Trading up, more room for the kids, closer to the office, away from the traffic noise, life style opportunity … moving on, moving up, trading down – common reasons to buy and sell.
When does a regular replacement of the family home equate to a business enterprise? And if that enterprise is carried out by trustees – what liability do the trustees have?
If a property is purchased with the intention of resale, the proceeds of sale can be income for income tax purposes. Where there are regular sales and purchases the question of whether a taxable activity is being carried on for income tax purposes must also be considered.
The Taxation Review Authority (TRA) has held that the proceeds of sale derived by trustees of a trust (the Trust) that bought and sold 11 properties over 12 years was income, the TRA finding that the properties were acquired for the purpose of intention of sale. The TRA also held that the Trust was in the business of erecting buildings and that the residential land exemption did not apply. The TRA found that the Trust was deemed to be registered for GST and accordingly the Trust was also liable for GST.
In addition, penalties were applied on the basis of the Trust’s gross carelessness for failing to correctly identify the Trust’s tax position.
Further, the trustees (including the independent professional trustee later replaced with a trustee company) were jointly and severally liable for the income tax, GST and the shortfall penalties. Sobering stuff.
It is important to appreciate that these matters are decided on a case by case basis. However, the case highlights the importance of considering when trustees have transitioned from considering what kind of property best meets the beneficiaries needs to actively trading in property.
The Trust was established on standard terms. The trustees were the settlors and their solicitor who was later replaced with a trustee company.
Over a 12-year the Trust bought and sold 11 properties. 10 of the properties were purchased as vacant sections of land. The trust built a house on 9 of the 10 sections.
Beneficiaries of the Trust lived in each property (except one) for periods of time ranging from 2 to 10 months. The last property purchased by the Trust was occupied by beneficairies for approximatley 2 1/2 years. In total the beneficiaries lived in 18 properties over the same period due to renting properties when houses were being built.
Not all of the sales resulted in a profit.
Following a tax audit the Commissioner issued default assessments to the trust for income tax and GST on the basis that the proceeds of sale from seven of the 11 properties were income and that the buying of land, errecting houses and selling of those seven properties constituted a taxable activity for GST purposes.
The issues for determination by the TRA included whether the:
- properties were acquired for the purpose or intention of sale
- Trust was in the business of erecting buildings
- residential exemption to properties acquired with an intention of resale applied
- Trust was liable to account for GST (this will be the case where a taxpayer is deemed to be registered, even if GST is not claimed or recovered)
The reasons given for each purchase and sale and the surrounding circumstances are chronicled between para  to . While matters do not entirely turn on the reasons alone the facileness of these cumulatively start to tell a story. When the reason for selling a house is ” ..the family was very happy living at Property 3 however [one of the settlor/ trustees] found that her asthma was getting worse. She told the Authority that at the time she assumed that it must have been the wool carpet that caused this … [she] told the Authority that she changed medication and was subsequently able to live with wool carpet. She and her husband had used wool carpets in other homes which the Trust went on to build. When asked why she didn’t consider just replacing the carpet rather than uprooting the family and moving house, [she]stated that “it didn’t occur to us, its brand new carpet”.
The independent trustee was not able to assist with reasons for the different transactions. As noted in the decision:
“ Ms X told the Authority that Mr and Mrs B would come to her office with a signed agreement for sale and purchase. The loan agreements were negotiated by Mr and Mrs B and the loan documents were sent by the Bank directly to her firm. She was not consulted by Mr and Mrs B prior to entering into any of the transactions. It was Ms X’s evidence that when they came in Mr and Mrs B never gave any explanation as to why they were selling the particular property. Likewise she never enquired as to their intentions with regard to the section being purchased.”
An amount derived from the sale of land is income of a person if the land was acquired for the purpose or intention of selling it. The relevant time for determining a taxpayer’s purpose or intention is at the time of acquisition (ANZAMCO Limited (in liq) v C of IR ).
The burden of proof was on the Trust, not the CIR to show (on the balance of probabilities) that it did not acquire the land with the purpose or intention of sale (Jurgens and Doyle v C of IR.
While a general acknowledgment of the possibility of sale in the future is not sufficient, a contingent or conditional purpose or intention is sufficient.
The purpose or intention is subjectively assessed. However, it is the contemporaneous statements and actions of the taxpayer that must be considered of greatest weight (Commissioner of Inland Revenue v National Distributors Limited ).
Although it was clear that the independent trustee, who was a “passive trustee” did not have any views regarding intention, being little more than a cipher, this failure to execute the duties of office did not assist matters. For example:
“ Ms X told the Authority that she knew that Mr and Mrs B were buying vacant sections, building a family home and then on-selling that home. However she had no knowledge of the building contracts that Mr and Mrs B entered into on behalf of the Trust.
 It was Ms X’s evidence that the Trust had been set up as a family trust to own the Bs’ family home. She stated that as a firm, she and her partners would not involve themselves in a trading trust. This was because of the tax liability and because they weren’t prepared to be involved in a trust that they weren’t actively managing on a day to day basis. Ms X described her involvement as being confined in respect of each property, to transacting the sale and purchase and preparing appropriate resolutions to ratify the actions taken and documents executed by Mr and Mrs B purportedly on behalf of the Trust.”
