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Cite as: [2001] UKPC 51, [2002] 2 WLR 313, [2002] STC 581, [2002] 1 AC 362, [2002] AC 362

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Privy Council Appeal No. 44 of 2000

Kena Kena Properties Limited Appellant v.

The Attorney General Respondent

FROM

THE COURT OF APPEAL OF NEW ZEALAND

JUDGMENT OF THE LORDS OF THE JUDICIAL

COMMITTEE OF THE PRIVY COUNCIL,

Delivered the 27th November 2001

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Present at the hearing:-

Lord Nicholls of Birkenhead

Lord Hoffmann

Lord Hobhouse of Woodborough

Lord Millett

Lord Scott of Foscote

[Majority Judgment delivered by Lord Hoffmann]

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Kena Kena Properties Ltd ("KKP") used to run the Kena Kena Rest Home at Paraparaumu Beach. The company joined the Rest Home Subsidy Scheme when the Minister of Social Welfare established it in 1989. The purpose of the scheme was to subsidise the cost of providing rest home accommodation for needy elderly people. A rest home proprietor who joined the scheme agreed to provide a resident with a certain level of accommodation and services in return for a fee which did not exceed the "maximum fee-for-service rate" fixed by the Department of Social Welfare. The department would assess the resident's financial eligibility for subsidy. If he was eligible, his national superannuation or guaranteed retirement income would be paid direct to the rest home proprietor. Sometimes the resident or his relatives, if they had the means, would be required to make an additional contribution. The balance of the fee would be paid to the rest home by the department.

KKP joined the scheme on 15 May 1989 by entering into a contract with the department in a standard form headed "Rest Home Subsidy Scheme. Agreement with Participating Rest Homes". It provided in clause 1 that the department "retains [KKP] to provide the services described in Schedule A … in the above-described rest home … and subject to the conditions described in Schedule B". By clause 4, the department agreed to pay KKP "for the services provided under this Agreement in the manner provided in Schedule D". Schedule A set out the standard of accommodation and services to be provided to residents. Schedule B contained a condition that KKP would not charge subsidised residents more than the maximum fee-for-service. Schedule D provided that the "level of subsidy" would be the difference between the maximum fee-for-service rate (or the rate actually charged, if less) and the resident's contributions by way of superannuation benefit or otherwise.

Paragraph 1(c) of Schedule D provided for annual adjustment of the fee-for-service rate on the first payday in April. The rate was fixed by reference to three components: non-labour operating costs, labour operating costs and a return on investment. At each review the non-labour operating cost element was adjusted by reference to changes in the Consumer Price Index, the labour operating cost element by reference to movements in average weekly wages and the return on investment by reference to changes in market rates of return.

When the fee-for-service rate was first determined in 1989, the calculation of labour and non-labour operating costs took into account the fact that goods and services tax ("GST") would be payable by the rest home proprietor. At that time the rate of tax on dutiable items was 10%. Rest homes were allowed a discount for goods or services not subject to GST and paid 8.2% on the fees they charged. Although the fee-for-service rate was fixed as a global figure without mention of GST, the liability was built into the calculation.

Almost immediately after the signing of the agreement between KKP and the department, on 1 July 1989, the general rate of GST was increased to 12.5% and the rate for rest homes to 10.25%. The unchallenged evidence before the judge of Mr Gallen, on behalf of the department, was that, at the first adjustment of the fee-for-service rate in 1990, the increase was taken into account in determining the new figure. The increased rate was then used to calculate the figures in subsequent years.

On 30 June 1993 the contract between the department and KKP came to an end. On 14 January 1999 KKP commenced proceedings in which it claimed that the sums paid to it by the department during the period from 1 July 1989 until the contract expired should have been increased by the difference between an 8.2% GST rate and a 10.25% rate. This amounted to $17,844.89.

