YANDINA INVESTMENTS LIMITED V COMMISSIONER OF INLAND REVENUE HC WN CIV-2006-485-1228

YANDINA INVESTMENTS LIMITED V COMMISSIONER OF INLAND REVENUE HC WN CIV-2006-485- 1228 20 December 2010IN THE HIGH COURT OF NEW ZEALANDWELLINGTON REGISTRYCIV-2006-485-1228UNDER the Income Tax Act 1994 and the TaxAdministration Act 1994BETWEEN YANDINA INVESTMENTS LIMITEDPlaintiffAND COMMISSIONER OF INLANDREVENUEDefendantHearing: 15 December 2010Counsel: C R Carruthers QC and R J Cullen for PlaintiffMSR Palmer and M Deligiannis for DefendantJudgment: 20 December 2010 16:40:00I direct the Registrar to endorse this judgment with a delivery time of 4.40pm on the December day of December 2010.RESERVED JUDGMENT OF MACKENZIE J[1] This is an application by the plaintiff for orders that Westpac Banking Corporation, ANZ National Bank Limited, and BNZ Investments Limited be added as defendants in this proceeding.[2] This proceeding originated in the Taxation Review Authority in November 2003. The case was transferred to this Court on the application of the Commissioner. In it, the plaintiff challenges assessments made by the Commissioner for the years ended 31 March 1996, 1997 and 1998. The assessments involved a reconstitution to counter the effect of what the Commissioner contends is a tax avoidance arrangement.[3] The essence of the dispute may be summarised from the draft amended statement of claim which the plaintiff intends to file if its application is successful. The three intended defendants (the banks) were, with a fourth party, partners in a partnership formed to acquire an aircraft and lease it to Air New Zealand Limited under a leveraged lease. The partnership purchased the aircraft on deferred payment terms and leased it to Air New Zealand on terms whereby the purchase price was paid over the term of the lease, from the rental payments made by Air New Zealand.[4] The lease was structured so that members of the leasing partnership would have the benefit of tax deductions for depreciation at a rate permitted for income tax purposes which was higher than the economic depreciation rate. The broad effect of that was that the lease produced little or no taxable income to the leasing partnership in the earlier years, but would, in the later years, result in taxable income.[5] In 1994, an arrangement was entered into under which the leasingpartnership's interest in the lease was transferred to an entity involving the plaintiff(Yandina). It was envisaged that Yandina would have the ability to offset the income against tax losses available to Yandina.[6] The arrangement involving Yandina resulted from an approach made by the leasing partnership to an intermediary, proposing an assignment of the equitable interest in the partnership for the period 1995 to 1997 to a company which had, or could utilise, tax losses. Those losses would offset the taxable income which was about to accrue under the lease. Some quite complex arrangements were entered into, which it is unnecessary for me to describe. In the course of implementing the arrangements, the leasing partnership obtained two binding rulings from the Commissioner. The detail of those rulings is not before me at this stage. Under the arrangements, Yandina was incorporated and became a 99.99 per cent partner in a partnership to which the lessors' interest in the lease arrangements for the aircraft was assigned. Yandina had no role in the management or activities of the partnership, despite holding virtually the entire ownership interest in it. Accounts were prepared for the partnership by a firm of chartered accountants. Yandina was advised of the amount of taxable income derived by the partnership in the 1996 and 1997 years, but did not know about or understand any of the financial andtransactional detail concerning that income. When returning its income for the 1996 and 1997 years, Yandina offset certain tax losses available to it. Those produced a nil taxable income for Yandina for each of the two years.[7] The Commissioner has formed the view that the arrangements involve or include a tax avoidance arrangement on the part of Yandina. The Commissioner reassessed the income as returned for the 1996 and 1997 years, effectively to disallow the losses claimed. The Commissioner also assessed the 1998 year, for which no return had been filed. He assessed taxable income for the year and allowed no losses against it. The total income reassessed for the three years is $83 million. The total residual income tax resulting from the three assessments is $27.5 million. Late payment and other penalties and use of money interest claimed by the Commissioner add very considerably to the amount of tax now in issue in this proceeding.[8] The plaintiff seeks to join the banks, as partners in the original leasing partnership. The claims which it seeks to raise against the banks are twofold.[9] The first relates to the proposition that Yandina has received $83 million income from the lease. Yandina asserts that on investigation, it has discovered that this income has not in fact been paid, although the transaction documents required the sum to be paid to Yandina. It claims against the banks for the balance allegedly owing in terms of the arrangements. Yandina contends that if that action is successful it will have the resources to pay the tax claimed by the Commissioner, otherwise it does not have the resources to pay tax on income which it has not received. If the claim is unsuccessful, Yandina claims that this will be relevant to itschallenge to the Commissioner's assessment.[10] The second basis of the plaintiff's claim is that it alleges that, if there is a taxavoidance arrangement, that arrangement is much wider than that alleged by the Commissioner and involves the banks. It further asserts that there are tax warranties given by the banks to Yandina when the transactions were entered into and that those tax warranties operate to require the bank to pay any fine, penalty, or other cost, incurred by Yandina in respect of tax payable. Counsel for the plaintiff submits thatjoinder should be ordered on the basis that the banks ought to have been joined, or that their presence before the Court may be necessary to adjudicate on and settle all questions involved in the proceeding, in terms of r 4.56(1)(b).