Tax: Tannadyce Investments v. CIR

It was an abuse of process for a taxpayer to try and circumvent the prescribed tax disputes process by claiming Inland Revenue was refusing to disclose records it was holding. In refusing judicial review of Inland Revenue’s behaviour, the Supreme Court ruled the taxpayer did not specify how it was in any way prejudiced by Inland Revenue conduct.

Tannadyce Investments has been in a long running dispute with Inland Revenue. Controlling shareholder of the Christchurch-based company was David Ian Henderson.

The court was told Tannadyce claimed Inland Revenue was holding financial records needed by the company to file its tax returns for the years 1993-1998.

If Inland Revenue were acting in bad faith, withholding documents it knew a taxpayer required, judicial review is available to hold officials to account for an abuse of power. The Supreme Court ruled this was not such a case.

In March 1999, Inland Revenue issued Tannadyce with “nil” assessments for the tax years in question. The company responded with what it called a “global return” for these tax years claiming tax losses of $1,539,733. Inland Revenue argued that a “global return” does not comply with the statutory requirement to file returns for each tax year. It reissued its “nil” assessments, requiring Tannadyce to follow the normal tax disputes process to prove its claimed tax losses. In subsequent tax years, Inland Revenue disallowed the claimed tax losses as losses carried forward.

Tannadyce said it could not use the tax disputes process because Inland Revenue was holding all necessary records and was refusing to release them. Tannadyce stood by its global return.

The Supreme Court ruled that Tannydyce failed to show it was not practically possible for the normal rules to be followed. Its global return managed to claim a loss for the six tax years down to the last dollar. It is perfectly plain, said the court, that Tannydyce had sufficient information and records to file a global return. It should have been able to apportion this global figure between the various tax years, using reasonable estimates where needed.

While the claimed losses collectively covered six years, there was evidence that Tannydyce ceased trading in 1992 having traded for no more than 18 months at most.

Tannadyce Investments Ltd v. CIR – Supreme Court (20.12.11)

12.002

Blue Chip: re Northern Crest Investments

Australian investors needed High Court approval to support their claim to three million dollars used to prop up Blue Chip operations in Australia just before the company went into liquidation. New Zealand based liquidators had their doubts as to whether the money was ever available for use by the insolvent Australian Blue Chip company.

With Blue Chip operations in New Zealand going down the gurgler, promoter Mark Bryers set up shop in Australia with a company later named Northern Crest Investments. The company was listed on the Australian Stock Exchange (ASX) in 2006. The court was told some $A22 million was invested in the company by Manifest Capital Management Pty Ltd acting as a conduit for a number of investors.

In February 2008, Northern Crest was suspended from trading on the ASX. Attempts to rescue the company became problematic when Macquarie Bank withdrew previous offers of funding. With its large investment in Northern Crest, Manifest became deeply involved in refinancing negotiations. It agreed to provide $A3 million to help the company through its liquidity difficulties. Manifest described this advance as part of an underwriting agreement pending Northern Crest raising more equity capital, with the advance to be treated in the interim as a non-interest bearing loan.

In June 2011, Northern Crest was put into liquidation with New Zealand-based liquidators appointed: Messrs Lawrence and McCullagh.

Manifest’s claim in the liquidation for its purported $A3 million advance was rejected by the liquidators. They doubted whether there was a debt due because of concerns over the accuracy of Northern Crest’s financial records. Manifest was required to provide originals of any documents supporting their claim.

In the High Court, Justice Heath approved Manifest’s $3 million claim in the liquidation of Northern Crest. While the liquidators acted precipitately when initially rejecting the claim, he said, Manifest was criticised for not being more open with the liquidator about the circumstances of the debt.

The liquidators had been suspicious because documents supporting Manifest’s claim were miss-dated and the funds were paid not to Northern Crest but to a related company.

re Northern Crest Investments Ltd – High Court (20.12.11)

12.001

Tax avoidance: Alesco NZ Ltd v. CIR

Sixteen different taxpayers and revenue totalling $300 million is in dispute with Inland Revenue as it targets use of hybrid securities to fund intra-group transactions.

The first shot has felled ASX listed company Alesco after a High Court finding that use of optional convertible notes to buy into New Zealand companies amounted to tax avoidance. Tax deductions of $10.95 million were disallowed for the tax years 2003-2008. In addition to tax payable on an extra $4.9 million assessable income, Alesco was ordered to pay shortfall penalties of $2.4 million and use of money interest of $1.2 million.