The claim is made by virtue of section 78(2) of the Goods and Services Tax Act 1985:

"Where an alteration in the law is made and a supplier has at any time entered into any agreement or contract in respect of the supply of goods and services with a recipient, unless express provision for the exclusion of any such alteration in the law is contained in the agreement or contract, or where the alteration in the law has been taken into account, every such agreement or contract shall be deemed to be modified as follows:

(a) Where the alteration in the law renders that supply liable to be charged with tax or increases the amount of any tax charged or chargeable in relation to that supply, the supplier may add to the agreed price in the said agreement or contract the amount of that tax or the increase of that tax …

Provided … that this subsection shall not apply to require a public authority to alter any amount agreed to be paid by the authority in respect of any supply of goods and services where the consideration for that supply is in the nature of a grant or subsidy."

KKP says that it entered into an agreement with the department in respect of the supply of goods and services, namely the services to be provided to subsidised residents under Schedule A, for an agreed price, namely the fee-for-service rate or (if less) the total fee charged, less the resident's contribution. It was therefore entitled to add the difference between an 8.2% rate and a 10.25% rate.

There is very little merit in the claim. KKP agreed that increases in its costs should be adjusted each year. If it was dissatisfied with the scheme it could have withdrawn on 60 days notice: see clause 10(a) of the contract. The adjustment made in April 1990 and subsequent years reflected the increase in the rate of GST. So KKP is claiming the increase twice over. But the department has not argued, as possibly it might have done, that the alteration in the law had been "taken into account". It has taken its stand on the proviso, saying that no increase is required because its payments to KKP were "in the nature of a grant or subsidy". This of course has wider implications. It means that no increase would have been required even if the annual adjustment had not taken GST into account.

The appellant's submission, economically and attractively advanced by Mr Napier, is that the payment by the department was a subsidy to the residents but not to the rest home. KKP was simply being paid a commercial rate for the services which it provided under the contract. The words "in the nature of a grant or subsidy" in the proviso should be construed to mean a grant or subsidy to the other party to the contract.

The same point was argued before the Court of Appeal in Director-General of Social Welfare v De Morgan [1996] 3 NZLR 677 and rejected. Richardson P said (at pp. 683-684):

"It is the character or quality of what is to be paid and of the consideration which is given which is crucial, not its receipt in the hands of the payee."

In the present case, Doogue J. and the Court of Appeal followed De Morgan's case without further comment.

Their Lordships do not think that it is possible to restrict the application of the proviso to grants or subsidies of which the beneficiary is the other party to the contract. Most grants or subsidies will be made to public, charitable or private bodies in order to confer benefits upon third parties. They are made because it is considered in the public interest to enable such bodies to provide accommodation, health services, cultural events and so forth to members of the public at concessionary rates. The body in question is not itself the intended beneficiary although the subsidy may enable it to attract business. It is the conduit through which the benefits are provided. If that is not what was contemplated by the proviso, their Lordships find it difficult to imagine what was.

Mr Napier was inclined to concede that the proviso would apply to a case in which the party providing the service in return for the grant or subsidy, although not itself the beneficiary, was a non-profit-making organisation. KKP, on the other hand, was a commercial company. It provided the service for the department in the same way as it would have provided a similar service to a privately-funded resident. But that is a different argument from the one which says that "grant or subsidy" must be construed as grant or subsidy to the party providing the service. It relies instead upon a distinction between "commercial" and "non-profit-making" recipients which is very hard to find in the statutory language.

Their Lordships think that the policy behind the proviso was to leave the level of grants or subsidies, whether paid directly to the beneficiaries or by way of contracts with service providers, to government decision. It therefore looks at the question of whether the payment is a grant or subsidy from the government's point of view. It is a matter for the government to decide whether an increase in GST requires the level of subsidy to be correspondingly increased. No automatic contractual provision is necessary or desirable. In the case of the Rest Home Subsidy Scheme it was taken into account in the next adjustment of the fee-for-service rate. In another case the government might consider that the level of subsidy did not need to be changed.

Their Lordships therefore think that the Court of Appeal in De Morgan's case was right in saying that the question was whether, from the point of view of the department, the character or quality of the payment was in the nature of a grant or subsidy and not whether it was for the benefit of the service provider rather than the recipient of the service. If that is the question, there can be no doubt about the answer. Their Lordships will therefore humbly advise Her Majesty that the appeal should be dismissed. The appellant must pay the costs of the Attorney-General before the Board.