[11] Counsel for the Commissioner opposes the application on the grounds that there is no jurisdiction under r 4.56(1)(b). He submits that the proposed defendants ought not to have been joined and the presence of the proposed defendants before the Court is not necessary to adjudicate on and settle all questions involved in the proceeding. The Commissioner asserts in the alternative that if there is jurisdiction the Court should exercise its discretion against joinder. Counsel refers to r 4.1 and submits that the presence of the banks before the Court is not necessary to justly determine the issues arising; nor ought the banks to be bound by any judgment given.[12] The essential question is whether the banks are necessary parties to these proceedings, for one or more of the following reasons:(a) The question whether or not the relevant income was derived by Yandina, in issue on the proposed first cause of action, involves the banks; or(b) Yandina's contention that the tax avoidance arrangement is wider than that contended for by the Commissioner would potentially involve the banks as parties to a tax avoidance arrangement; or(c) The success of the Commissioner on the tax avoidance issue which is the subject of this proceeding might expose the banks to a potential liability under the tax warranties.[13] I deal first with the proposed first cause of action, namely the action to recover monies from the banks, on the basis that the amount assessed by the Commissioner has not been paid by the banks and Yandina is entitled to recover it from them. Mr Carruthers submits that the justification for joinder can be tested by asking whether the plaintiff is entitled to sue the banks on this course of action. Hesubmits that the answer is undoubtedly yes. I agree that that is so, but I do not agree that it necessarily follows that the claim can properly be joined in this proceeding. That is a quite distinct and separate question.[14] In the ordinary case, the fact that assessable income to which a taxpayer is entitled has not been paid by the party from whom it was derived will not be relevant to the assessment of that income by the Commissioner. The assessment and recovery by the Commissioner of tax on that income, on the one hand, and the recovery of any debt between the taxpayer and a third party which has resulted from the right of the taxpayer to receive that income on the other, are separate matters which could not properly be included in the same set of proceedings. There are in essence two respects in which Mr Carruthers submits that this case is different from that ordinary case.[15] First, he submits that, without that recovery from the banks in this case, Yandina will be unable to meet the tax liability which will become payable if the Commissioner's assessment is upheld in this proceeding. This, he submits, means that the banks ought to be joined so that the recovery of the debt which is necessary before the tax payable if the Commissioner is successful can be determined in the same proceeding. Counsel submits that s 6A(3) of the Tax Administration Act 1994 is of some relevance. That section imposes a duty on the Commissioner to collect over time the highest net revenue that is practicable within the law having regard to the factors set out in that section.[16] The second respect in which Mr Carruthers submits that the present case is, at least potentially, different from the ordinary case that I have described, is that the issues between Yandina and the banks may involve issues not simply of whether the monies have been paid, but whether they are payable. He submits that the question whether the monies are payable to Yandina by the banks is directly relevant to the amount of income derived by Yandina, so that question should be resolved in thesame proceedings as the Commissioner's assessment of the income is determined.[17] I do not consider that the first of these distinctions from the ordinary case provides any justification for joinder in this case. The present proceeding isconcerned only with the determination of the extent of the plaintiff's tax liability. Itis not concerned with recovery by the Commissioner of the amount of that tax liability. That would be a later stage. Only at that later stage of collection of tax could the Commissioner's duty under s 6A(3) of the Tax Administration Act 1994 have any relevance. Further, if it were relevant, it is for the Commissioner, not this Court, to determine how that duty is fulfilled. The Commissioner has a wide managerial discretion as to the best means of obtaining the highest net return.1 I do not consider that s 6A provides any support for the proposition that, either in the ordinary case which I have described or in this case, debt recovery proceedings against a third party should be joined with a challenge to the Commissioner'sassessment.[18] The second matter, referred to at [14], namely that the issues between Yandina and the banks may involve the question of whether the income asserted by the Commissioner is receivable by Yandina, does at first blush potentially provide a more robust basis for joinder. However, on examination I do not consider that that is so. There are strict limits, in tax disputes, on the issues which may be raised.2 For present purposes I assume, but do not decide, that the plaintiff may be able to argue that the income of $83 million has been derived by it. But, as between Yandina and the Commissioner, that issue will be capable of being addressed in this proceeding without the presence of the banks. A consideration of the legal effect of contracts or dealings between taxpayer and third parties is a common feature in tax disputes. The other parties to such dealings are not, ordinarily, necessary parties to the tax litigation. Any evidence necessary to enable such questions to be answered by the Court in this case can be obtained by procedures such as non-party discovery, and donot require the presence of the other parties to the plaintiff's arrangements before theCourt.