THE COMMISSIONER OF INLAND REVENUE V LUNDY FAMILY TRUST AND ANOR CA CA115/04

THE COMMISSIONER OF INLAND REVENUE V LUNDY FAMILY TRUST AND ANOR CA CA115/04 10 November 2005IN THE COURT OF APPEAL OF NEW ZEALAND CA115/04BETWEEN THE COMMISSIONER OF INLAND REVENUE Appellant AND LUNDY FAMILY TRUST AND BEHEMOTH CORPORATION LIMITED Respondents Hearing: 12 September 2005 Court: Glazebrook, Hammond and O'Regan JJ Counsel: J H Coleman and M D Deligiannis for Appellant C E Bibbey for Respondents Judgment: 10 November 2005JUDGMENT OF THE COURT A The appeal is dismissed to the extent set out at [43] and [48]. Further submissions are sought on whether the appeal should be allowed in the respect set out at [45] below. B Costs are reserved.____________________________________________________________________REASONS(Given by Glazebrook J)Table of Contents Para No Introduction [1]The legislation [4]Procedural history [10]Taxation Review Authority judgment [15]The High Court decision [19]The Commissioner's submissions [27]The taxpayers' submissions [31]Discussion [34]Result and costs [49]Introduction[1] The respondent taxpayers were in the business of buying, developing and selling (mainly residential) property and were registered for GST. Ten properties that they had purchased for development proved difficult to sell. They were therefore let for residential purposes but were at all times kept on the market. All have subsequently been sold. [2] The taxpayers have always accepted that GST adjustments had to be made while the properties were being let. They say, however, that the adjustments should have been calculated by reference to the depreciation on the buildings. They also claim that there should have been a reversal of the adjustments when the properties were finally sold. The Taxation Review Authority (TRA), in a decision now reported at (2004) 21 NZTC 11,289, and the High Court, in a decision now reported at (2004) 21 NZTC 18,595, found on both issues for the taxpayers. [3] The Commissioner appeals. His argument in this Court was that there should have been an adjustment based on depreciation on the buildings as well as one based on an allowance for the cost of the land (but acknowledges that it is too late to argue for the latter in relation to these taxpayers). He also argues for adjustments relating to other service costs and says that there should be no reversal of these adjustments when the properties are sold.The legislation[4] We set out below the legislation as it was at the relevant time. [5] Section 20(3)(a) and (b) of the Goods and Services Tax Act 1985 (GST Act) provides for deductions of input tax. Input tax is defined in relevant part in s 2 as:"Input tax", in relation to a registered person, means – (a) Tax charged under section 8(1) of the Act on the supply of goods and services made to that person: (b) (c) Any amount equal to the tax fraction (being the tax fraction applicable at the time of supply with the meaning of section 9 or any other provision of this Act) of the consideration in money for the supply, being a supply by way of sale that is not a taxable supply, to a registered person of any secondhand goods situated in New Zealand being in any case goods and services acquired for the principal purpose of making taxable supplies.[6] Section 21(1) of the GST Act provides for adjustments to be made where goods and services acquired for the principal purpose of making taxable supplies are applied for another purpose. It creates a deemed supply of the goods or services by the registered person to the extent that they are so applied. It provides:21. Adjustments (1) ... to the extent that goods and services applied by a registered person for the principal purpose of making taxable supplies are subsequently applied by that registered person for a purpose other than that of making taxable supplies, they shall be deemed to be supplied by that registered person in the course of that taxable activity to the extent that they are so applied: Provided that this subsection shall not apply to any goods and services to the extent that they are applied for the purpose of making exempt supplies where at the commencement of any taxable period there are reasonable grounds for believing that the total value of all exempt supplies to be made by that registered person in that month then commencing and the 11 months immediately following that month will not exceed the lesser of – (a) The amount of $48,000: (b) An amount equal to 5 percent of the total consideration in respect of all taxable and exempt supplies to be made during that 12 month period:Provided further that where this subsection applies to any goods, being goods forming part of the capital assets of a taxable activity and having a cost of less than $10,000, that registered person may, for the purposes of the return to be furnished in respect of the taxable period during which those goods were acquired or produced, make an assessment in accordance with a method approved by the Commissioner, of the extent to which those goods are to be applied for a purpose other than that of making taxable supplies, and that registered person shall be deemed to make a supply of those goods, to that extent, in that return period and not in any later return period. (1A) For the purposes of the first proviso to subsection (1) of this section, in determining the total value of all exempt supplies to be made in any 12-month period by a registered person (where that person is required to account for tax payable on a payments basis pursuant to section 19 of this Act), an exempt supply shall be deemed