Dissenting judgment delivered by Lord Hobhouse of Woodborough and Lord Scott of Foscote

The Court of Appeal of New Zealand has twice decided that payments made by the Director-General of Social Welfare to resthomes under the standard form of "Agreement with Participating Rest Homes" are the consideration for the supply of goods and services "in the nature of a grant or subsidy" as that expression is used in the second proviso to s.78(2) of the Goods and Services Tax Act 1985. However, the Court of Appeal in the present case nevertheless gave leave to appeal to this Board. The decisions and the grant of leave to appeal have been based upon the question of the effect of the proviso. No issue has been raised upon the question whether the terms of the standard Agreement did not take it outside the scope of s.78(2) altogether. If it is indeed correct that the provisions of Schedule D of the Agreement meant that the increase in GST was automatically taken into account in the maximum fee for service rate at each annual review, then this would be a case where an express provision takes into account any alteration in the rate of tax and the question under the proviso would not arise. It would be, as has already been pointed out, absurd to construe the contract as permitting the same adjustment to be claimed twice over even for a limited period. However that is not the question with which this appeal has been concerned. It is the question which arises under the proviso.

The reasons given by the Court of Appeal for applying the proviso have on each occasion been brief. In Director-General of Social Services v De Morgan [1996] 3 NZLR 677 at 683-4, Richardson P said:

"It is the character or quality of what is to be paid and of the consideration which is given which is crucial, not its receipt in the hands of the payee. And the extending words 'in the nature of' make it clear that even if technically not a grant or subsidy, the consideration will come within the proviso if it is within the nature of a grant or subsidy (cf Doak v Bedford [1964] 2 QB 587, 594.)

The transaction … [is] much more than an ordinary commercial contract specifying a commercial fee for a commercial service. … The contractor participates in the rest-home subsidy scheme and is 'retained' to provide the services described in the agreement.

In turn, the Director-General is performing a standard function on behalf of the state of providing financial support in respect of residents who satisfy the dual criteria of assessed need and financial eligibility for the service. The full charge for the service recipient is met in part by the resident and as to the balance by the department under the rest-home subsidy scheme. …"

In the present case Thomas J, referring to the judgment of Richardson P, said:

"Its decision recognised that the proviso was intended to clarify that no increase in a subsidy or grant would automatically follow to compensate for increases in GST."

There are thus two strands: understanding the structure and content of the contractual agreement and adopting a purposive construction of the statutory proviso.

The Contract:

The parties to the contract are The Director-General of Social Welfare ("the Department") on behalf of the Crown and the rest-home licensee ("the Contractor"). Stress has been laid on the fact that the document is headed "Rest Home Subsidy Scheme". It is therefore necessary to refer to the circumstances surrounding the making of the contract. The contractor holds a licence to run various rest-homes which are typically suitable for providing the elderly, the mentally incapacitated and the convalescent (the "service-recipients") with suitable residential facilities, short and long term. The Contractor is a commercial profit-making concern and has standard fees which it charges for its services. The Department is a department of government responsible for administering a publicly funded scheme for providing financial support to those in need of such rest-home facilities and who cannot themselves afford to pay for those services. Anyone who seeks such support must apply for it and be assessed by officers of the Department as qualifying for it on (among other things) financial grounds. If the applicant has some means, the support will only be partial. The applicant must pay the balance of the rest-home fee himself; where the applicant has a capital asset, the payment of support may be by way of loan. The financial scheme as between the Department and the recipient was thus that the Department would make up the difference between what the recipient could afford to pay and the amount of the rest-home fee. As a safeguard against profiteering by rest-homes, the Department also operated a procedure for fixing the reasonable maximum which a rest-home is allowed to charge.

By the contract, the Contractor undertakes an obligation to provide residential rest-home services (which include full board and primary health care: Schedule A) to those admitted to the rest-home by the Contractor, per Schedule B paragraph (b), and assessed by the Department to be in need and eligible (Schedule C) and in respect of whom the Department is paying the rest-home subsidy: clause 2. In consideration, the Department undertakes to pay to the Contractor in respect of each such person a sum calculated as provided in Schedule D. The essence of this calculation is that the Department pays a sum which, after deducting the service-recipient's own net income, is equivalent to the lesser of the standard fee and the maximum fee, as assessed under paragraph 1(c). This is termed the "level of subsidy payable" and is assessed by the Department: paragraph 1(d). The Department also undertakes to pay direct to the Contractor the service-recipient's national superannuation or social security benefit, paragraph 1(a), being his or her income which will have been allowed for before assessing the level of subsidy. It appears that in the large majority of cases the superannuation or benefit will represent the only income of the recipient, so that all the payments which the Contractor receives come from the Government. But, in some cases, the recipient will have been assessed as having other income and the Contractor will then have to look to the recipient for the payment of the balance of the fee, subject to the permitted maximum: Schedule B paragraph (c).

