005) 22 NZTC 19,027, a test case for scheme investors, Venning J held the Commissioner was right to disallow the deductions. He found, among other things, that tax avoidance was a more than incidental purpose of the Trinity scheme. [5] The Court of Appeal is to hear an appeal in Accent Management in September. The merits of the Trinity scheme in tax law do not concern me, but the scheme and resulting litigation supply the context for this judgment. The deductions that are contested here assumed the scheme was lawful. [6] For my purposes, the chronology began on 13 August 2002, when the taxpayers filed returns for the 2000 income year. For reasons that have not beenexplained, they did not claim the Trinity losses. The Commissioner duly issued assessments agreeing with the returns. The same course was adopted for the 2002 year, but on 11 July 2003, shortly after filing their 2002 returns, the taxpayers issued notices of proposed adjustment (NOPAs) claiming the Trinity losses for both years. [7] The NOPAs triggered the disputes procedure in Part IVA of the Tax Administration Act. It is an administrative rather than an adjudicative process, designed to improve the quality of the Commissioner's decisions and to do so in a timely and cost-effective way. It does so, in principle if not in practice, by allowing the Commissioner to reconsider disputable decisions following full disclosure of the case for and against the taxpayer. Under the disputes procedure, the Commissioner was required to issue a notice of response (NOR) within a prescribed response period if he wished to reject the NOPAs. He overlooked the matter, and was deemed to accept the adjustments. [8] On 30 January 2004, the Commissioner issued a generic NOPA applying to all investors in the Trinity scheme. So far as the present taxpayers were concerned, it was issued for the 2002 income year only, and it did not refer to the previous NOPAs. The taxpayers responded with NORs rejecting the proposed adjustments. [9] Venning J delivered his judgment in Accent Management on 20 December 2004. The Commissioner then made assessments disallowing losses claimed in the Trinity taxpayers' 2000 income year. The assessments were made on 30 March 2005 because of an imminent time bar. They were not released to the taxpayers immediately, but all Trinity investors were told that the Commissioner had made assessments that followed Venning J's decision. On 23 May, the Commissioner told the present taxpayers of the amended assessments and explained that they must issue NOPAs if they wanted to dispute the assessments. [10] On 16 and 17 June 2005, the Commissioner first issued assessments to the present taxpayers allowing the losses, so conceding that he was deemed to have accepted them under the previous disputes process, then issued amended assessments disallowing the losses.[11] The taxpayers invoked the disputes procedure by issuing NOPAs on 16 August. They also raised the same issues in challenge proceedings under Part VIIIA of the Tax Administration Act. [12] The Commissioner duly issued NORs so that he was not again deemed to have accepted the taxpayers' NOPAs, but he maintained the NOPAs were invalid, saying the taxpayers were attempting to dispute matters that were expressly excluded by s138E(1)(e) of the Act, which provides that Part VIIIA does not confer rights of challenge to the discretion to issue amended assessments. He refused to continue the disputes procedure, the next step in which is the issue of the Commissioner's disclosure notice and statement of position. [13] The taxpayers' challenge proceedings addressed the 2000 and 2002 years. Before me, however, Mr Scott accepted that they erred by including the 2000 year, because certain statutory prerequisites in s138B(3) had not been met when the challenge was filed. The proceedings will be amended by deleting the 2000 claim. The taxpayers still insist that the dispute should be determined under the disputes procedure in Part IVA so far as it concerns the 2000 year. [14] Mr Scott also confirmed that the taxpayers no longer claim that the dispute concerning the 2002 year should continue under the disputes procedure. They accept that s89D(1) precludes use of the disputes procedure for that year, because it allows a taxpayer to issue a NOPA only where the Commissioner has issued a notice of assessment and the Commissioner has not previously issued a NOPA about the assessment. The generic Trinity scheme NOPA that the Commissioner issued on 30 January 2004 applied to the 2002 year. [15] Accordingly, this proceeding now addresses only the 2000 year. Mr Coleman did not dispute that the taxpayers were entitled under s89D(1) to issue NOPAs for the 2000 year, or to file challenge proceedings for the 2002 year. The Commissioner's complaint rather concerns the grounds that they have relied on in their NOPAs.The Commissioner's objection to the disputes process[16] I was given to understand that the Commissioner has long held