Occasionally, the administration of the Inland Revenue Acts goes wrong. It is in those comparatively rare occasions that the usual sympathy towards the Revenue’s position evaporates, and the rights of taxpayers are reasonably strenuously defended by the courts. These instances are also an example of the rare times when judicial review is the appropriate remedy to deal with administrative injustice. This article is prompted by the win Mr Dunphy and others had over the Commissioner (CIR) in Dunphy v Commissioner of Inland Revenue (2010) 24 NZTC 24,205 (HC).
Dunphy was a case in which the CIR did make an error in administration - and the courts insisted that the consequences of getting it wrong be put right. This article will explore what went wrong in the Dunphy case, and whether there are areas in the current Inland Revenue administration that could potentially go off the rails in a similar way.
The background to the Dunphy case stretches back to the early 1980s, when promoters were offering film investments as a way of mitigating the tax consequences of having a 66% top marginal tax rate. With tax rates that high, the top earners in the country were powerfully motivated to enter these and other schemes that were being promoted at the time. Other contemporaneous schemes involved investments in goats and kiwi fruit.
By the late 1980s, Inland Revenue had investigated and assessed the participants in many of these schemes, and primarily disallowed the deductions that they generated to shelter other professional income. Particular firms organised committees to manage the dispute with the CIR. It was in the context of managing multi-party litigation that the relevant administrative errors occurred.
In the early 1990s, the dispute procedure was still the 'objection and case stated' approach. The CIR was required to consider and reject an objection, and if so requested, to state a case to the courts for determination. The CIR also had the ability to accept late objections. This power was open-ended and was not prescribed to anywhere near the same extent as the comparative provisions in the Tax Administration Act 1994.
In this context, the investors in the Utu Film partnership were divided in their approach. Some wanted to proceed as a test case (the Hay group) and others wanted to await the result of the test case. By informal agreement, those taxpayers that wanted to be involved in the test case were assessed, and made objections. In the case of several taxpayers in the scheme, the CIR did not make assessments at all. The internal discipline within the taxpayer groups was not great, however. Some taxpayers approached Inland Revenue directly and settled directly with it.
Naturally Inland Revenue wanted to know which taxpayers were going to be bound by the result of the test case. They called this group "those with continuing objections".
On 22 July 1997, there was an interlocutory hearing concerning the evidence that could be called by Inland Revenue. The taxpayer group was unsuccessful, and rather dramatically, only days before the substantive matter was to be heard, the test case group discontinued their case stated. Those taxpayers who were on the “in” list were covered by the result in the test case and were expected to abandon their objections. Some taxpayers were not on the “in” list and hence were not explicitly dealt with by the CIR following the discontinuance of the test case.
The Dunphy taxpayers ended up being overlooked in the CIR’s attempts to wrap up the assessments relating to the Utu film scheme. At about this time, one of the taxpayer investors, Mr Peterson, decided to take a case independently to the Taxation Review Authority (TRA). He lost before the TRA; and the High Court on appeal, and in the Court of Appeal - but in 2005, he succeeded before the Privy Council.
Over the years in which Mr Peterson’s case was being litigated, there was no communication with the Dunphy group of taxpayers: Dunphy v Commissioner of Inland Revenue (2010) 24 NZTC 24,205 at . However, following Mr Peterson’s unexpected victory, Mr Dunphy’s advisors wrote to Inland Revenue asking whether the Department had a record of whether he had a live objection. Under the system that existed prior to the changes introduced by the Tax Administration Act in 1994, it was possible for the CIR to sit on an objection and not disallow it. This was often a device used to enable some cases to be held back, while de facto test cases were advanced.
Mr Dunphy was advised that no objection had been received in relation to the assessments disallowing the deductions pertaining to the Utu Film scheme. At this point difficulties arose. Inland Revenue officers at first considered that the inclusion of the taxpayers on an initial “in” list was not good enough, since nothing had been heard from them for some 15 or more years.
The present judicial review proceedings were then filed. As part of the CIR’s defence of the proceedings, an Inland Revenue officer was asked to consider whether the Department would accept “late objections”. That officer decided that Inland Revenue would not accept late objections. The taxpayers abandoned the argument that they had continuing live objections, and instead focused on the argument that late objections should be accepted on their behalf.
