Calkin v. Commissioner of Inland Revenue

[1984] 1 NZLR 440

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(Judgment by: Cooke J.)

Calkin
vCommissioner of Inland Revenue

Court:

Judges:
Cooke J.Richardson J.
Somers J

Subject References:
Income tax
Deductions
Misappropriations by agent
Taxpayer had been the victim of a confidence trick and had suffered a nett loss of $89,500
Taxpayer had believed that his money was being used by a person who was acting as his agent to buy and sell various assets for a profit with the agent taking a 10% commission
Agent turned out to be a confidence trickster and the transactions were fictitious
Whether the taxpayer was engaged in a business
Whether there had been an 'undertaking' carried on for pecuniary profit
Whether taxpayer's net loss was deductible for income tax purposes
Whether s 129CF allowed the deduction of a capital loss
Discussion of the distinction between fact and law in tax cases

Legislative References:
Land and Income Tax Act 1954 - ss 2, 111 and 129CF.

Case References:
Inland Revenue (Commissioner of) v Parson - [1968] NZLR 375.
Lowe v Commissioner of Inland Revenue - [1981] 1 NZLR 326

Hearing date: 3 February 1984
Judgment date: 10 May 1984

Wellington, New Zealand

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Judgment by:
Cooke J.

The appellant is the managing director of an Auckland-based company and is a chartered accountant by qualification. He was introduced by a business acquaintance to a young woman who had apparently arranged and carried through lucrative business deals for investors. He was impressed by her and the trappings of wealth evident in her style of life in the Wairarapa. Over about nine months in 1976 and 1977 he provided her with a total of $167,500 for various transactions in which she was to act as his agent, for 10% commission, to buy and sell for him various assets. He used partly his own funds and assets and partly money that he borrowed for the purpose from his bank and from his family and friends. The intended transactions were to involve the purchase of sheepskins from a tannery for sale to certain Japanese buyers; a commercial real estate property near to Wellington airport, which the appellant inspected and spoke about to her solicitor from time to time; the plant and machinery of another tannery that was going out of business; a concrete batching plant; and a "speculative work of art" to be bought and sold to a collector.

The appellant saw no documents relating to any of these proposals, but he received from her from time to time payments in return totalling $78,000. She represented that these were profits on the sheepskins, the tannery assets and the concrete batching plant. He was in constant contact with her by telephone and occasionally visited her in Wellington and stayed overnight at her and her husband's Masterton farm. She proposed other deals to him, possibly three or four, but he decided not to proceed with them, not thinking that they would be sufficiently profitable. In at least one of these other cases he inspected the Wellington real estate supposed to be involved. Ultimately a cheque from her said to represent profit on the work of art was dishonoured and he discovered that, like many others who had trusted her, he had been the victim of what he called in evidence in the High Court "a classic sting". It turned out that all the supposed transactions were probably fictitious. She was convicted and imprisoned for theft by misappropriation from various other persons, and the appellant's case appears to have been in the same category.

His net losses amounted to $89,500, of which $6500 was incurred in the year ended 31 March 1976 and the rest in the year ended 31 March 1977. He claimed these losses for income tax purposes, but the Commissioner considered that they were losses of capital and not deductible. On a case stated to the High Court, treated as stated under the Income Tax Act 1976, s 33, Wallace J held that in the activities in question the appellant was not "carrying on a business" within the meaning of the income tax legislation and that the Commissioner had accordingly acted correctly.

From a decision in the High Court on such a case stated there is the ordinary unrestricted right of appeal under the Judicature Act 1908, s 66: Commissioner of Inland Revenue v Parson [1968] NZLR 375. The case stated here covered questions of both law and fact. It follows that the appeal need not be confined to questions of law. The original notice of appeal on behalf of the appellant specified as the only ground that the judgment was erroneous in law. During the hearing we gave leave, there being no objection for the respondent, to amend the grounds to include error in fact. The point is of some significance because, in my view, the appellant could not succeed in this case unless he could show that Wallace J was wrong on the facts.

Losses by misappropriation

There is, however, one pure question of law that was argued in both Courts. On the view that he reached, the High Court Judge ultimately found it unnecessary to express an opinion on this question. But it may be seen as a preliminary question and is of general importance. It does not seem difficult and I understand this Court to be unanimous upon it. So it may conveniently be dealt with first.

Section 129CF of the Land and Income Tax Act 1954, the present equivalent of which is s 164 of the Income Tax Act 1976, provided:

"129CF. Misappropriation by employees and other persons engaged for the purposes of the business of the taxpayer- (1) Where a taxpayer carrying on any business incurs any loss (being a loss which has not been taken into account otherwise than under this section in calculating the assessable income of the taxpayer for any income year) in the course of the business as a result of the misappropriation of property of any kind by any person who is employed by, or renders services to, the taxpayer for the purposes of that business, the Commissioner may, in calculating the assessable income derived by the taxpayer in the year in which the loss is ascertained, or in such one or more earlier years as the Commissioner considers equitable in the circumstances, allow a deduction for the amount of that loss: Provided that any amount recouped by the taxpayer at any time, whether by way of insurance, indemnity, reimbursement, recovery, or otherwise howsoever, in respect of that loss shall be deemed to be assessable income derived by the taxpayer in the income year in which the amount was recouped.

