What’s Mine Is Yours – Section 157 Notices – December 2008
What’s Mine Is Yours – A New Dimension to Section 157
Most tax practitioners will know, if not love, section 157 of the Tax Administration Act 1994 (“TAA”). It enables the CIR to require someone who has an obligation to make a payment to a defaulting taxpayer or who holds funds on a defaulting taxpayer’s behalf to pay an amount from that payment or those funds to the CIR instead, in satisfaction of the taxpayer’s tax debt. Its effect is therefore like the civil remedy formerly known as (and still colloquially referred to as) a “garnishee order”: a charging order issued against a person other than the judgment debtor, in situations where that person owes a debt to the judgment debtor or is holding moneys on account of the judgment debtor.
A very recent decision, Enterprises Lakeview Ltd v CIR (Unrep High Court Hamilton, 13 November 2008, CIV-2007-419-1727, Gendall J), appears to extend the application of s 157 from cases where the CIR can issue a notice to A who owes money to B, requiring A to pay that money to the CIR in satisfaction of B’s tax liability, to circumstances where the CIR issues a notice to A, who owes money to B, requiring A to pay that money to the CIR in satisfaction of C’s liability. This article examines whether the apparently surprising outcome is justifiable.
The Facts in Enterprises Lakeview
It does not appear as if the taxpayers in this case engaged the Court’s sympathy. Mr and Mrs Smith operated, as a partnership, a business selling kindling wood and trellis fencing. An IRD investigation showed that large amounts of income tax, GST and PAYE had been evaded, and Mr and Mrs Smith were found guilty and sentenced to prison and home detention respectively.
In October 2007, after charges had been laid, the CIR issued s157 notices to Solid Energy Limited requiring payment to the CIR of money which Solid Energy owed to the partnership and to a related company (Trellis and Fencing Warehouse Ltd) in respect of outstanding tax which each owed. Solid Energy duly paid these amounts over to the CIR.
Mr Smith then entered into an agreement to sell the business to a Ms Parker, and invoices were subsequently sent to Solid Energy under the name “Lakeview Enterprises”, or “Enterprises Lakeview”, a company being incorporated under the latter name. The sale to Ms Parker did not proceed.
Following an interview with Ms Parker which seemed to show that she knew very little about the business and that the transfer did not take place, the IRD investigator sent a fax to Solid Energy on 19 October 2007, saying:
It is our opinion that Lakeview Enterprises is merely an agent for either Mr and Mrs Smith or Trellis and Fencing Warehouse Ltd. There is no evidence that the money is payable to anyone else other than Mr and Mrs Smith or Trellis and Fencing Warehouse Ltd.
Therefore please pay the funds to us in accordance with the s 157 notices.
Solid Energy then proceeded to do this, despite the apparent fact that the section 157 notices did not require it to pay to the CIR moneys owing to Enterprises Lakeview. Judicial review proceedings were taken on behalf of Enterprises Lakeview Ltd challenging the legality of the CIR requiring payment due to that company to be diverted so as to satisfy other taxpayers’ debts.
Reasoning in Enterprises Lakeview Ltd
Gendall J held that:
· The purported sale of the business was “an artifice or device created by Mr Smith”, done so as to escape the impact of the s 157 notices.
· Ms Parker did not acquire the shareholding, goodwill or assets of Trellis and Fencing Warehouse Ltd.
· Ms Parker did not acquire the shares in Enterprises Lakeview.
· The “true creditor” was not Enterprises Lakeview.
· The Courts will not allow the corporate form to be used for purposes of fraud or as a device to evade legal obligations where advantages of incorporation are used and intended to deprive others of their rights.
· A legal entity may be acting as an agent of an individual and in fact doing his business and not its own at all. The evidence before Gendall J established that that was the case.
Analysis of Reasoning
At first glance the result seems hard to justify. One of the main attractions of the corporate structure is to separate the assets and liabilities of a trading operation from those of the people who own and run that company. In this sense many companies (especially one-man companies) may be factually indistinguishable from those of the individuals who own and run them. It is easy to stigmatise such arrangements as “using and intending the advantages of incorporation to deprive others of their rights”; in itself a question-begging phrase. Limited liability, however, must mean that, and the cases recognise that even in the case of one-man companies, the separate legal personality of the company will be respected (see for example Lee v Lee’s Air Farming Ltd [1961] AC 12, NZLR 325 (PC)). Consequently it should not be enough for the CIR to require payment due by A to B to be paid to the CIR in satisfaction of C’s debts, even if B is a company associated with C.
The essence of Gendall J’s judgment (endorsing the CIR’s apparent argument) seems to be that the business was never effectively transferred to Enterprises Lakeview, and hence the amounts payable by Solid Energy remained owing to the defaulting taxpayers, even though the invoices directed payment to the plaintiff company, Enterprises Lakeview. As such, and as recognised by the Judge (paragraph [52] of the unreported judgment), the decision does not involve or require ignoring a company’s separate entity status. Rather the judgment appears to rely on the principle of agency: Enterprises Lakeview received the payments from Solid Energy as agent for the real creditors, the defaulting taxpayers.
The judgment may also be defensible on the alternative basis that a payment if transferred by the payer at the direction of the payee to some third party, is still recognised as payment to the payee (section BD 3(4) Income Tax Act 2007), or at least “an amount payable in relation to” the payee. This appears to be the basis on which an earlier decision under section 157’s equivalent for GST[1], Gennaker Holdings v IRD (1991) 13 NZTC 8,154 (HC), was decided.
The Reasoning in Gennaker Holdings
In Gennaker Holdings the lessee of a building was required by the GST equivalent of a s 157 notice to pay the CIR rather than the lessor (the defaulting taxpayer). Gennaker Holdings was a mortgagee of the lessor, and an agreement was made between it, the lessee and the lessor that all rent was to be paid to Gennaker Holdings directly in discharge of the lessor’s obligations under the mortgage.
The Court held that there was “an amount payable [by the lessee] in relation to the taxpayer”, being the statutory language in section 157, its predecessor [2]and its equivalent in relation to GST, because the lease had not been assigned to Gennaker Holdings and therefore the rent was an amount payable “in relation to” the defaulting taxpayer, the lessor.
Summary
In summary, the result may not be so surprising as appears at first glance. While ordinarily establishing a different corporate structure to take over an existing contract may mean that (at best for the CIR) a replacement section 157 notice needs to be served, if such “restructuring” is as insubstantial as it appears to have been in the current case then the Courts may be justified in holding that the successor company has not taken over, just acted as an agent or nameplate for the defaulting taxpayers.
[1] Section 43 of the Goods and Services Tax Act 1985
[2] Section 400 of the Income Tax Act 1976