that a NOPA may not be issued disputing discretionary decisions that, under s138E, may not found challenge proceedings. They include the discretion to issue amended assessments under s113 of the Act. The Commissioner maintains that the disputes procedure is available only for "disputable decisions", which term is defined to exclude a decision that cannot be challenged under Part VIIIA. He says it would be absurd if a matter that cannot be challenged could be prosecuted under the disputes procedure. [17] This practice may bear the imprimatur of time, but it is nonetheless wrong. The Act defines disputable decision thus:disputable decision means— (a) an assessment: (b) a decision of the Commissioner under a tax law, except for a decision— (i) to decline to issue a binding ruling under Part 5A; or (ii) that cannot be the subject of an objection under Part 8; or (iii) that cannot be challenged under Part 8A, or (iv) that is left to the Commissioner's discretion under sections 89K, 89L, 89M(8) and (10) and 89N(3)[18] The definition is in two parts. The first is an assessment. The second is a decision of the Commissioner under a tax law, subject to certain exceptions one of which is a decision that cannot be challenged under Part VIIIA. As a matter of construction, assessments are always disputable decisions. They are not subject to the exclusion of decisions that cannot be challenged under Part VIIIA. [19] Section 138E provides that Part VIIIA "does not confer a right of challenge" to a matter that under s113 or various other specified provisions "is left to the discretion, judgment, opinion, approval, consent, or determination of the Commissioner." Again as a matter of construction, this restriction is confined to challenge proceedings under Part VIIIA, which are held in the Taxation Review Authority or this Court. It has nothing to do with the administrative disputesprocedure in Part IVA. It seems that the Commissioner has been confused by the drafter's technique of conveniently adopting the list of excluded decisions in Part VIIIA when defining disputable decisions that are not assessments. [20] Mr Coleman cited this Court's decision in Gilchrist v CIR (2005) 22 NZTC 19,094 as authority that a taxpayer cannot issue a NOPA about a matter that cannot be challenged under s138E. But Gilchrist is not authority that a taxpayer is unable to invoke the disputes procedure in Part IVA for an assessment, whatever it may say about availability of the disputes procedure in other cases. It involved debt recovery proceedings brought by the Commissioner to recover unpaid GST. The taxpayer's defence was that the Commissioner must review his discretionary decision to refuse to accept payment by instalments. On appeal, Ronald Young J held that the decision was not reviewable under s138E, and held that challenge by NOPA was precluded under s138E(1)(e)(iv). [21] The taxpayers had the right under s89D(1) to issue NOPAs "in respect of" the assessments issued on 17 June 2005 for the 2000 income year. There is no limit on what may be raised in a NOPA. Section 89F provides that a taxpayer's NOPA must identify the adjustments, provide a statement of the facts and the law in sufficient detail to inform the Commissioner of the grounds for the proposed adjustment, state how the law applies to the facts, and include copies of significantly relevant documents known to the taxpayer. Under s89G, the Commissioner is required within the prescribed response period to issue a NOR if he wished to reject the proposed adjustment. A NOR must state concisely the facts or legal arguments in the NOPA that the Commissioner considers are wrong, the reasons why, any facts and legal arguments relied on by the Commissioner, and how the legal arguments apply to the facts. This process is apt to deal with questions of correctness or validity or discretion, unless expressly excluded. [22] I do not think that anything in the scheme of the Tax Administration Act stands in the way of these conclusions. In a challenge proceeding, a third party (the Taxation Review Authority or this Court) determines the correctness or validity of an assessment or other disputable decision. Under the disputes procedure, the Commissioner reconsiders his own decision. Section 89A says that the disputesprocedure is intended to improve the accuracy of disputable decisions made by the Commissioner, reduce the likelihood of disputes arising between the Commissioner and taxpayers by encouraging open and full communication, promote the early identification of the basis for any dispute, and promote the prompt and efficient resolution of disputes. In that context, the Commissioner should be able to re- examine all the considerations that led him to make the disputable decision in the first place. [23] It is true that Part IVA allows the taxpayer to insist on the Commissioner reconsidering disputable decisions. That suggests there must be limits to the decisions that can be disputed, in the