Accountant loses appeal in High Court for expenditure on rental properties and treatment of trust income and expenses

Summary

This decision concerns the appellant taxpayer’s (Mr Wong) appeal against the Taxation Review Authority’s (“the Authority”) decision upholding the Commissioner of Inland Revenue’s (“the Commissioner”) assessments in the 2013 and 2014 income years (“years in dispute”) (TRA Case 09/16 [2017] NZTRA 04). The Commissioner disallowed interest and other expenditure on funds borrowed to purchase properties for commercial rental having the effect of increasing Mr Wong’s taxable income. The High Court was not satisfied that Mr Wong had discharged his onus of showing how and by how much the Commissioner’s assessments were wrong ultimately finding the Authority’s decision correct in all respects and disallowing the appeal.

Impact

This decision confirms, as per Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2 NZLR 289, that the onus of proof rests on the taxpayer to show that the Commissioner’s assessments are wrong and by how much they are wrong (at [171]). The ability to accrue, carry forward and apply tax losses falls within the broad definition of a “tax shortfall” pursuant to ss 3 and 141 of the TAA, being a tax benefit, credit or advantage of any type or description whatever benefiting the taxpayer or another person.

Facts

Mr Wong is a chartered accountant and operates a consultancy business from his residential address. Mr Wong’s rental and consultancy income went into his various revolving credit accounts. Business and personal expenditure were paid by the disputant from personal credits cards and from funds in the revolving credit accounts.

Three rental properties were identified by the Commissioner during her investigation into Mr Wong’s tax affairs. The first property was purchased by Mr Wong in 2002 (“Upland Road”) for $555,000 and in the name of the Madeline Francesca Family Trust (“the Trust”). Mr Wong and his brother are trustees with Mr Wong and his daughter being beneficiaries. In September 2003, Mr Wong and his late partner purchased a rental property (“Ranfurly Road”) for $685,000 and another in August 2004 (“Victoria Avenue”) for $842,000. The total cost of the properties was $2,082,000. Funding for the properties was largely obtained by loan and credit facilities from ASB.

Mr Wong claimed interest on the borrowings for the Ranfurly Road property for only a small part of the 2013 income year. He also claimed interest in respect of the Victoria Avenue and Upland Road property for both tax years in dispute.

Decision

The High Court dismissed the appeal finding the Authority’s decision was correct in all respects.

Interest deductions

The High Court held that upon sale of the Ranfurly Road property the debt relating to the acquisition of that property should be excluded. The Court also suggested that it would be necessary to exclude part of the debt attributable to Upland Road, given it was owned by the Trust, Mr Wong failing to establish sufficient nexus pursuant to ss DA 1 and DB 6 of the Income Tax Act 2007.

While the High Court agreed with Mr Wong’s counsel that interest deductions on the Victoria Avenue property would have exceeded that allowed in the Commissioner’s assessment, Mr Wong had failed to prove the underlying premise, that the entire sum of $842,000 remained outstanding, and the actual interest paid thereon. The High Court was not persuaded that the Authority erred in rejecting Mr Wong’s claim that he was entitled to deductions for interest that he sought (Wong v Commissioner of Inland Revenue [2018] NZHC 2729 at [31]).

Upland Road

Mr Wong challenged the Authority’s finding that he was not entitled to deductions in relation to Upland Road submitting that the Commissioner “can’t have it both ways” i.e. that he should not be liable for the tax on the income from the property but at the same time be denied deductions for expenses. However, the High Court, in agreeing with the Authority, determined that Mr Wong was not entitled to deduct any expenses for insurance and rates for Upland Road given those expenses were incurred by the trustees of the Trust as owners of the property (at [46]-[48]).

Penalties

In the Authority, Mr Wong contended that no tax shortfall arose because once his accumulated losses were taken into account, he had no taxable income in either of the years in dispute. The question before the Authority was whether the tax position taken by the disputant, in not filing tax returns by the due date, “overstate[d] a tax benefit, credit or advantage of any type or description whatever by or benefitting…the disputant or another person. (Italics added)” (TRA Case 09/16 [2017] NZTRA 04 at [66]).

On this point, the Authority concluded that the ability to accrue and carry forward tax losses thereby reducing the amount of tax payable on income earned in subsequent years is plainly a tax advantage to any taxpayer. The Authority was therefore satisfied that the disputant had taken a tax position that resulted in a tax shortfall in each of the years in dispute.

The High Court agreed that the Authority’s decision was correct for the reasons it gave (at [62]). Furthermore, the High Court agreed with the Commissioner’s submission that s 141 of the Tax Administration Act 1994 (TAA) made it clear that a tax shortfall may still arise if a taxpayer has no tax to pay (at [64]).