to take place during that period – (a) To the extent that payment is expected to be received during that period in respect of that supply, being a supply of goods and services which, if that supply were a supply charged with tax pursuant to section 8 of this Act, would be deemed to take place pursuant to section 9(1) or section 9(3)(a) or section 9(3)(aa) or section 9(6) or section 25(2)(a) or section 25(4) of this Act; or (b) Where the supply of goods and services would be made or deemed to be made during that period by that person if that supply were a supply charged with tax pursuant to section 8 of this Act, not being a supply to which paragraph (a) of this subsection applies. (2) Notwithstanding anything in section 9 of this Act, where the supply is deemed to be made pursuant to subsection (1) of this section the time of supply shall be deemed to be the time that the goods and services are applied for a purpose other than in the course of making taxable supplies.[7] The value of the supply on which GST is to be calculated under s 21(1) fell to be determined with reference to s 10(8) which provides as follows:10. Value of supply of goods and services (1) For the purposes of this Act the following provisions of this section shall apply for determining the value of any supply of goods and services ... (8) Where goods and services are deemed to be supplied by a person under ... section 21(1) of this Act, the consideration in money for that supply shall be deemed to be the lesser of - (a) The cost of those goods and services to the supplier, including any input tax deduction claimed in respect of the supply of those good and services to that supplier. (b) The open market value of that supply.[8] Where goods and services are not acquired for the principal purposes of making taxable supplies, a deduction from the amount of tax payable in a taxableperiod is still available under ss 20(3)(e) and 21(5) based on the tax fraction of the lower of the cost or market value of the goods and services. The first proviso to s 21(5) deals with the situation where a s 21(1) adjustment has been made. Section 21(5) provides as follows:(5) For the purposes of this Act, where no deduction has been made pursuant to section 20(3) ... in respect of or in relation to goods and services acquired or produced ... by a person other than for the principal purpose of making taxable supplies, and any such goods and services are subsequently applied in any taxable period by that person ... for the purpose of making taxable supplies, those goods and services shall be deemed to be supplied in that taxable period to that person ... and the Commissioner shall, to the extent to which those goods and services are so applied, allow that person ... to make a deduction under section 20(3) of this Act of an amount equal to the tax fraction of that part of the lesser of – (a) The cost of those goods and services, including any tax charged or any input tax deduction claimed in respect of those goods and services: (b) The open market value of the supply of those good and services– as is referable to such application: Provided that, to the extent that subsection (1) ... of this section [has] deemed a supply to be made of any goods and services, this subsection shall apply as if no deduction had been made pursuant to section 20(3) of this Act in respect of or in relation to those goods and services, and as if those goods and services were acquired or produced by the registered person other than for the principal purpose of making taxable supplies: Provided further that where this subsection applies to any goods, being capital assets having a cost of less than $10,000, that registered person may, for the purposes of the return to be furnished in respect of the taxable period during which those goods were acquired or produced, make an assessment in accordance with a method approved by the Commissioner, of the extent to which those goods are to be applied for the purpose of making taxable supplies, and that registered person shall be deemed to have acquired those goods for the purpose of making taxable supplies, to that extent, in that return period and not in any later return period.[9] These provisions have since been changed by the Taxation (GST and Miscellaneous Provisions) Act 2000, which came into force on 10 October 2000. The new sections explicitly give taxpayers the option of one-off, periodic or annual adjustment and set out the methodology of allocation between taxable and non-taxable purposes. The amendments, however, are not applicable to this case, as all the GST assessments currently under consideration concern the period ended 30 September 1998 to the period ended 31 July 2000.Procedural history[10] In their GST returns, the taxpayers based their s 21(1) adjustments on the basis of the example given in the Commissioner's then policy statement on s 21(1) adjustments in TIB Volume 5 No 8 January 1994. [11] In that TIB, the Commissioner said that s 21(1) deems the supply of rental accommodation (ordinarily an exempt supply) to be a taxable supply, on which the supplier must account for output tax, based on the lesser of cost or market value. In the example given in the TIB, cost was calculated only on the basis of depreciation. This is despite that fact that the TIB earlier had indicated that the cost will be the cost to the developer of making the deemed supply of residential accommodation, including depreciation, maintenance, rent collection costs and interest. [12] The Commissioner considered that the taxpayers should have made the s 21(1) adjustments on