(2) Nothing in subsection (1) of this section shall apply to any misappropriation of property of any kind by any person in any case where -

(a)

That person is a relative of the taxpayer; or

(b)

The taxpayer is a company, and that person, or any relative of that person, and the taxpayer are associated persons; or

(c)

The taxpayer is a trustee of any trust, and that person created the trust, or settled any property for the purposes of the trust, or is a beneficiary under the trust."

The section was inserted in the legislation in 1971. It was a companion to s 129CE (now s 163) which authorises the deduction of payments made by an innocent partner where there has been misappropriation by a partner of the property of other persons.

Apart from the two sections, the recognised principle is that losses through thefts by employees may be deductible if fairly incidental to the carrying on of a business; but thefts by a proprietor or a partner or a person in an equivalent position of responsibility are treated as losses of capital and so non-deductible: Commissioner of Taxation (NSW) v Ash (1938) 61 CLR 263 ; W G Evans & Co Ltd v Commissioner of Inland Revenue [1976] 1 NZLR 425. The general non-deductibility of capital expenditure or loss has been provided for in New Zealand by ss 110, 111 and 112(1) of the 1954 Act and ss 101, 104 and 106(1) of the 1976 Act.

So far as the two sections inserted in 1971 were aimed at a "mischief", it was presumably the non-deductibility of losses representing or payments compensating for misappropriations by proprietors or partners or persons in positions of similar responsibility. Evidently Parliament took the view that such losses should fairly be allowable as inherent risks of business activity. The Commissioner argues nevertheless that s 129CF and its successor section do not cover losses in the course of a business if they are capital losses.

The material words of the section were and are perfectly explicit and unqualified - "any loss (being a loss which has not been taken into account otherwise than under this section in calculating the assessable income of the taxpayer in any income year) in the course of the business as a result of the misappropriation of property of any kind . . .". To read in the limitation for which the Commissioner contends would be to emasculate the section. In my opinion it should be held to apply to capital losses.

The section is couched in permissive language. The Commissioner "may" allow a deduction (in the year in which the loss is ascertained, or in such one or more earlier years as he considers equitable). In the event, as will be seen, the present case does not raise the question whether or when the Commissioner could disallow any deduction for a loss falling within the section. If that can ever be proper, it seems likely to be quite rare. But it is better not to try to visualise cases in which the Commissioner might claim grounds for withholding an allowance. Such a case can be more satisfactorily considered if and when it arises.

The carrying on of a business

For the reasons already given, it would not matter that the appellant's losses were of capital, provided that he was carrying on any business and that the losses were in the course of the business. If there was a business, the agent (Mrs Pilmer) rendered at least some services to it and the other conditions of s 129CF were satisfied. Business is defined by s 2 in both the 1954 and 1976 Acts as including "any profession, trade, manufacture, or undertaking carried on for pecuniary profit". The argument for the appellant, as put in Mr Molloy's written submissions, is that "the series of Pilmer transactions should be regarded as an undertaking carried on by Mr Calkin"; that, when Wallace J held that the enterprise which the appellant was intending to undertake was the buying and selling of various items of property, the Judge was not stating the complete picture, which was that it was to be buying and selling through Mrs Pilmer; and that the first step in the transactions into which the appellant entered was not the actual purchase of property, but the putting of funds in her hands.

The reasoning of Wallace J in his judgment proceeded by the following steps. First he held that the lack of any genuine transaction created a fatal difficulty in relation to any of the possibly applicable paragraphs of s 88(1) of the 1954 Act [s 65(2) of the 1976 Act]. The relevance of those paragraphs was to whether the losses were incurred in gaining or producing assessable income. Wallace J said that what in simple terms happened was that Mrs Pilmer stole the objector's money without appropriating it to any property. There was simply a capital loss. This contention had not been, "in such a stark form", initially raised by counsel for the Commissioner, but the Judge had requested further written submissions. These confirmed his initial view. Trading stock had never been acquired. The losses being of a capital nature, their deduction was prevented by s 112(1)(a) of the 1954 Act [s 106(1)(a) of the 1976 Act] unless allowable under s 129CF [s 164].

As to the latter provisions, Wallace J went on to conclude that by simply making payments to his agent the objector did not get as far as commencing business. But the Judge said that, even if he was wrong in that view, there was a further ground for holding that on the facts of this case there was not "an undertaking carried on for pecuniary profit". This was that whether there was an undertaking could be tested by whether there was "a project or enterprise organised and directed to an end result" (words used by Richardson J in Lowe v Commissioner of Inland Revenue [1981] 1 NZLR 326, 339). As Wallace J said, it was really a question of fact. And in his view on the facts of the present case the transactions did not constitute an undertaking carried on for pecuniary profit. They were really a number of disparate deals. He did not consider that there was a sufficient number, continuity, pattern or coherence to the intended transactions to constitute an undertaking.

