The Judicial Committee of the Privy Council Decisions

Commissioner of Inland Revenue v. Auckland Harbour Board (New Zealand) [2001] UKPC 1 (24th January, 2001)

Delivered the 24th January 2001

[Delivered by Lord Hoffman]

1. In December 1988 the Auckland Harbour Board ("AHB") transferred nearly $20m worth of government and local authority stock for no consideration to two trusts which it had previously established. The transactions were politically controversial. AHB was about to be abolished as part of a reform of local government. It created the trusts and made the transfers to perpetuate certain of its activities which it thought might not survive under the new regime. The Local Government Commission took the view that AHB was trying to defeat the objects of the reform. Special legislation was passed to enable transfers to be set aside and the money retrieved by the Auckland Regional Council ("ARC"), AHB’s successor in title. The present appeal, however, is about the effect of the transfers upon the AHB’s liability to income tax. For this purpose the Commissioner accepts that the transfers must be treated as valid. Their Lordships therefore consider that the unusual circumstances in which they were made are irrelevant to any question which has to be decided.

2. The holdings of stock transferred to the trusts were "financial arrangements" as that expression is defined in section 64B of the Income Tax Act 1976. They were accordingly taxable under the accrual regime contained in sections 64B to 64M. This innovative system was introduced in 1986. It has two main features: first, in principle and subject to exceptions, it taxes the entire yield from a financial arrangement without regard to whether it is income or capital. Secondly, it deems that yield to be receivable over the expected life of the arrangement. In its simplest form, it requires the whole of the expected cash return from the arrangement to be calculated, the acquisition price deducted, and the difference treated as taxable income which will be received evenly over the tax years until maturity. Mr McKay, who appeared for AHB, pointed out that this approach required one to discard traditional and intuitive reactions based upon the principle that income tax is a tax on income. As Glazebrook and Oliver say in their book, The New Zealand Accrual Regime at para. 301:-

"[The traditional] legal/accounting approach to defining what constitutes income can be compared with an economic approach. Under economic principles all gains in wealth are generally considered to be ‘income’ and all reductions in wealth are subtracted from income. Whether any ‘gain’ or ‘loss’ can be categorised as capital or revenue assumes no relevance, the only issue is whether there is an overall gain or loss of wealth over the period for which the income is being measured.

The accrual regime can be interpreted as a fundamental shift from the rest of the income tax regime which operates on traditional legal/accounting principles. It is a move to a regime where the Act operates more on economic principles."

3. As the calculation of yearly income depends upon the expected cash return on the assumption that the arrangement will be held to maturity, the system requires an adjustment if the actual yield turns out to be different or if the taxpayer disposes of the arrangement before maturity. This is called a "base price adjustment", made in accordance with section 64F. The relevant provisions are as follows:-

"(2)...where, in relation to any person, a financial instrument matures or is remitted (other than by way of being written off as a bad debt), sold, or otherwise transferred by the person in any income year, the amount of the base price adjustment in relation to that income year, that person, and that financial arrangement shall be an amount calculated in accordance with the following formula:

a - (b + c)

where -

a is -

(i) In the case of a holder, the sum of -

(A) the amount of all consideration that has been paid, and all further consideration that has or will become payable, to the person; and

(B) Any amounts that have been remitted by the person and that are not included in subparagraph (A) of this paragraph:

…

b is the acquisition price of the financial arrangement in relation to the person; and

c is -

(i) in the case of a holder, all amounts that are income derived, less the aggregate of amounts of expenditure deemed to be incurred under section 64C or section 64I of this Act or be deemed to be an allowable deduction under section 64D of this Act by the person..

…

(4) ...the amount of the base price adjustment in relation to any financial arrangement and any income year shall

(a) in relation to a holder –

…

(ii) where it is a negative amount, be deemed to be an allowable deduction in calculating the assessable income of the holder in the income year."