the basis of all of the holding costs of the properties and, after a lengthy investigation, he issued a Notice of Proposed Adjustment (NOPA) to that effect. The dispute reached the Adjudication Unit. In its report of 6 September 2002, the Unit held that the TIB had proceeded on an incorrect interpretation of s 21(1). In the Unit's view, the deemed supply under s 21(1) is not the residential letting. It is the property itself that is deemed to be supplied. The Unit held that the cost of the property for that purpose includes the acquisition cost and ongoing costs such as rates and interest (but not the property management costs). [13] Turning to the question of apportionment (arising because of the use of the words "to the extent that" in the subsection), the Unit acknowledged that, at a practical level, there is a real difficulty with s 21(1) given the current state of the jurisprudence on this issue. It pointed out that caselaw has tended to suggest that a one-off adjustment should be made but both parties to the adjudication had proceeded on the basis that there should be period-by-period adjustments and the Unit had thus also proceeded on that basis. It considered that depreciation should be used to spread the acquisition cost over time for the purposes of making a period-by-period adjustment. The other ongoing costs should be allocated to therelevant period. It was acknowledged that, if periodic adjustments were made, those could exceed the original acquisition cost over time. [14] Assessments were issued on the basis of the Adjudication Unit's approach. In the event, because of the view taken by the Unit as to what was included in the cost of the property, the difference between the Unit's approach and that in the NOPA was not significant. We note that, although the Unit expressed the tentative view that s 21(5) could allow for the "re-recovery" of the earlier GST adjustments, it had not been called upon to adjudicate on that issue.Taxation Review Authority judgment[15] The Commissioner's argument before Judge Willy in the TRA was that the properties in question were being applied 100% to the non-taxable purpose of providing rental accommodation. Under those circumstances, the whole of the cost of letting the properties (interest, rates, insurance, depreciation and maintenance) should be included in the calculation for the purposes of the s 21(5) adjustment. On the other hand, the taxpayers' argument was that, because their principal purpose of ultimately on-selling the properties remained, all costs other than depreciation arose from holding the properties for sale as they would have been incurred regardless of whether the properties were tenanted. Under those circumstances, depreciation should be the only cost to be included in the adjustment calculation. [16] Judge Willy said that the purpose of the valuation pursuant to s 10(8) must be kept in mind. As Judge Barber pointed in Case U13 (1999) 19 NZTC 9,147 at 199,156, s 10(8) is the machinery provision for giving effect to s 21. The policy behind s 21 is to stop taxpayers from claiming an input tax deduction on the purchase of property and then applying the property for an exempt purpose. Parliament achieves that object by requiring an adjustment pursuant to s 21 and s 10 values that adjustment. [17] Judge Willy considered that Commissioner of Inland Revenue v Morris[1998] 1 NZLR 344 and Commissioner of Inland Revenue v Carswell Investments Limited (2001) 20 NZTC 17,149 are authority for the proposition that it is possible tohave two concurrent principal purposes. He held therefore that the value of each, applying s 10, is the amount of the holding costs directly referable to each purpose. He considered that it was not possible to say that all of the holding costs wereipso facto referable to both principal purposes simply because they were incurred in relation to the property. He accepted the taxpayers' submission that the only holding cost which is unique to the residential letting was the wear and tear imposed by the tenants. This was a form of depreciation of the property and therefore it was appropriate to treat it as the only ingredient unique to letting in the cost of the goods. He considered that this approach achieved the policy of Parliament in capturing back that part of the input tax referable to the letting, the second primary purpose in holding the property. Judge Willy noted that this was the approach to s 21 for which the Commissioner contended in his relevant TIB and the one the taxpayers applied in this case. [18] On the second issue, the Commissioner had argued that s 21(5) applies only where there is a one-off adjustment under s 21(1) rather than a period-by-period adjustment. Judge Willy accepted the taxpayers' submission that the first proviso to s 21(5) does not in any way discriminate between one-off adjustments and periodic adjustments. In his view, the policy of the Legislature was to deprive a taxpayer of some of the benefit of an input credit received where goods originally purchased for a tax supply are applied for a non-taxable (in this case exempt) purpose. For that purpose, the legislation created the fiction that, once the property is (in this case) leased, the owner becomes a consumer and must pay GST on the transaction assessed pursuant to s 21(1) and s 10(8). In his view, it must follow that, when the property is returned to a taxable supply purpose, there must be a recovery by the taxpayer of the GST paid on the fictional supply.The High Court decision[19] Chisholm J began by analysing Morris and Carswell. Counsel for both the