IN THE HIGH COURT OF NEW ZEALAND WELLINGTON REGISTRY CIV [2015] NZHC 2318

Transcription

1 IN THE HIGH COURT OF NEW ZEALAND WELLINGTON REGISTRY CIV [2015] NZHC 2318 BETWEEN AND AAA DEVELOPMENTS (ORMISTON) LIMITED Appellant THE COMMISSIONER OF INLAND REVENUE Respondent Hearing: Memoranda Filed: Appearances: 18 June June 2015 from Respondent 25 June 2015 from Appellant 3 July 2015 from Respondent (Supplementary submissions pursuant to leave granted) M T Lennard for Appellant M Deligiannis and J Norris for Respondent Judgment: 23 September 2015 JUDGMENT OF GENDALL J AAA DEVELOPMENTS (ORMISTON) LTD v COMMISSIONER OF INLAND REVENUE [2015] NZHC 2318 [23 September 2015]

2 Table of Contents Para No What this decision is about [1] The Core of the Dispute [1] The issues [6] Background facts [8] The disputed assessment [16] The TRA decision appealed from [25] Approach to appeals [30] Deductions generally [31] The Timing Issue and the Nexus Issue [38] The Business Definition Issue [39] The Cessation Issue and the Nexus Issue [47] The Breadth of Business Issue [60] The Interest in Land Issue [69] Land Taxing Provisions [76] Settlement Agreement Issues [86] The Penalty Issue [101] Conclusion [109] What this decision is about The core of the dispute [1] This is an appeal from a decision of the Taxation Review Authority (the TRA). 1 It concerns the income tax treatment of certain expenditure incurred by the appellant, AAA Developments (Ormiston) Ltd (AAA). AAA was an aspiring property developer formed in November In February 2006 it agreed to acquire a parcel of land for a retail and residential development, and paid a series of deposits. The due diligence condition in the agreement was satisfied in March The agreement was conditional on the vendor, by 31 October 2006 (later extended 1 AAA Development (Ormiston) Ltd v The Commissioner of Inland Revenue [2014] NZTRA 17.

3 ultimately to 31 January 2008), obtaining resource consent for the subdivision of a larger property to obtain title for the land to be sold to AAA. Later, issues arose between the vendor of the land and AAA. At various times each party tried to walk away from the purchase agreement and then the vendor endeavoured to enforce it. In subsequent litigation in this Court it was held that the purchase agreement was binding and neither party could cancel it. Thereupon AAA, who had incurred costs in relation to that litigation, was also unable to recover a large part of the purchase deposit it had paid. [2] AAA contended that those costs, and the part of the deposit which it could not recover, were deductible for income tax purposes as they were incurred in the course of its business and/or they were part of the costs of its revenue account land acquisition and were incurred in the course of deriving income from that land. [3] The respondent, the Commissioner of Inland Revenue (the Commissioner) denied these deductions which were claimed in AAA s income tax returns for the 2009, 2010 and 2011 years. She did so on the basis that AAA s business had ceased on 24 July 2008 and any expenditure after that date had no nexus with the income earning activities of the business. Essentially the Commissioner denied deductibility contending that the expenses were not incurred in deriving assessable income nor incurred in the course of carrying out a business for the purpose of deriving assessable income. 2 [4] In response, AAA maintains that its business did not cease until a later date. This was first, either December 2011, when it entered into an agreement for the sale of its development documentation and resource consent rights relating to the property in question, or secondly, December 2010 when the parties entered into a settlement agreement, or thirdly, possibly even March 2013 when the resource consent rights for the project expired. Thus, it says that its expenditure here was a revenue expense and properly deductible for income tax purposes. 2 As set out in the relevant parts of s DA 1 Income Tax Act 2007 (the Act).

4 [5] The matter went to the TRA which upheld the Commissioner s decision. The TRA found that all the expenditure in question after 24 July 2008 was not properly deductible. It is against that decision of the TRA that AAA now appeals. The issues [6] The determination of this substantive question requires resolution of the following five issues: (a) the date on which AAA s business ceased (the Timing Issue); (b) whether there is a sufficient nexus between the business of AAA and the disputed expenditure (the Nexus Issue); (c) whether the nature of AAA s business is wider than the property development for which it was formed (this is a new argument on appeal its consideration is opposed by the Commissioner) (the Breadth of Business Issue); (d) whether the equitable interest in the Land acquired by AAA in 2006 was revenue account property and therefore the expenses incurred in relation to it were deductible as part of the cost of that revenue account property (the Interest in Land issue); (e) whether the TRA was correct to hold that shortfall penalties apply (the Penalty Issue). [7] Before engaging in the resolution of those issues, I set out in more detail certain background facts in relation to this proceeding. Background facts [8] AAA was incorporated on 30 November 2005 it seems specifically for the purpose of acquiring and completing the retail and residential development project on the property at Flatbush, Manukau. That property comprised 6292 square metres and was located at 125 Ormiston Road, Flatbush (the Land). On 28 February 2006,