interests of sensible administration. The legislature has set such limits in s89D and the definition of 'disputable decision'. A taxpayer may invoke the disputes procedure only for a disputable decision. A disputable decision that is not an assessment is defined to exclude certain specified decisions, including those that may not be challenged under Part VIIIA, and even where the decision qualifies as disputable the taxpayer cannot issue a NOPA unless it can also show that the decision affects it. But an assessment is always a disputable decision and the taxpayer may always issue a NOPA "in respect of" it (unless the Commissioner himself has previously issued a NOPA in respect of the same assessment). [24] Mr Scott also argued that, in any event, the Commissioner was wrong to characterise the taxpayers' complaint as an attack upon the exercise of his discretion. The taxpayers say the Commissioner is bound in law by the assessments resulting from the earlier disputes process. Whether or not the taxpayers are right about that, he contended, their claim cannot be characterised as an attack upon the Commissioner's discretion. They are not trying to stop the Commissioner from issuing assessments in the first place; assessments are a prerequisite to the NOPAs they have issued. I can see the Commissioner's point, however. There may be a point of law, but on its face the discretion in s113 is unrestricted. The Court is also quite well equipped to deal with a point of law in the challenge proceedings, and Mr Scott further assured me that the taxpayers do not wish to force the Commissioner to reconsider in haste. It is a reasonable surmise, then, that the taxpayers' enthusiasm for administrative reconsideration owes something to an intention to plead that, as adiligent administrator of the tax laws, the Commissioner should not revisit assessments that result from his own mistakes. [25] The point remains, however, that this is in form and substance a dispute under Part IVA. The taxpayers may deploy the disputes procedure for assessments and the NOPAs have been issued "in respect of" the particular assessments that are in dispute. The Commissioner can find no foundation in the statute for his resistance to review of the assessments under Part IVA on the ground that the decision to issue them may have been discretionary.Relief[26] Mr Scott sought a declaration:that the defendant is required to promptly issue to the plaintiffs disclosure notices in respect of the notice of proposed adjustment issued by the plaintiffs on 18 August 2005 concerning the 2000 income year, and thereafter to allow the Disputes Resolution Procedure (including referral to adjudication) to be completed in respect of all of the issues raised by the plaintiffs in that notice of proposed adjustment;[27] Mr Coleman responded that any declaration should be confined to stating that s138E does not preclude the Commissioner from completing the disputes process. [28] As the declaration sought makes clear, the taxpayers aspire to have their complaint considered by the Adjudications Unit. The unit is described in a tax information bulletin Vol 8, No.3 (August 1996), which explains that adjudicators are impartial officers within Inland Revenue, independent of the Department's audit functions. An adjudicator takes a fresh look at the application of law to the facts. The Commissioner has delegated his authority to determine disputed adjustments to the adjudicators, and their decisions are final. Cases are "generally" sent to the Adjudications Unit for consideration, regardless of the issue or the amount of tax involved, where agreement has not been reached on all issues at the end of the conference/disclosure stage. [29] However, the Act does not compel the Commissioner to send unresolved disputes to the Adjudications Unit, which is a creation of the Commissioner that isnowhere referred to in the legislation. Indeed, until 21 December 2004 the prescribed steps under the legislation ended with an issue of a NOR, which the recipient of a NOPA was required to issue if it did not accept the proposed adjustment. The Commissioner then had a discretion to issue a disclosure notice providing the taxpayer with his statement of position, which would outline the facts, evidence, and propositions of law on which he intended to rely and outline the issues as he saw them. If the Commissioner issued a disclosure notice, the taxpayer was required to respond with its own statement of position within a prescribed response period. Nothing in Part IVA required the Commissioner to reach a decision before issuing an amended assessment, let alone to refer the dispute to the Adjudications Unit. The Commissioner might at any time choose instead to issue an amended assessment. I was given to understand that flexibility was thought to be important because the Commissioner may confront a time bar to reassessment before the disputes process is concluded. [30] The Act was amended on 21 December 