Commissioner and the taxpayers agreed that these cases are not authority for the proposition that it is possible to have two concurrent principal purposes as the TRA had found. Indeed, Chisholm J considered that both Giles and Panckhurst JJ in thosedecisions were careful to point out that s 21(1) referred to "the principal purpose" and "a [subsequent] purpose", not two principal purposes. Clearly two principal purposes are not contemplated by s 21(1) and were not contemplated by Giles and Panckhurst JJ. However, Chisholm J considered that, although the TRA erred in that respect, it did not mean that the end result was wrong. [20] Chisholm J considered that the crucial issue was "the extent that" the properties were applied for the non-taxable purpose of providing rental accommodation. By using that phrase on no less than two occasions in the relevant portion of s 21(1), Parliament must have contemplated that the relevant goods or services would not necessarily be applied 100% to the non-taxable activity. Thus, s 21(1) requires a determination to be made about the extent to which the goods or services have been applied for the non-taxable purpose. [21] In Chisholm J's view, the principal purpose of the taxpayers in this case was the purchase of the properties for ultimate sale. Once each property was purchased, the taxpayers were effectively locked into the cost of holding that property until it sold, regardless of the time taken to achieve a sale and whether or not the property was tenanted. Interest, rates and insurance would thus represent the primary costs of holding the property pending sale. Any decision to rent the property for residential purposes would not alter these commitments which will continue to accrue. On the other hand, the letting will produce its own costs, which the taxpayers have equated with depreciation. In Chisholm J's view, that was not only a realistic approach but one which properly applied ss 21(1) and 10(8). [22] The Commissioner had attempted to mount the argument (which Chisholm J thought found favour in Case U13) that the letting of premises effectively displaced the principal purpose. In Chisholm J's view, that argument was unsustainable for several reasons. First, it effectively rewrote s 21(1) which not only makes it clear that the principal purpose and subsequent purpose may co-exist but also provides that the extent to which the goods and services are applied for the non-taxable purpose must be determined. Secondly, it tended to undermine the reasoning inMorris and Carswell. Thirdly, where two purposes are running concurrently, it was difficult to see how one could be completely shut out by the other. Fourthly, ratherthan preventing the properties being applied for the purpose of sale, letting, even for a relatively lengthy duration, might actually enhance sale prospects. Finally, no distinction is drawn in s 21(1), and none can be inferred, between one-off and period adjustments. [23] With regard to s 21(5) Chisholm J adopted the obiter comments of Giles J inMorris at 356:The legislature has enacted s 21 to ensure that the Inland Revenue Department does not carry the cost of an undeserved input credit. The Commissioner may apportion and recover thereby reversing the cash flow disadvantage the Crown would incur if the taxpayer maintained the credit. In due course, once the non-taxable supply is discontinued, there will be a re-recovery by the taxpayer pursuant to s 21(5) of the Act. [Chisholm J's emphasis][24] Chisholm J held that in effect s 21(5) provided that, where no input deduction had been made in relation to goods and services that were subsequently applied for taxable purposes, the Commissioner had to allow an input credit. The first proviso specifically extended this requirement to situations where there had been a deemed supply under s 21(1). In Chisholm J's view, the underlying purpose of s 21(5) was clear. It was to avoid a taxpayer being unfairly penalised because an input credit was not available. If the Commissioner's argument was right, these taxpayers would have paid GST on an exempt supply, despite the fact that the need for the s 21(1) claw back disappeared once the principal purpose was consummated and output tax was paid. Put another way, the taxpayers would have suffered the very penalty that s 21(5) was designed to avoid. [25] Chisholm J pointed out that, to a large extent, the Commissioner's argument revolved around the distinction between one-off and periodic adjustments. Significantly, however, Parliament did not attempt to distinguish between such adjustments in s 21(5). Chisholm J considered that, if such a distinction had been intended, Parliament would have said so. In his view, the section was capable of perfectly meaningful application without the distinction the Commissioner sought to introduce.