The statutory obligation to pay the 'subsidy' is an obligation imposed by statute upon the Department in favour of the qualifying recipient - "providing financial support for eligible rest-home residents" (per Thomas J, sup.). The contractual relationships are respectively those between the recipient and the rest-home and between the Department and the rest-home. The rest-home in each case undertakes to provide the rest-home service, the recipient and the Department each undertaking to pay their respective share of the fee. Applying the words of the proviso to this structure, there is (it is understood) no dispute that as regards the recipient's share of the fee it does not come within the proviso. Therefore it should follow that the element of superannuation or benefit does not either. As regards the Department's share, the Department is making a payment to the Contractor in consideration of the supply of the service. There is no element of subsidy involved. No more (and, maybe, less) than the market value of the service is being paid. No sum by way of grant is being paid to the Contractor. The only nature which the sums paid to the Contractor has is that of reasonable commercial consideration for the supply of a service.

The argument successful in the Court of Appeal would cover any commercial contract where the person buying the goods or services was receiving financial support from the Government. One can think of many examples: a subsidised municipal railway placing an order for new rolling stock, a national health service engaging contractors or consultants, a legal aid scheme providing financial support to impoverished defendants. In each example the relevant contract of supply is a commercial contract involving no more than the payment of the price of that supplied. In contrast it is possible that the government might choose to support an uneconomic industry or enterprise by purchasing from it goods or services at an over-value, ie at more than the market rate, or by guaranteeing a certain price which would not otherwise be achieved, say, because of international competition. The inclusion of the phrase "in the nature of" assists the appellant not the respondent. It requires that the nature of the consideration be examined. In this contract the nature of the consideration is the payment of a reasonable commercial price for the services supplied. Without linguistic support from the wording of various parts of the contract, the respondent's case would become almost unarguable. The inclusion of the phrase "in the nature of" shows that the substance of the parties' contract must be looked at not merely some of the language.

The Statute:

The purposive argument looks to the government's interest in not taxing its own subsidies or grants. Thus it is said that the purpose of the proviso is "to clarify that no increase in a subsidy or grant would automatically follow to compensate for increases in GST". This statement points up the problems for the respondent on this appeal. The Contractor simply asks for the payment of the agreed consideration for the supply; the Contractor does not seek any subsidy or grant from the Department. The primary purpose of s.78(2) is the achievement of a fair adjustment of the price as between supplier and purchaser to take account of the increased cost to the supplier of making the supply. The respondent's argument seeks to defeat this primary purpose. There are many things a government can do to increase the costs of suppliers. If the government wishes to continue to purchase such supplies, it will as an ordinary exercise in market economics find itself having to pay the supplier more. That is what [it is to be assumed] has happened here. But the government will always, subject to any contractual obligations it has entered into, have the choice whether or not to continue to make the purchases. In the present scheme, the government has the political choice to take steps to reduce or discontinue its subsidy of the disadvantaged and needy. It is not part of the purpose of s.78(2) to alter any entitlements as between the disadvantaged and needy and the government. But that entitlement is not the subject of this litigation.

To summarise, in our opinion the question whether, for the purposes of the second proviso, consideration is "in the nature of a grant or subsidy" must be assessed by reference to the position as between the contracting parties. If it is not a grant or a subsidy as between them, it is not, in our view, caught by the proviso. It is not to the point that the payer, in contracting for the supply of the services or goods, may intend them to be provided for the benefit of a third party and thereby to subsidise the third party.

On the point argued before the Board, therefore, we must dissent from the advice given by the majority of their Lordships and would have advised that the appeal be allowed and the decision in the De Morgan case over-ruled.