It will be seen then that in essence there were alternative grounds for the Judge's decision. First, that payments to the agent did not amount to the commencement of business. Secondly, that in any event there was not one undertaking but a number of disparate or unrelated intended transactions. (The taxpayer does not suggest that each intended transaction could itself be described as an "undertaking or scheme".)

Although Mr Fardell did not go to the length of drawing the analogy, the argument for the Commissioner in so far as it adopts the first ground is reminiscent of the philosophy of Berkeley: an undertaking did not exist; there was merely an accumulation of data received by the taxpayer's mind which led him to believe that one did. If our function on the appeal were to decide the facts de novo , I would respectfully regard the approach that treats as decisive the bogus nature of Mrs Pilmer's activities as rather narrow and unreal.

I would see the undertaking as a somewhat unusual one involving diverse investments, in which Mrs Pilmer's personality and supposed abilities were a key feature but the appellant himself played an active part. He raised the money, partly by the sale of assets and borrowing, and he made certain repayments of loans; he supplied the money to her he travelled to Wellington and Masterton from time to time for consultations with her; he spoke with her solicitor from time to time; he inspected properties and approved or disapproved proposed transactions. He did all this with the undoubted intention of making a profit. Indeed it was his sole motive. The fact that the profit was to come from investments made by her on his behalf does not, as I see it, compel a finding that he had not commenced the undertaking. On the contrary, he had done a great deal in the undertaking - everything in truth that was required of him.

Similarly I would be at least disposed to regard the various intended transactions, although relating to different kinds of property, as sufficiently part of an organised and coherent plan, and sufficient in time, scale, volume and the commitment of money and effort, to warrant calling the whole an undertaking. Considerations of this kind have been laid down by this Court as relevant in determining whether a taxpayer is in business in the ordinary sense of that word: Grieve v Commissioner of Inland Revenue [1984] 1 NZLR 101. If there is any shade of difference, "undertaking" appears a little wider.

It also seems to me that the foregoing conclusions, although not inevitable as a matter of law, would accord better with the spirit of the 1971 Amendment Act and Parliament's intention in allowing more liberally than in the past for the deduction of losses from misappropriation.

But, as was recognised by Wallace J and as is consistent with the judgments in Grieve, whether there was an undertaking must ultimately be a question of fact, to be determined by "the character and circumstances of the particular venture" (Richardson J in Grieve at p 110). And it is very evident that a view different from the foregoing can be taken of the facts here. Not only did Wallace J regard the evidence as failing to show either that the appellant had commenced an undertaking or that there was a sufficient number, continuity, pattern or coherence to the intended transactions. As well, both the other members of this Court, as I understand it, agree with him on the first point at least.

It is appropriate to bear in mind what was said in Edwards v Bairstow [1956] AC 14 , the locus classicus as to law and fact in tax cases. An inference drawn from primary facts is itself a conclusion or finding of fact - although it must be based on the correct legal tests. Wallace J did not expressly say that he regarded his first ground as an inference of fact. But he did not cite any authorities or invoke any established principles for this ground, and I think it is rightly to be seen as an inference of fact. His second ground was expressly treated by him as a decision of a question of fact.

Assuming that the first ground was an inference of fact, it cannot be said to be vitiated by any error of law on the Judge's part in formulating the test. When an undertaking has been commenced must be a question of fact and degree. And there was certainly no error of law in the Judge's statement of the test to be applied in connection with the second ground.

In this case, unlike Edwards v Bairstow, the scope of the appeal is not confined to questions of law. Still, on the ordinary principle as to the exercise of appellate jurisdiction, this Court should not disturb a finding of fact unless it is shown to be wrong. The tax field is full of examples of facts striking different judicial minds differently. In Edwards v Bairstow at p 34 Lord Radcliffe illustrated this by a quotation from Lucan (identified for me by a reliable source) referring to Cato the Younger, who preferred suicide to the opinion of the gods that Caesar had the better cause. His Lordship was comparing a view of Rowlatt J that Commissioners were bound to find that a trade existed, with that of two appellate Judges, Warrington and Atkin LJJ, who saw room for more than one inference.

That is a salutary reminder not to be dogmatic about inferences of fact. Respect for the opinions of Wallace J and my colleagues leads me to think that the present case falls within Lord Radcliffe's words in Edwards v Bairstow at p 33 ". . . there are many combinations of circumstances in which it could not be said to be wrong to arrive at a conclusion one way or the other". I do not think that Wallace J has been shown to have been wrong in the way in which he dealt with this distinctly unusual case.

The Court being unanimous as to the result, the appeal is dismissed with $750 costs to the Commissioner.