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Deemed Correctness in Time-Barred Years - November 2008

Deemed Correctness in Time-Barred Years

In the recent High Court decision McIlraith v CIR (2007) 23 NZTC 21,456, Asher J held that the CIR could  amend the current account balance carried forward from a time-barred year into a year which was not time barred.  An issue which has not been explored in the reported decision is whether the deemed correctness of earlier years’ assessments impacts on the CIR’s and the Court’s ability to vary a figure carried forward from a time-barred period.

Deemed Correctness

Section 109 Tax Administration Act 1994 (“TAA”) provides that

SECT 109.             DISPUTABLE DECISIONS DEEMED CORRECT EXCEPT IN PROCEEDINGS -  

Except in objection proceedings under Part VIII or a challenge under Part VIIIA, -

(a)          No disputable decision may be disputed in a court or in any proceedings on any ground whatsoever; and

(b)          Every disputable decision and, where relevant, all of its particulars are deemed to be, and are to be taken as being, correct in all respects.]

The main type of disputable decision to which this section applies is an assessment of Income Tax or GST (see definition of “disputable decision” in section 3 TAA).  This section’s purpose is obvious – to prevent challenges to the correctness of the CIR’s assessments in any forum except the Part VIIIA TAA challenge procedure (or its predecessor in Part VIII).  Consequently, a taxpayer faced with debt collection proceedings by the CIR cannot raise as a defence that the sum demanded is not owing because the CIR’s assessment is wrong – see e.g. Re Seagar, ex parte CIR (2001) 20 NZTC 17,144 (HC). 

There is a surprising dearth of case law on what the “particulars” of an assessment are which are deemed to be correct.  First principles would seem to indicate that they must be all matters of fact and law bearing on the correctness and quantum of the assessment. 

Section 109 has been held on several occasions to prevent the CIR (or the taxpayer) from disputing the correctness of previous (time-barred) periods’ particulars in the context of a dispute about later, non-time barred, periods.

·         In Simunovich Fisheries Ltd v CIR [2002] 2 NZLR 516 (CA) Richardson P held that the provision prevented the Commissioner in a later GST period from disputing the characterisation of an asset for GST purposes in an earlier GST assessment (the Commissioner wished to treat a fishing boat as having been acquired as a second-hand good, whereas he had previously assessed its acquisition as a taxable supply, but quantum of the earlier assessment remained the same),

·         In Macfarlane v C of T [1923] NZLR 801 (CA) the section was held to bind the Commissioner to the standard value basis on which Mr Macfarlane had returned the stock and been assessed in previous years, and

·         In Kirkpatrick v CIR [1962] NZLR 493 (HC) the section bound the Commissioner and the taxpayer from making or disputing assessments inconsistent with the basis on which prior assessments were made.  In particular, the taxpayer could not challenge the assessed opening value of wool on hand because of the “nil” return for closing value in the last time-barred year.

Similar principles have been upheld in other jurisdictions, e.g. Wm H Muller & Company (London), Limited v CIR (1928) 14 TC 116.

Limitations on Deemed Correctness

There are however, limits on this principle which are apparent from the cases and from the scheme and purpose of the TAA.  Section 109 does not mean that a taxpayer can rely on the (deemed) correctness of other years’ or taxpayers’ assessments on the same or similar transactions as some sort of precedent:

·         There are many cases where earlier years have been statute barred and only later years open for challenge – e.g. BNZ Finance Ltd v Holland (CIR) (1997) 18 NZTC 13,156 (CA) which was a judicial review of the validity of assessments – two of four years were held to be statute barred and in the context of a judicial review, if the finding on the earlier years meant the later years could not be amended, one would expect the Court to have said so;

·         Arguments in analogous and potentially stronger cases have been unsuccessful – e.g. Brierley Investments Ltd v Bouzaid [1993] 3 NZLR 655 (CA) where the taxpayer argued unsuccessfully that the CIR’s acceptance in earlier years of the application of a certain formula for allocating interest to revenue and capital expenditure (which allocation determined the deductibility of the interest) created a “legitimate expectation” that the formula would continue to be applied – if the mere fact of earlier years’ assessments created an estoppel then that would have been a simple answer in the taxpayers’ favour.

The apparent principle from the cases is that the mere fact of an earlier year’s assessment does not mean that the CIR or the taxpayer are bound to apply that same result for later years, but that if there is a particular factor or status of an asset or transaction which is implicit in the earlier year’s assessment which directly carries across to the later year’s assessment, then the CIR and the taxpayer are bound to treat that factor consistently with the deemed correct earlier assessment.  Examples from the cases include closing stock values, valuation bases, the GST status of an asset.  Perhaps other examples would include accumulated depreciation, the amount of losses to carry forward, and the value of shares under the FIF or CFC rules.

McIlraith

Mr McIlraith disputed his assessment in relation to whether payments from his companies were income or simply drawings against his current account.  It appears from the judgment that the figure of $25,034 was reassessed by the CIR as the current account balance from (time-barred) 1995 that was to be carried forward into the 1996 accounting year, which was not time-barred and was the first year in dispute.

The taxpayer appears to have relied solely upon the time bar provision in his arguments, and Asher J rejected them shortly, pointing out that the CIR was not amending the time-barred 1995 year but the non-time barred 1996 year:        

“I consider that Mr McIlraith's submission is based on a misunderstanding as to the nature of the 1996 assessment. The Commissioner was not seeking to increase the assessment for the 1995 income tax year. He was merely correctly inserting, as he had to, the current account balance to be carried forward. The Commissioner has not amended the assessment for the 1995 year. Obviously, a balance must always be carried forward. I do not consider that the inclusion of the current account balance of $25,034 was time barred. $25,034 was the current account balance from 1995 that was carried forward into the 1996 accounting year.”

Asher J expressed the view that had CIR been seeking to alter an assessment for a time barred year, he would have been able to do so under s 25(2) ITA 1976, as the taxpayer had omitted to mention all income from the company in the 1995 year.  While this would be the case on the facts as found, the taxpayer and CIR would probably have had to have engaged in separate dispute and challenge proceedings in relation to the 1995 year in order to determine this.

The disappointing aspect of the judgment is that it does not consider whether the closing value of the 1995 year current account is one of those “particulars” of an assessment which is deemed correct and binds the CIR and taxpayer alike, so that it had to be carried forward into the 1996 year at the same figure.  By analogy with the closing stock value in Kirkpatrick, or the valuation basis in Macfarlane (both decisions considered and approved by the Court of Appeal reasonably recently), it would seem that the closing value is indeed one of those particulars and it was not open to the CIR to substitute a different opening value for the following year.

To illustrate that this is one of the particulars of the previous year’s assessment, one should consider how the correctness of the opening value could be determined.  Clearly this could only be done by an inquiry as to the correctness of what happened in the previous year(s), including all the transactions which led to the closing value for the 1995 year.  Yet those years are (subject to the exceptions to the time bar) immune from challenge.  If the judge’s approach in McIlraith were correct, it would seem that any taxpayer who had losses carried forward, accumulated depreciation, or relied on a certain closing value carried forward for some matter of account would effectively lose the protection of the time bar, for the CIR could simply adjust later years to deny the tax advantages from time-barred years.

Conclusion

It seems to the writer that the decision that the amount brought forward from the previous year could be adjusted without an adjustment to the amount carried forward at the end of that previous year, is contrary to established cases and wrong in principle.  However, as above, Asher J held that even if the time bar would otherwise have prevented the carrying forward from the 1995 year, that year was in any event not covered by the time bar because of a failure to disclose income. Therefore the result to this taxpayer would (in the end) have been the same in any event.