[26] The Commissioner had argued that the taxable supply had been "used up" but, in the Judge's view, this overlooked the fact that the properties giving rise to the supply (whether by way of the principal purpose or by way of the deemed supply under s 21(1)) remained in existence. The Commissioner had also argued that s 21(5) cannot apply once the GST period is over because the goods and services cannot be subsequently applied for the principal purpose of making taxable supplies as required by the subsection. The Judge considered that this argument too had to fail as the first proviso to s 21(5) specifically encompassed the situation where there had been a deemed supply under s 21(1).The Commissioner's submissions[27] As indicated above, the Commissioner's contention in the TRA and the High Court was that the s 21(1) adjustment had to be calculated on the basis of all of the holding costs of the properties in question, including rates, interest, insurance, maintenance and depreciation. The Commissioner also contended that there should be no further adjustment upon sale of the properties. [28] After discussion with the Bench, and having taken instructions, Mr Coleman, for the Commissioner, modified the stance on the first issue. The Commissioner now accepts that the s 21(1) adjustment requires an allocation of the acquisition cost (or market value if that is lower) of the property to the relevant taxable period and that depreciation represents a principled basis of allocation over the GST periods in which the adjustments must be made. Mr Coleman did not, however, accept that there should be a cap equal to the cost of the building. In Mr Coleman's submission, the cost of the land would also have to be allocated. An acceptable method of doing this would be to apply the depreciation rate also to the land (although the Commissioner accepted that this could not be applied to the respondent taxpayers as it had never been the basis of the assessments). [29] With regard to ongoing costs, such as rates and insurance, Mr Coleman's primary submission was that these must, during the time the properties were let, be seen as being related to the residential letting only and so no input tax deduction should be available. Mr Coleman's fallback position was that there should be a50/50 allocation between the exempt and taxable purposes. While Mr Coleman accepted that this submission differed from the basis of assessment, he submitted that it was sufficiently allied to it for there to be no unfairness to the taxpayer in the Commissioner now advancing that basis of assessment. [30] As to s 21(5), the Commissioner submitted that the subsection does not provide for a reversal of all previous adjustments. It provides a basis for claiming an input tax deduction where a good or service has been applied for a taxable purpose in a particular period but only with regard to the taxable period in question. It does not apply to reverse periodic adjustments made in previous taxable periods. In this case, because the adjustment was periodic (relating to a particular taxable period) rather than one-off, no s 21(5) adjustment is available. In Mr Coleman's submission, this distinction can be demonstrated most clearly by reference to a service. A service is by its very nature consumed over time. In any period where there has been a change of application, the cost of that service must be the cost referable to the period in which there is a change in application. It is not all of the costs of the service while it was being applied for the purpose other than that of making taxable supplies.The taxpayers' submissions[31] The taxpayers support Chisholm J's judgment on both issues. With regard to the first issue, Ms Bibbey, for the taxpayers, submitted that what should have been allocated to each period was the cost of letting of the properties as that is what was deemed to be supplied under s 21(1). She submitted that depreciation was the only cost directly attributable to the residential letting. The cost of the land itself should not be included as there was no cost to the taxpayers that was attributable to the residential letting in relation to the land. That is because land generally does not depreciate in value with use. [32] With regard to the other holding costs, Ms Bibbey submitted that costs such as rates and insurance would have been incurred in any event, even if the properties had not been let, and therefore were properly attributable to the taxable activity of property development. There had, however, been input tax deductions claimed by the taxpayers on property management services referable only to the residentialletting and it had been conceded after the TRA hearing that an adjustment would be made in relation to those costs. [33] Ms Bibbey further submitted that the wording of s 21(5) clearly allowed a re-recovery in this case to the extent that s 21(1) deemed a supply. She agreed with Chisholm J's finding that Parliament did not distinguish between one-off and periodic adjustments in s 21(5).Discussion[34] Registered persons can claim as an input tax deduction, under s 20(3)(a) and (b) of the GST Act, the amount of tax charged on the supply of goods and services to them or the tax fraction of the consideration on secondhand goods, but only where those goods or services are acquired for the principal purpose of making taxable supplies. Adjustments, through the mechanism of there being a deemed supply under s 21(1), are then made to the extent that the goods or services are applied to any non-taxable purpose. Where goods and services are not acquired for the principal purpose of making taxable supplies, an input tax deduction is nevertheless available under s 20(3)(e) and s 21(5) to the extent that the goods and services are applied for a taxable purpose. [35] Subsections 21(1) and 21(5) are effectively mirror provisions. Conceptually, s 21(1) can be seen as a mechanism for ensuring the claw back of unwarranted input tax credits where they are no longer related to a taxable activity, while s 21(5) is the mechanism for ensuring that proper input tax credits are available when they are related to a taxable activity. Both subsections, however, take into account that there may have been a fall in value below cost at the date of the change in application and provide for adjustments to be made on the basis of that