It was also noted that there was no complete minute book or history of trust resolutions. As has been said before – there is no such thing as a passive trustee, just a trustee who is abdicating the trustee’s responsibility. Had the independent trustee turned her mind to the Trust’s actions, given her firm’s views and policy regarding trading trusts, she may have been able to advise on the risks moving forward. Although how the sale and purchase of 12 properties in quick succession did not alert the professional “trustee” that the Trust might be a trading trust could warrant further enquiry.
The question for the court requires assessment of whether the trustees can make a collective decision when one trustee is not involved in the decision making. Any “independent trustee” who thinks that their responsibility can be minimised by minimising their involvement needs to consider the following passages of the decision:
“The unanimous decision requirement in the Trust Deed requires that the Trustees are unanimous as to the action or decision to be taken which in this case, involved the purchase of land. However, I accept the Commissioner’s submission that it does not necessarily follow that the Trustees have to be unanimous as to their intention for the future use of that land for example for resale or development. There may be situations where Trustees have different intentions.
 In the present case where there was no unanimous decision the Commissioner argues that Ms X subsequently ratified the various transactions. Resolutions were produced which were signed ratifying some of the transactions. As a number of the conveyancing files have been destroyed, it is not possible to say that a resolution was signed in respect of every transaction however Ms X processed the transactions and in my view, by her actions, she ratified each sale and purchase. Mr Beck submits that there can be no ratification without sufficient knowledge of the transaction. This again is to confuse the decision to purchase with Mr and Mrs B’s intentions. For the reasons set out below, I have found that Mr and Mrs B had the intention to sell at the time they entered into the relevant sale and purchase agreement.
 Even if that approach is not correct, Ms X knew that Mr and Mrs B were entering into agreements for sale and purchase and building contracts on a regular basis. It was her evidence that she even raised with Mrs B the risk of a tax liability because of the frequency of these transactions. She allowed her co-trustees to enter into these transactions and in my view, she is now estopped from denying that she sanctioned or approved the decisions of Mr and Mrs B. Dobson J noted that there may be situations where Trustees’ intentions are different where for example, there has been a breach of fiduciary obligations. In the present case I have found that Mr and Mrs B entered into the agreements for sale and purchase within their capacities as Trustees of the Trust with the requisite purpose or intention of resale. Ms X adopted a passive role and permitted her co-trustees to operate as decision makers for the Trust and as a consequence, Ms X may have had a different intention. However, a passive trustee cannot delegate their responsibilities in this fashion and I am of the view that in these circumstances, it is the intention of the co-trustees which becomes the intention of the Trust and Ms X cannot set up a different intention from that of her co- trustees.
 In any case, I consider that it would be an extraordinary outcome if a trust can simply ignore the unanimous trustee decision requirement in its day to day operation and then be able to take advantage of that requirement when considering its tax obligations. In the present situation I am of the view that Ms X cannot plead her own ignorance of her co-trustees’ intentions when she has simply maintained a passive role and permitted Mr and Mrs B to effectively run the Trust particularly knowing as she did, that Mrs B did not understand her responsibilities as a trustee and saw Ms X as simply having a rubber stamping role.
 For these reasons I am satisfied that the purpose or intention to sell can be attributed to the Trust.”
Ultimately, the totality of the actions mitigated against any possible finding other than an intention of re-sale. For the same reason the Trust could not prove that it was not in the business of erecting buildings.
Whether the end result depended on the additional finding of the Trust being in the business of erecting buildings is not clear. However, any trust that regularly buys and sells property would be wise to consider that the additional element of the Trust also being the builder is not significant in the outcome, which is still predicated on the intention requirement. The building element does contribute to the GST risk in that the regularity of the activity populated the finding that a taxable activity was being carried out.
Note that there is an exemption in s CD 1(3) for houses occupied “primarily or principally” as family residences. However, the TRA found that this exemption for residential land did not apply as the homes were only occupied for a temporary period to enable the homes to be finished, marketed and sold.
The finding that the intentions or purposes of some trustees (as determined extrinsically) can be attributed to all of the trustees is significant, and follows (altough using a different line of reasoning) Regal Castings. The message to take from the case is that trustees can be held to views they don’t have if they don’t step up. Sobering stuff.
Liability for GST
The total value of the Trust’s taxable supplies made in the course of carrying on all taxable activities exceeded the relevant threshold and it was deemed to be registered for GST from 1999. The relevant test for GST was not whether the Trust acquired property with the intention of re-sale but whether the activity involved, or was intended to involve, the supply of goods and services to another person for consideration, which clearly was the case.
Joint and several liability
It is a well-established principle that a trustee is personally liable for all debts incurred in the conduct of a trust. In the first instance any trustee will have indemnity from the assets of the trust.
In the case at hand the settlor/trustees were jointly and severally liable for all income tax, GST and shortfall penalties. With regard to the independent trustees, the joint and several liability of the corporate trustee was limited to the period of its appointment with the professional trustee being personally liable for the income tax, GST and shortfall penalties that related to her duration of appointment.
As a TRA decision, the decision is not high authority. However, the lack of authority should not be treated as a reaons to disregard this reasoned decision.
The decision has been appealed.
- Trustees of the B Trust v CIR  NZTR 05
- Income Tax Act 1994, sub-part CD
- Tax Administration Act, s 141
- ANZAMCO Limited (in liq) v C of IR (1993) 6 NZTC 61,522
- Jurgens v C of IR (1990) 12 NZTC 7,074
- Commissioner of Inland Revenue v National Distributors Limited (1989) 3 NZLR 661
- Regal Castings v Lightbody  NZCA 396