There were deficiencies in the taxpayers' pleadings, because they did not plead the late objection point, but had only pleaded that they had continuing objections from the late 1980s. Chisholm J invited the pleadings to be amended however, and despite protestations from CIR, his Honour allowed the changes:  to .
Part of the CIR's defence was the argument that the Peterson Privy Council judgment could not be expected to apply to the three Dunhpy taxpayers because the outcome in that case arose only as a result of what were called concessions made by the Commissioner: . It was argued that the concessions were “contrary to the economic reality of the transaction”: . The logic behind this argumentwas that that in light of subsequent developments in the New Zealand jurisprudence and the fact that no concessions would be made if the litigation were repeated, the Privy Council outcome could not be said to apply to these three taxpayers.
The Judge had “considerable difficulty” with the CIR’s argument in this regard: . In this regard Chisholm J listed seven reasons as to why this argument was wrong. His Honour was satisfied that the CIR should have considered the late objection from the perspective that the facts of Peterson applied to these taxpayers: .
Chisholm J then considered whether the Departmental officers had misdirected themselves in their respective decisions. The Judge's reasoning was essentially as follows:
- That there was an objection capable of qualifying as a late objection.
- That there were acceptable reasons explaining the delay between assessment and objection.
- That the CIR’s argument that there needs to be finality is correct in principle, but does not rule out the possibility of a late objection being accepted in particular factual situations.
- That there was merit in the application for a late objection in the circumstance of this case.
His Honour's conclusion was that the officers had so misdirected themselves. Consequently Chisholm J directed the CIR to reconsider their applications to file late objections. Thus this case represents a comparatively rare example of a successful judicial review proceeding being brought against the CIR.
The Dunphy case is therefore an example of the administration of the Revenue going wrong. Arguably, this state of affairs can be traced back to the early 1990s, with the confusion surrounding the taxpayers who were "in" and those who were not “in” regarding the test case. With the benefit of hindsight, it would have been preferable for the CIR to stick more closely to the statutory scheme of the time. That is, he should have expected and obtained objections from all taxpayers who wished to object to his assessments disallowing the film case depreciation deductions. He should have then disallowed those objections and insisted on a request being made to “state a case” if the taxpayers wanted to proceed with their objection.
Once a case was stated there was plenty of scope within the High Court rules to manage multi-party litigation. One approach would have been to apply for stays of all cases bar the test cases. Once the initial case had been discontinued, the CIR should then have consolidated the other cases and sought to have them heard. Those taxpayers who did not wish to proceed would have needed to file a notice of discontinuance.
Under this approach, there would be no room for argument as to which if any cases were still alive at the conclusion of thePeterson litigation, and it would also have been clear which cases were riding on the outcome of the Peterson case.
There is far less scope for these sorts of errors to occur now. The Tax Administration Act 1994 has strict time frames, and normally 2 month response periods. If the taxpayer or the CIR does not take particular prescribed steps within those response periods, there are deemed consequences. Further, while there are provisions dealing with failure to respond within the stipulated periods, those provisions are carefully prescribed. They drive off events beyond the taxpayer's control. Hence there is now no possibility of a repeat of the administrative looseness which surrounded the Utu cases.
Indeed, the Tax Administration Act 1994 has tightened up a number of areas where there was previously potential for administrative slackness. For example, the introduction of s 6A and the managerial discretion was accompanied by the removal of the older provisions that required write-offs of more than $50,000 of tax to be approved by the Minister of Finance. The latter requirement had previously lead to unfortunate litigation, where the Minister's approval had been overlooked by Inland Revenue in its settlement of some litigation. See for example Kemp v Commissioner of Inland Revenue(1999) 19 NZTC 15,110 (HC).
One area in which previous administrative errors are now coming to light is the Charitable sector. Entities which had previously been treated by Inland Revenue as charitable are being knocked back by the Charities Commission as not in fact meeting the requirements for charitable registration (see for example, Canterbury Development Corporation v Charities Commission (2010) 24 NZTC 24,143). While this trend may indicate that there were errors made while Inland Revenue administered the charities space, it is unlikely that those errors will lead to any litigation directly against the CIR.