4. As AHB received no consideration for the financial arrangements transferred to the trust, the calculation required by section 64F produced a negative base price adjustment of $8.6m. AHB claimed that it was entitled to deduct this sum from its assessable income under subsection (4)(a)(ii).

5. The Commissioner accepts that upon the true construction of section 64F, AHB is entitled to the deduction. But he claims that he is entitled to reject it under section 64J(1):-

"Where the Commissioner, having regard to any connection between the parties to the issue or transfer of a financial arrangement and to any other relevant circumstances is satisfied that the parties were dealing with each other in relation to the issue or transfer in a manner that has the effect of defeating the intent and application of sections 64B to 64M of this Act, the Commissioner may, for the purposes of calculating the assessable income or expenditure of the parties under section 64C or section 64D or section 64F or section 64I of this Act, deem the consideration for the issue or transfer to be equal to the consideration that might reasonably be expected for the issue or transfer if the parties to the issue were independent parties dealing at arms' length with each other in relation to the issue or transfer."

6. It is of course true that the parties to the transfer were connected. The trusts had been established by AHB itself. The parties were certainly not dealing commercially at arms’ length. So the Commissioner was entitled to have regard to this relationship. But the question is whether he was entitled to conclude from this relationship and any other relevant circumstances that AHB and the trusts were "dealing with each other…in a manner that has the effect of defeating the intent and application of sections 64B to 64M of this Act". For that purpose, it seems to their Lordships that the only other relevant circumstance was the fact that the transfer was for a nil consideration. There is some suggestion in the judgment of Potter J., who decided the case at first instance in favour of the Crown, and the minority judgments in the Court of Appeal, that the reasons for which the transfers had been made were also relevant circumstances. Thus Potter J. said that if the stock had been transferred directly by AHB to ARC, it would have been (or possibly would be deemed to have been) at market value and would not have given rise to a base price adjustment. Their Lordships express no view on whether this is right or not, because, assuming it to be true, it can be no more relevant than the fact that if AHB had disposed of the stock in the market, the base price adjustment would have been correspondingly less. The question is whether the transfer it actually chose to make, for nil consideration, was a dealing which had "the effect of defeating the intent and application" of the accrual regime. Similarly, Gault J. said:-

"This was a deliberate action by a public body to thwart announced restructuring and which required legislation to undo. There should not be the reward of the tax deduction of $8.6m by application of the accrual rules when that would not otherwise have been available."

7. There may be a legitimate place for indignation at the constitutionality of AHB’s actions. Perhaps it was intended to thwart restructuring. Their Lordships have no opinion on the matter. But section 64J(1) does not give the Commissioner power to do anything on the ground that the parties to the transaction were intending to thwart restructuring. The question is whether the transaction had the effect of defeating the "intent and application" of the accrual regime.

8. The submission of Mr Jenkin Q.C., counsel for the Commissioner, was that a transfer of a financial arrangement for a nil consideration does in itself have the effect of defeating the intent and application of the accrual regime. Parliament did not intend such transfers to attract a base price adjustment. Their Lordships consider that the only way to test this submission is to inquire into what Parliament’s intention in the matter actually was. And for this purpose, the only available material is the language in which Parliament has expressed itself, properly construed according to currently accepted notions of how a taxing act should be interpreted and with due regard to section 5(j) of the Interpretation Act 1924 as amended.

9. At this point it appears to their Lordships that Mr Jenkin was faced with a logical difficulty. He concedes that, giving section 64F the liberal construction which the Interpretation Act requires, reading it in the context of the general scheme of the accrual regime, in the purposive spirit prescribed by Challenge Corporation Ltd v. Commissioner of Inland Revenue [1986] 2 NZLR 513 and with the best will in the world, it is not possible to read the section as requiring anything other than the actual consideration to be used as part of the formula for calculating the base price adjustment. If the consideration is nil, that is the figure to be inserted. If this is what section 64F means, their Lordships find it difficult to understand on what basis it can be said that it was not its intention.