5 AAA entered into an agreement for sale and purchase with Ormiston Group Ltd (Ormiston) as vendor to purchase the Land (the purchase agreement), at a price of $5,977,400 (plus GST, if any). 3 Ormiston was to subdivide this 6292 square metres area off its existing larger block. The Land was purchased by AAA with the intention of developing on the Land 17 retail units, 127 residential apartments, and 221 car parks, in order to earn assessable income from the sale of the completed units and apartments. [9] The broad due diligence clause in the purchase agreement, cl 25, was satisfied on 14 March The deposit required was to be paid in four periodic tranches, requiring 10 per cent, and then three further instalments each of 7.5 per cent. 4 Between 31 March 2006 and 1 June 2007, AAA paid these deposits which totalled $1,942, The Bank of New Zealand provided funding for the project on 7 August AAA applied for a resource consent for the development (not the subdivision) on 22 August 2007 and this was granted on 6 March [10] Pursuant to cl 14.2 of the purchase agreement, Ormiston was required to obtain resource consent for the subdivision of the Land off its existing larger block by 31 October This date was extended by agreement on two occasions, first to 30 September 2007, and then to 31 January Ormiston had not satisfied this condition by 31 January 2008 however, and subsequently it purported to cancel the purchase agreement on 10 March The cancellation was predicated on there no longer being a valid contract in existence, because the resource consent condition had not been satisfied by the required deadline. [11] On 17 March 2008, counsel for AAA wrote to Ormiston indicating that the latter s attempt to cancel the purchase agreement was not accepted by AAA. Ormiston replied on 20 March 2008 stating that it considered the purchase I note that although the purchase price is stated to be $5,977,400, there is a hand written note on the purchase agreement stating that the parties had agreed to a price of $935 per square metre on 23 March If this figure is correct, the purchase price would have been $5,883,020 (plus GST, if any). The dates of the deposit instalments were 31 March 2006, 1 June 2006, 1 January 2007 and 1 June Those amount to a total of 32.5 per cent of $5,977,400, not of $5,883,020. Thus, despite the apparent alteration to the purchase price, it seems the parties continued to operate under the original figure, at least for the purposes of the deposit payments.

6 agreement had been cancelled and returned the deposit money to AAA s solicitors. The returned deposits were held by AAA s solicitors on interest bearing deposit. [12] AAA responded by initiating court proceedings on 1 May 2008, seeking specific performance to compel Ormiston to settle the sale of the property. Later, the resource consent for the subdivision Ormiston was required to obtain was granted. This occurred on 2 July On 24 July 2008, nearly three months after the proceedings were issued, AAA changed its position and wrote to Ormiston stating that it had elected to accept Ormiston s earlier repudiation of the purchase agreement, and that AAA was no longer bound by the contract. Mr Wong, sole director and shareholder of AAA, says that the decision was made at that point not to proceed with the project because of the Global Financial Crisis in 2008 (and presumably its impact on Auckland property prices). 6 [13] Then, on 21 January 2009, AAA gave written notice cancelling the purchase agreement. Subsequently, titles to the subdivision were issued on 19 March 2009 and Ormiston replied to the notice on 30 March 2009, declaring the purchase agreement at that point to be unconditional. The reply required settlement within 10 working days (later amended to 15 April 2009). Sometime later, the dispute over the purchase agreement came before this Court for hearing. Following that hearing on 23 November 2010, Clifford J released a judgment holding that the purported cancellations by both Ormiston and AAA were ineffective and the purchase agreement remained on foot. 7 [14] Following the release of Clifford J s decision, on 16 December 2010 the parties entered into a settlement agreement (the Settlement Agreement). Under this, it was agreed that: (a) AAA would transfer to Ormiston half of the deposit it held, together with all accrued interest (namely, half of $1,942,655, plus all interest accrued). 6 7 A valuation obtained by AAA in December 2008 placed the value of the land at $3,100,000. AAA Development (Ormiston) Ltd v Ormiston Group Ltd (2010) 12 NZCPR 329 (HC).

7 (b) AAA would pay all of Ormiston s costs, in the sum of $70, (c) AAA was to receive the remainder of the funds held on interest bearing deposit (namely, half of $1,942,655, less the costs of $70,046.73). (d) both parties would discontinue all claims each had against the other and issue no further proceedings. [15] At the time the dispute was determined in the High Court, it appears that AAA was insolvent. It could not proceed with the development, which left outstanding the issue of AAA s resource consent for the development (I repeat, not the subdivision). On 9 December 2011, AAA entered into an agreement by which it agreed to sell the resource consent rights (including the rights to the project and documents, plans, reports and calculations) to a third party, King Street Investments Ltd for $650,000 (plus GST, if any). A condition of that agreement was not satisfied, however, and the agreement lapsed. Nothing more happened and those resource consent rights finally expired on 5 March The disputed assessment [16] Turning to its income tax position, AAA filed income tax returns for the financial years In response, on 26 March 2012 the Commissioner issued a notice of proposed adjustment to AAA. AAA filed a notice of response on 21 May The Commissioner issued a disclosure notice and statement of position to AAA on 10 December AAA responded with a statement of position on 11 February On 13 May 2013, the Commissioner s adjudication unit issued an adjudication report. On 20 May 2013, notices of assessment were issued for the 2009 and 2010 years. The notices of assessment reflected the decision in the adjudication report. A notice of assessment for the 2011 financial year was issued on 24 May [17] AAA claimed total deductions of $1,521,953 divided between income tax returns for the years ending 31 March 2009, 31 March 2010 and 31 March 2011 as follows:

8 Total Administration Expenses $11,800 $7,612 $19,412 Development Fees $75,878 $2,856 $78,734 Legal Expenses $23,232 $52,304 $129,683 $205,219 Forfeiture of Deposit $1,218,588 $1,218,588 Total $110,910 $62,772 $1,348,271 $1,521,953 [18] In response the Commissioner, as I have noted, in her assessments for those income years disallowed all income tax deductions claimed by AAA after 24 July 2008 on the basis that AAA was not in business after that date. [19] As a consequence of this, of the 2009 deductions noted above, $86,834 were allowed as incurred before 24 July The disallowed deductions for that year were therefore $24,076. [20] And, for subsequent years, the total disputed deductions which were disallowed were therefore: (a) $62,772 (b) $1,348,271 Total disallowed deductions therefore for the 2009, 2010 and 2011 years were $1,435,119. [21] The Commissioner also imposed shortfall tax penalties of $39, concluding that AAA had taken an unacceptable tax position for the 2011 income tax year. This was on the basis that, after allowing a deduction for accounting fees incurred by AAA in relation to its interest income, there was a tax shortfall of $391, The shortfall penalty that was imposed allowed for a 50% reduction in accordance with s 141FB of the TAA for AAA s previous good behaviour. [22] When this matter came before the TRA, it found that AAA had ceased its property development business on 24 July 2008 and there was no nexus between AAA s development business and any of the expenses incurred after that date. The

9 TRA came to this conclusion, it seems, after hearing evidence from the sole shareholder and director of AAA, Mr Wong, and from Mr Kemps, the solicitor acting for AAA during the relevant time. [23] Thus the TRA upheld the Commissioner s assessments and disallowed the purported deductions noted at para [17] above. [24] The ultimate question for determination on this appeal, as it was before the TRA, is whether any of the expenditure incurred by AAA after 24 July 2008 is deductible. The TRA decision appealed from [25] Judge Sinclair heard the application in the TRA 8 and gave her decision on 9 December Her Honour commenced the discussion by noting the general limitation contained in s DA 1 if the Income Tax Act 2007 (ITA) and the definition of business in s YA 1 as including any profession, trade, or undertaking carried on for profit. After referring to various authorities regarding the meaning of business, deductibility and the cessation of business, Her Honour moved to consider the first issue in the proceeding, namely when AAA s business ceased. As to this cessation of business issue, Judge Sinclair held: [48] I am satisfied on the evidence that the disputant s efforts after 24 July 2008 (when AAA wrote to Ormiston stating that it had elected to accept Ormiston s cancellation of the contract), were directed solely towards the cancellation of the Agreement and recovery of the deposit and costs incurred to that point on the project. I do not accept that there was any temporary cessation of the business by the disputant in the period from 24 July to December 2010 and/or that the disputant had any expectation of resuming its business of property development following the High Court decision. [26] Her Honour then went on to consider the impact of the agreement to sell the resource consent rights. On this aspect, Judge Sinclair stated: [53] Importantly, the business being undertaken by the disputant was that of property development. It was not in the business of selling resource consents. The resource consent for land use was an integral part of the development so that the attempted sale of the consent has nothing to do with 8 AAA Development (Ormiston) Ltd v The Commissioner of Inland Revenue [2014] NZTRA 17.

10 the conduct of the property development business. In these circumstances, I do not accept that the disputant was still carrying on this business activity when it entered into the Project Rights Agreement (or up to the expiration of the resource consent). The transaction in my view was nothing more than a further attempt by the disputant to defray the losses suffered by it as a consequence of the failed property development venture. [54] In the 2009 year the disputant claimed expenses in the period after 24 July 2008 totalling $24,076. These expenses consisted of legal fees, administrative expenses (including accounting fees and interest) and planning consultancy fees. In 2010 the disputant claimed similar expenses totalling $62,772. In 2011 the expenses claimed totalled $1,348,271. These expenses consisted of legal fees, administrative expenses and the sums paid on settlement of the vendor s claim. (The legal costs incurred relating to the Project Rights Agreement are not part of this proceeding.) For the above reasons I find that the disputant ceased its property development business on 24 July 2008 and I am satisfied that there is no nexus between the disputant s business of property development and any of the expenses incurred. [27] The next argument considered by Her Honour was whether the land (defined by s YA 1 of the Act) was held on revenue account. More specifically, it was contended that because the land was acquired for resale, any expenses relating to the land should be deductible, because there existed the requisite nexus under s DA 1 of the Act. It is on this basis that it was argued that forfeited deposit funds were deductible, in the form of: (a) a payment made by AAA to escape an onerous agreement; (b) a loss on the disposal of equitable rights in and to the land; or (c) a payment of damages. [28] These arguments were roundly rejected by Judge Sinclair. She found that no sufficient nexus of any real kind existed. [29] In summary, overall, materially the TRA, in upholding the Commissioner s assessments, found: (a) that AAA s business ceased on 24 July 2008 (at [48] and [54]). Consequential findings were:

11 (i) as I have noted, that there was no nexus between AAA s business of property development and any of the expenses incurred (at [54]; (ii) that there was insufficient nexus between any of the expenses incurred and any income-earning process undertaken by AAA (at [61] and [68]); (b) that AAA did not derive income from disposal of an interest in the Land (at [71] and [72]), that AAA on acquiring an equitable interest in the Land on 14 March 2006, did not intend to dispose of that interest (other than by way of a sale of the completed units/apartments and transfer of the full legal title on completion) and that the damages paid and sought to be deducted by AAA were not incurred as the cost of revenue account property (at [75])); (c) that the damages were not an expected expense and hence were not deductible (at [74]); (d) that the damages paid and sought to be deducted by AAA were not deductible as incurred as part of a profit-making scheme again as there was no appropriate nexus here (at [75]); (e) that the fees and expenses in question were not incurred by AAA, in whole or in part, before 24 July 2008 (at [81]; (f) that there was no nexus between the legal fees expended and any potential recovery in the High Court litigation (at [92]); and (g) that AAA took an unacceptable tax position (at [102]). Approach to appeals [30] An appeal lies against the decision of the TRA by virtue of s 26A of the Taxation Review Authorities Act The right of appeal in s 26A is prima facie

12 unqualified and therefore proceeds by way of rehearing. The principles applicable to such appeals were set out by Wylie J in Russell v Commissioner of Inland Revenue, where His Honour stated: 9 [69] The appeal is brought pursuant to s 26A of the Taxation Review Authorities Act It proceeds by way of rehearing pursuant to r of the High Court Rules. Both parties were agreed that the approach outlined by the Supreme Court in Austin, Nichols & Co Inc v Stichting Lodestar applies. [13] The following principles can be derived from that decision: a) the appellant bears the onus of satisfying the appeal court that it should differ from the decision under appeal; b) it is only if the appellate court considers that the appealed decision is wrong that it is justified in interfering with it; c) the appeal court has the responsibility of arriving at its own assessment on the merits of the case; d) no deference is required beyond the customary caution appropriate where the first instance fact finder had a particular advantage such as technical expertise or an opportunity to assess the credibility of witnesses; e) the appellate Judge is entitled to use the reasons of the first instance decision-maker to assist him or her in reaching his or her own conclusions, but the weight the Judge places on them is a matter for the Court. [70] The position is summed up in the judgment of Elias CJ as follows: Those exercising general rights of appeal are entitled to judgment in accordance with the opinion of the appellate court, even where that opinion is an assessment of fact and degree and entails a value judgment. If the appellate court's opinion is different from the conclusion of the tribunal appealed from, then the decision under appeal is wrong in the only sense that matters, even if it was a conclusion on which minds might reasonably differ. In such circumstances it is an error for the High Court to defer to the lower Court's assessment of the acceptability and weight to be accorded to the evidence, rather than forming its own opinion. Deductions generally [31] Section DA 1 of the Income Tax Act 2007 (ITA) contains the general permission for deductions. It provides: 9 Russell v Commissioner of Inland Revenue (2010) 24 NZTC 24,463 (HC) (footnotes omitted), citing Austin, Nichols & Co Inc v Stichting Lodestar [2007] NZSC 103, [2008] 2 NZLR 141.

13 DA 1 General permission Nexus with income (1) A person is allowed a deduction for an amount of expenditure or loss, including an amount of depreciation loss, to the extent to which the expenditure or loss is (a) (b) incurred by them in deriving (i) (ii) (iii) their assessable income; or their excluded income; or a combination of their assessable income and excluded income. incurred by them in the course of carrying on a business for the purpose of deriving (i) (ii) (iii) General permission their assessable income; or their excluded income; or a combination of their assessable income and excluded income. (2) Subsection (1) is called the general permission. [32] It is commonly said that the general permission incorporates two limbs of deduction. Thus, a taxpayer will be allowed a deduction for expenditure incurred in either deriving assessable and/or excluded income or incurred by the taxpayer in the course of carrying on business for the purpose of deriving assessable and/or excluded income. There are also six general limitations, set out at s DA 2. [33] The leading case in this area is Commissioner of Inland Revenue v Banks (Banks). 10 Mr Banks was an accountancy lecturer who claimed certain deductions in respect of expenditure relating to his home because part of his home was set aside and used as an office from which he undertook income-producing activities. The Court of Appeal allowed the taxpayer s appeal and his claim. In doing so, it was stated: 11 There are two features of s 111 and its place in the scheme of the deduction provisions which are of particular importance in this case. The first is that the expenditure must meet the statutory standards in relation to the assessable income of the taxpayer claiming the deduction. The deduction is available only where expenditure has the necessary relationship, both with the taxpayer concerned and with the gaining or producing of his assessable Commissioner of Inland Revenue v Banks [1978] 2 NZLR 472 (CA) [Banks]. At