Alesco spent $85 million investing in New Zealand companies. It relied on advice from chartered accountants KPMG in seeking the most tax effective way of documenting the transaction.

The court was told Alesco (NZ) issued convertible notes to its Australian parent in return for advances totalling $78 million for a term of ten years. On maturity, Alesco had the option of being repaid the $78 million or converting the notes into 78 million Alesco (NZ) shares. These notes were hybrid securities, split into debt and equity components. The beauty of this arrangement was that Australian and New Zealand taxing authorities treated hybrid securities in differing ways: in New Zealand Alesco (NZ) could claim a deduction for a notional interest expense arising from the debt component of the notes with no withholding tax deduction; in Australia this notional payment was not assessable to the parent company, Alesco.

No cash would change hands. But Alesco (NZ) would be claiming a deduction for this notional interest, reducing taxable income for its New Zealand operations.

This notional liability for interest arose because of the accruals regime operating in New Zealand tax law since the 1980s. The accruals regime seeks to reflect the economic effect of financial transactions and aligns tax law with general accounting principles.

Alesco argued the financial arrangement chosen was a legitimate business transaction. Inland Revenue was dismissive, calling these hybrid securities interest free advances stapled to valueless and purposeless warrants.

In the High Court, Justice Heath ruled the transaction was invalid for tax purposes as tax avoidance. While the accounting treatment for the notes was appropriate, the tax advantage gained was not within the intent of tax legislation, he said.

First: there was no taxable income arising from the deduction claimed. Secondly: the hybrid security used was artificial, designed only to secure a tax advantage in New Zealand. There was no arms length negotiation to settle the terms of the transaction. The hybrid security had no commercial value. No third party buyer would be interested in buying the security. Thirdly: no real interest had been incurred and the notional interest deduction did not represent a real economic cost.

A shortfall penalty of $2.4 million was imposed after the court ruled that Alesco had taken an “abusive tax position” entering into the financing arrangement with a dominant purpose of avoiding tax.

Alesco NZ Ltd v. CIR – High Court (12.12.11)

(12.11.003)

Bankruptcy: Taylor v. Official Assignee

A court ruling that $227,000 be repaid by a family trust following bankruptcy was reversed on appeal when the bankrupt argued that payments were not made fraudulently. The bankrupt said she had been suffering from depression and there was no intent to defraud creditors.

Auckland accountant Bronwyn Taylor set up a family trust in 2000 to protect the family home from business creditors. In what is normal commercial practice, the family home was transferred to the Trust and the value of her equity in the home was left as a loan owing by the Trust to her personally. This loan was not repayable until 2030, but interest could be demanded on the outstanding balance and the loan was immediately repayable if any interest was not paid. Further money was later lent to the Trust to finance the purchase of a replacement family property.

She was bankrupted in 2006. Two creditors claimed $207,700: the tax department $123,100 and her failed accounting business Bronwyn Taylor Accounting Services Ltd claiming about $84,600.

The High Court ordered her family trust to repay $227,000 of the outstanding loan to cover the amount claimed from Taylor by creditors plus an extra $20,000 to cover administrative costs of her bankruptcy.

Being under the impression that Taylor had no income from the date the family trust was set up, the High Court considered the act of transferring her home to the Trust as being a fraudulent scheme intended to cheat creditors.

In fact, household income at the time the Trust was established totalled some $200,000. For the first two years after the Trust was established all personal debts were able to be paid. Arrears began to accumulate after that period.

There was evidence that Taylor developed depression lasting several years following an acrimonious breakup with her business partner. During this time she did not keep proper business records and took money out of the business as and when needed, leaving creditors unpaid. Taylor’s depressive state was compounded by falling ill with hepatitis.

The Court of Appeal ruled the evidence did not amount to fraud. Her disturbed mental condition meant she did not focus on the practicalities of the business. And when the extent of debts due to the tax department became apparent Taylor presumed she would be able to negotiate a deal, though no deal ever eventuated.

While reversing the earlier court ruling that Taylor’s family trust pay $227,000 to the Official Assignee, the Court of Appeal pointed out that the Official Assignee could still recover some money for creditors by calling for interest to be paid on her loan to the Trust.

Taylor v. Official Assignee – Court of Appeal (9.12.11)

(12.11.001)