Limitation periods – the crucial question of when tax liability arises
/Duthie v Roose [2017] NZSC 152
Background
In early 2008 Ms Roose wanted to protect herself against the possibility of a relationship property claim, and proposed to transfer property held by her company, DDL, into a trust. DDL had recently obtained a resource consent to subdivide the property into seven sections.
Ms Roose sought advice from her chartered accountant, Mr Duthie. According to Ms Roose, Mr Duthie advised her that transferring the property from DDL to a trust would not attract income tax liability. On 14 April 2008 DDL entered into an agreement to sell the property to a newly established trust for $1,950,000. Ms Roose’s solicitors settled the transaction on 2 May 2008.
Mr Duthie’s advice led to a less than ideal result for Ms Roose. When the Inland Revenue later carried out an audit, it determined that DDL had been carrying out a taxable activity (property development) and was liable to pay income tax for the 2009 year. A shortfall penalty was imposed.
Ms Roose, DDL and the trust commenced legal proceedings against Mr Duthie on 1 May 2014. The Roose parties claimed that Mr Duthie had given negligent accounting advice, and sought damages for adverse tax consequences.
Determining the date of loss
The preliminary issue before the Supreme Court was whether the Roose parties’ cause of action was barred by the six year limitation period in s 4 of the Limitation Act 1950. This depended on the date of loss. If tax liability arose at the date of settlement, 2 May 2008, the action could proceed. However if liability arose when the unconditional agreement was entered into on 14 April 2008, the action would be time barred.
The Supreme Court considered the wording of section GC 1 of the Income Tax Act 2004, under which DDL was liable to pay income tax. The section imposed income tax on “the amount” the vendor “derives from the disposing of land”. The question for the Court to determine was when, on the facts, DDL had “derived” income.
When income is ‘derived’
Income is generally said to have been “derived” when there is a right to sue for a debt. However as held in leading authority Gasparin,[1] the right to sue for specific performance under an unconditional agreement is not the same as the right to sue for a debt. If a purchaser refused to settle, the vendor would only be entitled to claim for damages, not the whole purchase price. Therefore, the general principle is that tax liability arises only on the point of settlement.
In Gasparin the unconditional sale and purchase agreements were between unrelated parties, meaning settlement was subject to contingences, and there was the possibility that settlement would not occur. The agreement between DDL and the trust differed in that it was between related parties, and the practical contingencies affecting settlement when third parties are involved were absent. However the Supreme Court decided to put any factual differences aside, and said the Gasparin approach should be applied anyway. The policy of the Income Tax Act is best advanced by taking a ‘bright-line approach’.
The Supreme Court upheld the Court of Appeal’s decision that tax liability did not arise until settlement date. The cause of action was within the limitation period and the claim could proceed.
Comment
Craig Langstone, Partner at Fee Langstone, says the Supreme Court decision is yet another example of the intricacies of the law relating to limitation. Interestingly this case concerned the old 1950 Act, rather than the new 2010 Act. We await cases on the new Act with interest.