14 income. Relationship with the taxpayer is not, in itself, sufficient, as the prohibition of a deduction for capital expenditure (s 112(1)(a)) and private and domestic expenditure (s 112(1)(i)) makes clear. There must be the statutory nexus between the particular expenditure and the assessable income of the taxpayer claiming the deduction. In this respect, the three references to "the assessable income" in s 111 referring to the assessable income of the particular taxpayer and to that income alone, are reinforced by the separate treatment of non-assessable income and the contrast between assessable and non-assessable income in s 110A and s 111A and the contrast with exempt income in s 112(1)(j). The second feature of s 111 is that, as has already been noted, the statutory language expressly contemplates apportionment. A deduction is allowed to the extent that the statutory standard of deductibility is met. Furthermore, this is not restricted to expenditure which can be dissected with distinct and severable parts being directly referable to the production of assessable income. It extends to outgoings not capable of such dissection but which serve both income earning and other purposes indifferently (Ronpibon Tin No Liability v Federal Commissioner of Taxation (1949) 78 CLR 47). [34] And later, Richardson J in the Court of Appeal decision went on to say: 12 The statutory requirement is that the expenditure be incurred in gaining or producing the assessable income. That has to be judged as at the time that the taxpayer became definitively committed to the expenditure for which deduction is sought (F.C. of T. v Flood (1953) 88 C.L.R. 492; King v C. of I.R. (1973) 1 NZTC 61,107. The concern of the section is with the relevant factual situation at the time the expenditure for which deduction is sought is incurred, rather than what may have been the position in respect of the property at an earlier date. It then becomes a matter of degree, and so a question of fact, to determine whether there is a sufficient relationship between the expenditure and what it provided, or sought to provide, on the one hand, and the income earning process, on the other, to fall within the words of the section. [35] Similarly, in Buckley & Young Ltd v Commissioner of Inland Revenue, Richardson J for the Court of Appeal again remarked: 13 There are two features of s 111 which are of particular importance in this case. The first is that a deduction is available only where the expenditure has the necessary relationship both with the taxpayer concerned and with the gaining or producing of his assessable income or with the carrying on of a business for that purpose. The heart of the inquiry is the identification of the relationship between the advantage gained or sought to be gained by the expenditure and the income earning process. That in turn requires determining the true character of the payment. It then becomes a matter of At Buckley & Young Ltd v Commissioner of Inland Revenue [1978] 2 NZLR 485 (CA) at 487.

15 degree and so a question of fact to determine whether there is a sufficient relationship between the expenditure and what it provided or sought to provide on the one hand, and the income earning process on the other, to fall within the words of the section (Commissioner of Inland Revenue v Banks [1978] 2 NZLR 472, 478). The second feature of s 111 is that the statutory language contained in the phrase "to the extent to which" expressly contemplates apportionment. [36] For AAA to be able to rely on s DA 1, it must therefore establish the three essential elements of deductibility: (a) the expenditure must be incurred by AAA; (b) there must be a sufficient relationship or nexus between the expenditure and the income earning process; i.e. a business, and (c) none of the general limitations set out in s DA 2 must apply. [37] There is no contest between the parties that the expenditure in question was incurred by AAA. I now turn to consider whether there was a sufficient relationship or nexus between the expenditure and the business or the income earning process. In considering this question, first, I will consider whether AAA s business was still in existence at the time the expenditure in question was incurred, the Timing Issue noted at [6] above. I will then, as part of this, move on, secondly, to consider whether there was a sufficient nexus between the business of AAA and the disputed expenditure, the Nexus Issue, also noted at [6] above. The Timing Issue and the Nexus Issue [38] Under those heads, as I have noted, I am required to determine, first, whether AAA s business was still in existence at the time the relevant costs were incurred. This issue requires resolution of two sub-issues; first, what was the business of AAA (the Business Definition Issue), and secondly, and more generally, when did the business of AAA cease (the Cessation Issue). The Business Definition Issue [39] The term business is defined by s YA 1 as including any profession, trade, or undertaking carried on for profit. The leading case as to what constitutes a business is Grieve v Commissioner of Inland Revenue. 14 In that case, the appellants, Mr and 14 Grieve v Commissioner of Inland Revenue [1984] 1 NZLR 101 (CA).

16 Mrs Grieve, in 1969 acquired a rundown farm of some 216 acres (93 acres freehold and 113 acres leasehold), together with a 10 acre island held under a Crown occupation license. The purchase price was $33,000, of which the Grieves paid $5,000 in cash and the vendor left in the remaining $28,000 for five years. The Grieves entered into a deed of partnership, by which they stated they were carrying on a farming business in partnership. The deed was accepted by the Inland Revenue Department from the date on which they commenced business. [40] The question on appeal was whether the Grieves were carrying on a business in the 1976/1977 tax year, such that they could claim deductions for losses sustained by the farming partnership. The Court of Appeal overturned the judgment of Sinclair J in the High Court, and concluded that the Grieves were in business. Richardson J delivered the judgment of the Court, engaging in a thorough examination of what is meant by business in the context of the Income Tax legislation. His Honour opened the discussion by stating: 15 The crucial question then is as to the meaning of "business" in the statutory context. Sinclair J concluded that to warrant recognition as a business for income tax purposes there must be not only an intention of making a profit, but also a reasonable prospect of doing so, although not necessarily for the year or years under review. For reasons which I can express quite shortly I am satisfied that he erred in concluding that a reasonable prospect of making a profit had to be established. [41] Richardson J then went on to consider what is meant by business in the tax context. His Honour articulated what is now accepted as a two-stage inquiry, consisting of, first, the nature of the business activity and, second, the intention of the taxpayer. Richardson J summarised the position as follows: 16 It follows from this analysis that the decision whether or not a taxpayer is in business involves a two-fold inquiry - as to the nature of the activities carried on, and as to the intention of the taxpayer in engaging in those activities. Statements by the taxpayer as to his intentions are of course relevant but actions will often speak louder than words. Amongst the matters which may properly be considered in that inquiry are the nature of the activity, the period over which it is engaged in, the scale of operations and the volume of transactions, the commitment of time, money and effort, the pattern of activity, and the financial results. It may be helpful to consider whether the operations involved are of the same kind and are carried on in the same way as those which are characteristic of ordinary trade in the line of business in At 106 (Emphasis added). At 110.