10. Mr Jenkin’s argument was that if one looks at the accrual regime as a whole, it was constructed on the assumption that transfers of financial arrangements would be at market value. So far as the language of section 64F could not be given such a construction, it should be regarded as an aberration in the execution of the legislative design which could be remedied by a determination of the Commissioner under section 64J(1).

11. Their Lordships will return in due course to consider whether a base price adjustment on the basis of a transfer for a nil consideration is inconsistent with some fundamental principle of the accrual regime. But they should first draw attention to the fact that the Commissioner’s argument involves putting section 64J(1) to a very unusual use. The section appears to their Lordships to contemplate that the circumstances which justify its application will be specific to a particular transaction, arising out of the relationship between the parties and other relevant circumstances. In this respect it is similar to other anti-avoidance provisions such as section 99. Their Lordships do not of course suggest that the two sections necessarily cover the same ground, but what they have in common is that they are generally speaking aimed at transactions which in commercial terms fall within the charge to tax but have been, intentionally or otherwise, structured in such a way that on a purely juristic analysis they do not. This is what is meant by defeating the intention and application of the statute. Some of the work such provisions used to do has nowadays been taken over by the more realistic approach to the construction of taxing acts exemplified by W.T.Ramsay Ltd v. Inland Revenue Commissioners [1982] AC 300, although their Lordships should not be taken as casting any doubt upon the usefulness of such tax avoidance provisions as a long stop for the Revenue.

12. In the present case, there is no tension between the commercial and juristic character of the transaction. It is, in legal, commercial or any other terms, a transfer of financial arrangements for no consideration. Such a transaction either attracts a deduction or it does not. The Commissioner accepts that it does, but claims the right under section 64J(1) to be able to amend the law to ensure that it does not. Their Lordships do not think that the section was intended to confer such a power. It would amount to the imposition of tax by administrative discretion instead of by law.

13. In any case, their Lordships do not find in the accrual regime any principle which would be infringed by taking the terms of section 64F at face value, whatever the consideration might be. The general scheme of the regime is to tax the holder of the arrangement on his entire cash inflow less his entire cash outflow. In the case of a transfer for no consideration, there is no inflow corresponding to the capital value of the arrangement and therefore the net balance is reduced or negative. On the other hand, the acquisition cost of the transferee is zero and his net balance for tax purposes will be correspondingly higher. To the scheme there are of course qualifications and exceptions. It is however important to notice that the effect of the Commissioner’s proposed use of section 64J(1) is not to tax AHB in accordance with the pure theory of the regime but to introduce what he considers to be another necessary exception or qualification. Such an exception has since been introduced by section 17 of the Taxation (GST and Miscellaneous Provisions) Act 2000 but the Commissioner claims the right to anticipate the legislative amendment.

14. Mr Jenkin said that such a qualification was needed because the legislature could never have contemplated that a transfer for no consideration would give rise to a deduction. But this submission seems to their Lordships to be contrary to several of the provisions of the Act, which is the appropriate place in which to discover what the legislature contemplated. The Court of Appeal drew attention to section 64(J)(3), which provides that a transfer of a financial arrangement for no consideration by a person whose business comprises dealing in such arrangements and who acquired it for the purposes of sale or disposal, shall be deemed to have been at market price. Their Lordships agree with the majority of the Court of Appeal in thinking that, in the face of such a carefully targeted provision, it is impossible to find a general legislative intention that all transfers for no consideration should be treated as having been at market value.

15. Nor do the indications stop there. There are, for example, complicated provisions in section 64F dealing with the forgiveness of consideration due under a financial arrangement, which is in commercial terms no different from a transfer back to the issuer for no consideration. These and other provisions show that the legislature had well in mind the possibility that the holder of a financial arrangement might deal with his interest otherwise than at arms’ length and that it made specific provision for those cases in which it considered that such dealings should be counteracted.

16. Their Lordships are therefore in agreement with the views of the majority in the Court of Appeal and will humbly advise Her Majesty that the appeal should be dismissed. The Commissioner must pay AHB’s costs before their Lordships’ Board.