lower value. [36] In this case, there is no dispute that the properties in question were acquired by the taxpayers for the principal purpose of making taxable supplies. An input tax deduction was thus properly claimed with respect to those properties under s 20(3)(a) and (b). Chisholm J also found that this principal purpose did not change when the properties were let for residential purposes and there is no challenge to thisfinding. Both parties, however, agree that the properties were applied for a purpose that was not taxable when they were let and that a s 21(1) adjustment was required. The issue is as to the amount and nature of that adjustment. [37] Section 21(1) deems goods or services to be supplied by a registered person if they are applied for a purpose other than for making taxable supplies. In this case, what is being applied for the purpose of residential letting are the properties themselves and thus it is the properties that are deemed to be supplied under s 21(1). Under s 10(8), the properties are deemed to be supplied at the lower of cost or market value (and the parties are agreed that in this case cost is the appropriate measure). It follows that it is the cost of the properties themselves (including the amount of any input tax deduction claimed) that is the relevant figure for the value of the deemed supply under s 21(1). We do not accept the taxpayers' submission (see at [31] above) that it is the cost of making the particular exempt supply, in this case the residential letting. We note the corollary of that submission is that the market value is the residential rent. The adjustment in that case would have the effect of a GST charge on what is an exempt supply, which would not accord with the scheme of the legislation. [38] The issue, therefore, is what the "cost" of the properties means. The term "cost" would be ordinarily understood as the acquisition cost and we consider that is its meaning in the present context. Holding costs are conceptually quite different and therefore the position taken by the Commissioner in the NOPA was, in our view, wrong. The Adjudication Unit recognised that the cost was the acquisition cost of the properties but then, for a reason that was not explained, also added in the holding costs – see at [12] above. We consider that approach also to be flawed. As explained below at [44], these costs should be treated quite separately. [39] The main difficulty that has arisen in this case, as identified by the Adjudication Unit, is that both parties have accepted that any adjustments should be on a periodic rather than a one-off basis. On one reading of the second proviso to s 21(1), periodic adjustments may even be required where capital assets have a cost in excess of $10,000. We do not think it should be read in that manner, however. We consider that the second proviso deals with a situation where there are likely tobe some variations between different periods in the use of an asset. In such cases, it allows a one-off adjustment to be made at the outset that takes account of these future variations. [40] In our view, s 21(1) is capable of being read in a manner that allows for both one-off and periodic adjustments. This was also the position taken by the Commissioner in the 1999 Government discussion document, GST: A Review, at [4.12]. There are, however, some situations where one-off adjustments alone are suitable. One is where there is a total change of use. If there is a total change of use of the whole of the goods (or services), the deemed supply will be of the whole of the goods (or services) at the lesser of cost or market value. Where there is a total change of use in relation to a portion only of the goods – for example where a quarter of business premises are turned into living quarters - there would be a deemed supply of a quarter of the premises at the lower of cost or market value. Conceptually, the same may apply where, for example, the premises are used for some of the day as a private residence and for the rest of the day as business premises. [41] Periodic adjustments, on the other hand, may be suitable where the use for non-taxable purposes is variable or where it is temporary and coincides with continued use in a taxable activity. In the latter case, one-off adjustments may be difficult to calculate and unfairly large where assets are of any size. In this case, the taxpayers' principal purpose of the sale of the properties in the course of their taxable activities subsisted. The properties were therefore at all times being used for that taxable purpose. They were part of the taxpayers' trading stock and, indeed, remained on the market at all times. At the same time, they were let for residential purposes, but on a temporary basis. Periodic adjustments were therefore appropriate. In terms of the principles discussed above at [38] the periodic adjustments must, however, relate to the cost of the properties (or market value if that is lower). Contrary to the Commissioner's submission above at [28], therefore, we consider that, in total, any periodic adjustments cannot exceed that cost (or lower market value).