[19] The second cause of action is an alternative to the first cause of action against the banks. It is a claim against the Commissioner. Yandina says that in the event that its claim against the banks for recovery of the money claimed fails then Yandina challenges the Commissioner's assessments on the grounds that the arrangements1 Raynel v CIR (2004) 21 NZTC 18,583 at [51].2 For example, s 138G Tax Administration Act 1994.assessed as being void for income tax purposes were wider than those contended for by the Commissioner and include the assignments of the interests in the original leasing partnership to Yandina. The plaintiff contends that those equitable assignments were also void for income tax purposes and that the Commissioner must exercise the power available to him under the tax avoidance provisions to adjust the taxable income to reflect that wider tax avoidance arrangement.[20] The plaintiff's submission is that, if the arrangement is defined properly as required by the legislation, particularly s GB 1 of the Income Tax Act 1994, and not just defined partially by the Commissioner as the plaintiff asserts is presently the case, the arrangement which would be void against the Commissioner under s BG 1 would include the equitable assignment of the lease to Yandina, so that Yandina would have received no taxable income under the lease.[21] Counsel for the Commissioner submits that the question of what steps make up the tax avoidance arrangement is, at law, determined by the Commissioner. He refers to Peterson v CIR where their Lordships said:3Their Lordships consider that the Commissioner is entitled at his option to identify the whole or any part or parts of a single composite scheme as the"contract, agreement, plan or understanding" which constitutes the "arrangement" for the purpose of s 99. Whether there was a single "arrangement" or two or more connected but distinct "arrangements" (asthere were in C of IR v BNZ Investments Ltd (2001) 20 NZTC 17,103; [2002] 1 NZLR 450) is a question of fact for the TRA. The Commissionermust then show (i) that the "arrangement" which he has identified has the purpose or effect of avoiding tax, an expression which includes reducing any liability to pay income tax; (ii) that whether or not the taxpayer was a partyto the "arrangement" he was affected by it; and (iii) that he obtained a taxadvantage from it. If he can satisfy these conditions, he can adjust theassessable income of any person affected by the "arrangement" in order todeny him the tax advantage which he has derived from it.[22] Counsel submits that it is no answer to the Commissioner's assessments of the plaintiff to argue that there was a wider tax avoidance arrangement. Nor, counsel submits, is it necessary for the Court to consider the alleged wider argument todetermine whether the plaintiff's arrangement identified by the Commissioner was, in fact, tax avoidance.3 Peterson v CIR (2005) 22 NZTC 19,098 (PC) at [33].[23] I would hesitate, without more detailed argument than was appropriate on this occasion, to read the comments of their Lordships in Peterson as going so far as to preclude a challenge by a taxpayer to the extent of a tax avoidance arrangement identified by the Commissioner. For present purposes, I assume, but do not decide, that Yandina may properly put in issue in this proceeding the question whether the arrangement identified by the Commissioner is properly to be considered in its context as part of a wider arrangement. Making that assumption, which is favourable to the plaintiff on this application, I do not consider that the banks are a necessary party to this proceeding. Indeed, I foresee considerable difficulties if the banks were joined.[24] The Commissioner has not taken any steps against the banks alleging that they are parties to a tax avoidance arrangement so as to affect their tax liability. If the banks were joined as parties, and if the plaintiff were successful in its contention that the banks were involved in a wider tax avoidance arrangement, then the banks would, as parties, be bound, as a matter of res judicata, by the Court's findings onthat issue. That might expose the banks to subsequent reassessment by the Commissioner, which the banks might not be able fully to defend under the usual processes, by reason of the findings in this litigation.[25] On the other hand, Yandina will not be precluded from making any arguments which it may wish to make as to the extent of any wider tax avoidance arrangement, so far as that may affect the tax liability of Yandina, if the banks are not parties. Full details of the arrangement will (subject to the constraints of the Tax Administration Act) be able to be adduced, if the banks are not parties. Any necessary evidence from the banks can be obtained, if the banks are not parties, by the use of the available interlocutory proceedings.[26] The final matter is the issue of the tax warranties. I do not consider that the possibility that the plaintiff may, if it is unsuccessful in this proceeding, have rights against the banks under the tax warranties is sufficient to justify joinder of the banks. The warranties, as these are referred to in the proposed statement of claim, do not suggest that the banks must be parties to any proceedings in which Yandina's taxliability is determined. Nor do they appear to provide any basis on which the banksmight dispute a tax liability which has been properly determined between Yandina and the Commissioner.[27] For these reasons, I have reached the conclusion that the banks are not persons whose presence before the Court is necessary to jointly determine the issues arising in this proceeding, nor are they persons who ought to be bound by any judgment given, in terms of r 4.1. They are not persons who ought to have been joined, nor is their presence before the Court necessary to adjudicate on and settle all questions involved in the proceeding, in terms of r 4.56. The application is accordingly refused.[28] As to costs, my preliminary view is that the Commissioner should have costs, on a 2B basis. If the parties are unable to agree, in the light of that indication, memoranda may be filed."A D MacKenzie J"Solicitors: Tomas Dewar Sziranyui Letts, Lower Hutt, for PlaintiffCrown Law, Wellington, for the Defendant