17 which the venture was conducted. However, in the end it is the character and circumstances of the particular venture which are crucial. Businesses do not cease to be businesses because they are carried on idiosyncratically or inefficiently or unprofitably, or because the taxpayer derives personal satisfaction from the venture. [42] Similarly, in Calkin v Commissioner of Inland Revenue, Richardson J in the Court of Appeal reiterated this point: 17 The decision whether or not a taxpayer is in business involves a two-fold inquiry: as to the nature of the activities actually carried on - including the period over which they are engaged in, the scale of operations and the volume of transactions, the commitment of time, money and effort, the pattern of activity and the financial results - and as to the intention of the taxpayer in engaging in those activities. [43] In the present case, it is not suggested that AAA was never in business at some point in time. At this stage of the inquiry, the issue is as to the nature of that business. On this point, Mr Lennard, counsel for AAA, referred me to Commissioner of Taxes v Miramar Land Company (Limited), in which it was confirmed that if a company is formed for the purpose of developing a sole parcel of land, the resulting undertaking is sufficient to amount to a business. 18 [44] AAA was incorporated on 30 November It was incorporated for the purpose of developing on the Land the proposed retail units, residential apartments and car parks for ultimate sale. In my view there is little support here for AAA s contention advanced in its submissions from its counsel that it was established to undertake business-like activities on a more general level, i.e.: 19. The appellant was established to undertake business-like activities and actively pursued them, locating and acquiring suitable land, arranging plans for development and obtaining resource consent. Indeed, the sole focus on development of this Land was confirmed by the taxpayer in its notice of claim. I therefore have little hesitation in concluding that in reality the business of AAA was solely limited to the development of the Land identified above at [8]. [45] In reaching that conclusion I have been influenced by the following factors: Calkin v Commissioner of Inland Revenue [1984] 1 NZLR 440 (CA) at 446. Commissioner of Taxes v Miramar Land Company (Limited) (1906) 26 NZLR 723 (CA).

18 (a) the company was incorporated very shortly before entering into the purchase agreement; (b) during the time AAA existed, it pursued no business activities other than those relating to the development of the Land; (c) the company existed for a number of years, during which time it would have been able to pursue other interests had that been part of its business, but it did not; (d) the name of the company supports the proposition that the company was incorporated to develop the land at Ormiston; and (e) once the Global Financial Crisis hit in 2008, AAA acknowledged through the evidence of Mr Wong, its sole director and shareholder, that it decided not to proceed with the project and to extract itself from what was now an onerous contract, and as a result to shut down its operations and its business in the best way it could. [46] The result of this, as I have said, is that I reject the submission of AAA that its business was broader. The Cessation Issue and the Nexus Issue [47] The more fundamental contests on this aspect of the present case are, first, the date upon which AAA s business ceased and, secondly, whether there is a sufficient nexus between that business and the disputed expenditure. On the cessation issue, AAA s position is that it ceased being in business in December 2011, when it agreed conditionally to sell to the third party its development documentation and resource consent rights, or on 5 March 2013 when the resource consent finally expired or, alternatively, at the earliest, December 2010, when AAA and Ormiston entered into the settlement agreement. The Commissioner s position, as I have noted, is that AAA ceased being in business from 24 July It is from this date, the Commissioner maintains, that it is clear AAA no longer had any intention to develop the Land, as it attempted to accept Ormiston s unlawful repudiation.

19 [48] At the outset I need to say that, as I see the position, the TRA was correct in finding that the business of AAA ceased from 24 July AAA was incorporated for one reason, and one reason alone. That was to develop the Land. From the moment AAA attempted to accept Ormiston s otherwise invalid cancellation of the purchase agreement, it is difficult to accept AAA s argument that it still maintained some profit making intention from this point in time forward. 19 Of course, in assessing this criterion it is necessary to have regard to statements made by a taxpayer. However, the ultimate analysis requires an assessment of a taxpayer s intention gleaned from all relevant circumstances. From the facts of this case, the following factors support the conclusions I have reached above: (a) AAA had effectively abandoned the property development venture from 24 July 2008 when it purported to accept the invalid cancellation of the purchase agreement by Ormiston. (b) By this time, AAA had decided not to proceed with the development of the Land, which was the reason for its very existence and, on my analysis, the sole business of AAA. The Global Financial Crisis and subsequent economic turndown undoubtedly played a role in this. (c) The activities of AAA from this point forward were directed towards damage-control and the recovery of expenditure, not advancing the development, or its business, in any way. (d) This leads to the conclusion, in my view, that from 24 July 2008 AAA no longer had any profit making intention. The factors favouring this conclusion are: (i) the development was not proceeding (due to first, AAA s and Ormiston s attempts to extricate themselves from the purchase agreement, seen as an onerous contract, secondly, the subsequent litigation and, thirdly, the economic downturn); 19 Profit making intention (not motive) is often considered the most important indicia of business existence:

20 (ii) from that point forward, there was no prospect of deriving assessable income, with efforts being directed towards recuperating losses and winding up of the business. [49] Turning now to the Nexus Issue, it is clear that to have earned income or made a profit, AAA always required an underlying profit-making structure, i.e. it needed the Land which it proposed to develop to be acquired so that this development could proceed. Up to 24 July 2008 the Commissioner allowed by way of deduction expenditure incurred by AAA in obtaining the necessary resource consent required for the development of the land and other related expenses. However, given AAA s intentions from 24 July 2008, I am satisfied the expenses it incurred after that date were not referable to a continuing business or income earning process. On 24 July 2008 AAA, through its solicitor, had written to the vendor Ormiston indicating that it accepted its unlawful termination of the purchase agreement as repudiation and acknowledged the contract is therefore at an end. [50] Thereafter, as I have noted, AAA s intentions were simply to extricate itself from the purchase agreement. This was confirmed, as I see it, in its pleadings filed on 2 April 2009 and following, seeking judgment against Ormiston by way of a declaration that AAA had lawfully avoided the purchase (agreement) either on 24 July 2008 or subsequently on 21 January [51] There can be no doubt in my mind that the expenses AAA incurred after 24 July 2008 were not referable to a continuing business or income earning process. They were incurred to extract AAA from what could be seen at that time as a bad buy and they were also incurred, it seems, in an attempt to secure damages from the vendor Ormiston. No enduring benefit characteristic associated with these expenses can be connected with AAA s property development business as it existed prior to July [52] The invoices provided by AAA post 24 July 2008 are important indicators of the nature of the activities which were being carried on. The expenses, it seems, were for lawyers and accountants and, where the planning consultants were still engaged, their focus was on the forthcoming litigation rather than the development

21 itself. Indeed, AAA s solicitor at the time, Mr Kemp, in cross-examination, admitted that the invoices from his firm after 24 July 2008 did not relate to the property development work because we never got to development. And, in his oral evidence, Mr Wong admitted that AAA did not intend to proceed with the purchase of the land after 24 July 2008, and at no time in reality did this intention change. [53] AAA refused to settle the purchase of the land when provided with a settlement statement by the vendor on 7 April 2009, even though at that time it was aware the resource consent for the subdivision had been granted. AAA s original bank financing offer had expired by 1 September 2007 and later attempts to obtain finance, it seems, were deliberately restricted and contrived so that finance would not be approved by the bank. Indeed, further evidence before the Court from Mr Kemp noted that Mr Wong s intention was to pursue damages for whatever possible he was going to try and recover from the vendor Ormiston. [54] All this, including Mr Wong s evidence before the Court, was consistent with AAA no longer having any requisite profit-making intention of any kind after July [55] The multiple allowed invoices which were before the Commissioner for the period up to 24 July 2008, when it was accepted AAA was in business, were clearly for development costs or stock expenses, being invoices for architects, traffic design costs, Meridian planning, and costs levied by the Manukau City Council, all of which show that AAA was actively seeking to obtain the necessary resource consent required for the development at that time. This must be contrasted, however, with the expenses incurred after 24 July There the position had changed to reflect costs incurred in attempting to avoid the purchase agreement that clearly, as Mr Wong has confirmed, had become a bad bargain. Expenditure incurred post July 2008 on legal and accounting costs and the final settlement amount paid to the vendor Ormiston was not, as I see it, in continuation of AAA s property development business activity. [56] As to the series of deposits paid under the purchase agreement, in terms of the settlement agreement, these were effectively refunded to AAA who then agreed

22 to pay the equivalent of one half of the deposit and costs to the vendor Ormiston. This payment was made purely as a litigation settlement after the business had ceased and, therefore, there can have been no enduring benefit to the business associated with this expenditure. [57] The present case differs from those to which I was referred by counsel for AAA where expenses were regarded as deductible in situations where sensible commercial business decisions were made to keep the business in question profitable. In the present case the payments were made in the context of a compromise reached by the parties to avoid the need for further litigation. The payments resolved any damages claim to which the vendor Ormiston was entitled, as well as costs. [58] In conclusion, I find that the damages payment required under the settlement agreement, calculated to represent one half of the deposit monies previously paid, together with costs paid to the vendor, and the other legal, accounting and related costs incurred by AAA post 24 July 2008, were simply the cost of AAA s actions in attempting to extricate itself from the onerous contract represented by the purchase agreement. [59] Based on all the evidence before her, the TRA was entitled to form the view she did that AAA s business ceased on 24 July 2008 when it issued the first cancellation notice to the vendor Ormiston. The TRA was also entitled, on the evidence, to find that there was no nexus between the disputed expenditure and AAA s business or income earning process. The Breadth of Business Issue [60] The next issue to consider as outlined at [6](c) above is what I have termed the Breadth of Business Issue. This concerns the question whether the nature of AAA s business is wider than the property development for which it was formed. As I understand it, this is a new argument AAA introduced on this appeal. AAA has put the question in the following way:

23 Whether the nature of AAA s income earning activity included making any form of profit or income in relation to the Land and, if so, whether the expenses were integral to that process? [61] An initial issue arises as to whether AAA is precluded from bringing this new argument on appeal. This is because its case has proceeded throughout on the basis that the only business activity of AAA was the development project involving the Land, which did not proceed. Indeed, as I understand the position, this is consistent with the pleadings filed by AAA and with its statement of position. I am told that previously, AAA has never argued or led evidence to the effect that its business and income earning process constituted anything other than making a profit or income from its dealings related to the development of the Land itself and subsequent sales of retail and residential units. [62] As a result, there can be no doubt that the Commissioner has based her case on the dispute as defined by AAA s statement of position, the pleadings and the agreed statement of facts. In all the circumstances prevailing here, I am satisfied that the Commissioner would be prejudiced if AAA at this late stage were now permitted to bring this new argument. [63] In addition, no application has been made for leave to amend the pleadings, nor any application brought under s 138G(2) of the Tax Administration Act 1994 (TAA) to rely on a new proposition of law. [64] But, in any event, in briefly addressing the substance of this argument, it seems to be undisputed that AAA s intention throughout was to develop the 17 retail units, 127 residential units and 221 car parks on the Land in order to derive income from the sale of the completed units and apartments. AAA s position now, as best I can tell, is that it says because a company does not require a constitution in terms of ss 16 and 28 of the Companies Act 1993, it is not constrained in any way as to the nature of business activity it carries on. Therefore it says that it follows its business would include any undertaking for profit, notwithstanding that this undertaking may not have been the purpose for which it was incorporated.

24 [65] On its face, this argument has a superficial attraction. In the circumstances of the present case, however, I am satisfied that not only is it inconsistent with the facts alleged in AAA s notice of claim and agreed for the purposes of the proceeding, but it also is purely a concocted and unsupported last minute afterthought. It has no merit. And, in challenge proceedings commenced under Part 8A of the TAA, where a disclosure notice has been issued, the parties can rely only on the facts and evidence and the propositions of law that are disclosed in their statements of position ( the evidence exclusion rule in s 138G). The Supreme Court in Ben Nevis Forestry Ventures Limited v Commissioner of Inland Revenue 20 at [153] has said: [153] Those issuing SOPs [Statements of Position] are generally limited by their terms as regards what may be argued at any later stage of the dispute or challenge process the disputes process is not a general enquiry into the taxpayer s liability to pay tax and the amount of that liability. It is an enquiry focused on and by the terms upon which the dispute is raised and responded to. That approach is reinforced by the terms of Part 4A [of the TAA]. [66] Section 138G(2) of the TAA, however, does provide that a hearing authority may, on application, allow new propositions of law to be raised in the challenge. However, that is only if: (a) those new propositions of law could not have been discovered or discerned with due diligence at the time of delivery of the statement of position; and (b) the admission of those propositions of law is necessary to avoid manifest injustice. [67] On this aspect in the present case, there is no cogent evidence before the Court to explain either why AAA was not able to discern the possible application of this new proposition of law at the time it issued its statement of position, or what manifest injustice would occur to AAA if it is not allowed to raise this new argument now. Taking into account the purpose of the disputes process as set out by the Supreme Court, I am satisfied AAA has not discharged its burden of satisfying 20 Ben Nevis Forestry Ventures Limited v Commissioner of Inland Revenue [2008] NZSC 115 at [153].

25 the Court that it should depart from the requirements of the statutory regime in Part 4A of the TAA to consider the new proposition of law it has raised at this very late stage in the proceeding. [68] I find, therefore, that leave should not be granted here to bring this new argument on appeal, as otherwise it would be prejudicial to the Commissioner and, in any event, it is inconsistent with the facts which were before the TRA and this Court and agreed for the purposes of these proceedings. The Interest in Land Issue [69] Next I turn to the issue noted at para [6](d) above which I have described as the Interest in Land Issue. This addresses the question whether what is said to be the equitable interest in the Land acquired by AAA in 2006 was revenue account property and therefore does it follow necessarily that the expenses incurred in relation to it must be deductible as part of the cost of that revenue account property? [70] This is an alternative argument advanced by AAA. It is to the effect that, even if its business did cease on 24 July 2008, and even if there was no nexus with an income earning process, the expenses in question are still deductible because they are part of the cost of a revenue account property, being the equitable interest in the Land that AAA acquired when in 2006 it entered into the purchase agreement. In other words, AAA is effectively arguing here that because the Land is held on revenue account, then all expenses related to it are automatically deductible. [71] On this point, the Commissioner s position is that, irrespective of whether the Land was held on revenue account, the expenditure in question did not have a sufficient nexus with the income earning process undertaken by AAA in order for it to meet the tests for deductibility. The same fundamental tests for deductibility outlined in the general permissions still need to be applied and satisfied. That general permission for deductibility, as I have noted above at [31], is contained in s DA 1 of the Act and this sets out the tests.