[42] As there was at the relevant time no legislative guidance given, any reasonable allocation method appears to be allowed by the statute. We thus accept the Commissioner's submission that depreciation is a suitable method of apportioning the cost of the buildings. We also accept the Commissioner's submission that the cost of the land should similarly be apportioned and agree that applying the depreciation rate to the land is a suitable methodology for this exercise. We do not accept the taxpayers' submission that the land should not be included. Both the land and the buildings are applied to the residential letting and the buildings are effectively no more used up in that process than the land is. [43] The above exercise spreads only the cost of the land and buildings between periods, however. There still needs to be an apportionment between taxable and non-taxable uses in the particular period. This creates conceptual difficulties because it is not possible to separate out the use of the properties on any time or space basis. In terms of both time and space the properties in this case are 100% dedicated to use for both purposes – see the discussion at [41] above. There must be an apportionment, however. Apportioning the depreciation on the buildings (but not the land) would be a possible (if somewhat rough and ready) means of recognising both uses. This is what the taxpayers did in this case. This was a reasonable allocation method and thus within the scope of the legislation. [44] We now turn to the periodic service costs relating to the properties (such as rates and insurance). As indicated above at [38], we consider that such costs are conceptually quite separate from the acquisition cost of the properties. The question in each taxable period will be whether or not the services have been acquired for the principal purpose of making taxable supplies. If they have, then an input tax deduction will be available under s 20(3)(a) or (b) with regard to the tax charged on that service. A s 21(1) adjustment will, however, be required to the extent that the services are applied to a purpose that is other than taxable. If the services have not been acquired for the principal purpose of making taxable supplies, then no input tax deduction will be available under s 20(3)(a) or (b). However, a deduction will be available under s 20(3)(e) and s 21(5) to the extent that the services are applied for the purpose of a taxable activity.[45] Applying that analysis to this case, because the taxpayers' principal purpose remained the sale of the properties, an input tax deduction was available with regard to the service costs associated with the properties, to the extent that they related to both purposes and did not relate solely (or possibly even mainly) to the residential letting activity, such as the property management fees referred to above at [32]. There then needed to be an adjustment, through a deemed supply under s 21(1), to the extent that the services were applied to the non-taxable purpose. As indicated above at [43], the conceptual difficulty with such an adjustment is that the service costs were in fact 100% applied to each purpose. One means of recognising this would be to apportion them 50/50, which was the Commissioner's back up submission. We do not, however, consider that this recognises that the principal purpose remained the sale of the properties and that these costs would have been incurred whether or not the properties were let. In our view, a 75/25 apportionment would recognise these factors. [46] This analysis with regard to the service costs is arguably different from the Commissioner's analysis upon which the assessments were based, from his arguments in the TRA and the High Court, and from his analysis before this Court. We therefore consider it appropriate to give the parties an opportunity to make further submissions on whether, in light of the Commissioner's possible change of stance, the appeal should be allowed on this point. [47] The next issue relates to the extent of any s 21(5) adjustments on the eventual sale of the properties. The purpose of s 21(5), as outlined above, is to allow input tax credits where goods and services have not been acquired for the principal purpose of making taxable supplies but only to the extent that they are applied for a taxable purpose. The first proviso extends that to situations where a s 21(1) adjustment has been made. This is because s 21(1) has effectively reversed out the earlier input tax deduction because of an application to a non-taxable purpose. Section 21(5) restores that input tax deduction when the goods and services are applied again to a taxable purpose (but taking account of any drops in value of the goods or services below cost).[48] We agree with the TRA and the High Court that there is nothing in the first proviso to s 21(5) that makes any distinction in this regard between periodic and one-off adjustments. Indeed, as both periodic and one-off adjustments achieve the same result (of reversing the earlier input tax credit) there is no reason that it should. We note, however, that, to the extent that goods and services have been "used up" at the time of any s 21(5) adjustment, then the market value of those goods and services will be lower than cost and, obviously, a lesser (and in some cases nil) adjustment will be made.Result and costs[49] The Commissioner's appeal is dismissed to the extent set out at [43] and [48]. The Commissioner has until 5.00 pm on 24 November 2005 to file and serve submissions on the point set out at [46]. The submissions should also cover the form of order should the appeal be allowed in the respect set out at [45]. The submissions can also cover the question of costs. The respondents have until 5.00 pm on 8 December 2005 to file and serve submissions in reply. The Commissioner may file and serve further submissions in reply on or before 5.00 pm on 15 December 2005. [50] Costs are reserved.Solicitors: Crown Law Office, Wellington for Appellant G D Horne, Christchurch for Respondents