2004 to extend the compulsory elements of the dispute resolution process. The amendments applied to disputes commenced under Part IVA on or after 1 April 2005. Section 89M was amended to require the Commissioner to issue a disclosure notice, subject to s89N which was inserted at the same time. That section applies only if a NOPA has been issued, the dispute has not been resolved by agreement, and none of a number of exceptions is applicable. Where s89N applies, the Commissioner may not amend an assessment under s113 before he or the taxpayer accepts a NOPA, NOR, or statement of position issued by the other, or the Commissioner considers a statement of position issued by the taxpayer. The amendments accordingly give the Commissioner an incentive to complete the disputes process or at least advance it to the stage where he has considered a taxpayer's statement of position. [31] In this case, Mr Scott maintained without protest from Mr Coleman that s89M applies because the dispute in relation to the 2000 year was commenced after 1 April 2005 and none of the exceptions in s89N applied to exempt the Commissioner from the requirement to issue a disclosure notice and statement of position. I observe that s89N does not apply if the taxpayer has begun "judicial review proceedings" about the dispute. This proceeding takes the form of an application fora declaratory judgment for that reason. Mr Coleman did not take the point that the proceeding is a species of judicial review; in the circumstances, I will assume without deciding that it is not. [32] Mr Scott accepted, nonetheless, that s89N(2) does not prohibit the amended assessments in this case, because the Commissioner had already amended them under s113 before any question arose of considering a statement of position issued by the taxpayers. It follows that the compulsory elements of the dispute resolution process will end in this case with the issue of the Commissioner's disclosure notice and statement of position and the taxpayers' statement of position in response. The Commissioner need not make a decision on the dispute before relying upon the amended assessments. However, Mr Scott contended that the Commissioner normally refers disputes to the Adjudications Unit, and has a duty under s6 to use his best endeavours to protect the integrity of the tax system. He suggested there could be no proper reason for failing to involve the Unit. [33] Mr Coleman argued that there may be good reason not to refer the matter to the Adjudications Unit. For example, the Commissioner may confront a time bar. There may be cases, and this is said to be one, where reconsideration would be inefficient because the challenge proceedings will settle the dispute. The Commissioner's statement of position and disclosure notice must set out the issues, facts, evidence, and law relating to all of the issues, including the substantive merits of the Trinity scheme. That is a very complex and time-consuming exercise that has yet to be undertaken for any Trinity investor, and most of the issues will soon be resolved by the Court of Appeal. He submitted that questions of sequencing should be addressed in the challenge proceeding, which is not presently before me. The Court might stay that proceeding, for example. I observe that he did not point to any authority that the Court might stay the compulsory elements of the dispute procedure under Part IVA. [34] All that is necessary to determine the narrow question in this proceeding is a declaration dealing with the question whether s138E precludes use of the disputes procedure in this case. The question whether the disputes procedure should be concluded before the taxpayers' challenge proceedings is not before me; I am notable to say whether the Court has jurisdiction to stay the disputes procedure or whether, if so, the jurisdiction should be exercised. Mr Scott suggested practical steps that can be taken to address the Commissioner's concern about issuing a statement of position that addresses the merits; for example, the Commissioner could simply incorporate his submissions in Accent Management by reference. And he indicated that the taxpayers will allow the Adjudications Unit to wait until the Court of Appeal delivers its judgment. [35] The taxpayers will have a declaration that nothing in s138E of the Tax Administration Act prevents the Commissioner from first issuing a disclosure notice in respect of the NOPAs issued by the plaintiffs on 18 August 2005 concerning the 2000 income year, and thereafter allowing the disputes resolution procedure to run its course in respect of all of the issues raised by the plaintiffs in their NOPAs.Costs[36] The taxpayers have succeeded and will have costs on a 2B basis.In accordance with r540(4) I direct the Registrar to endorse this judgment with the delivery time of 10.00am on the 6th day of July 2006.F Miller JSolicitors:Chapman Tripp, Wellington for the Plaintiffs Crown Law Office, Wellington for the Defendant