Ross Holmes Law Partnership v Collector of Inland Revenue [1995] CKHC 4; OA 06.1993 (24 March 1995)

IN THE HIGH COURT OF THE COOK ISLANDS
HELD AT RAROTONGA
(CIVIL DIVISION)
OA 6/93

BETWEEN

ROSS HOLMES LAW PARTNERSHIP
a firm of Solicitors practising in Rarotonga
APPELLANT

AND

COLLECTOR OF INLAND REVENUE
pursuant to the Income Tax Act 1972, of Rarotonga
RESPONDENT

Counsel: Mr Altments for the Respondent
Mr Holmes for the Appellant

Date of Judgment: 24^th March 1995

JUDGMENT OF DILLON J

These proceedings emanate from an investigation undertaken by an Assistant Inspector of the Respondent carried out in April 1993 with particular reference to the turnover tax liability of the Appellant partnership. As a result of the audit undertaken, an assessment in respect of monthly turnover tax deficiencies between April 1992 and February 1993 was calculated as $883.27. In accordance with the provisions of the Act, the Appellant paid that sum of $883.27 to the Respondent but made such payment "without prejudice" to his right of objection and to have a case stated to this Court for determination of liability.

CASE STATED

On 23 November 1993 the Respondent prepared a statement in accordance with the demand made by the Appellant to its objection to the results of the audit undertaken by the Respondent.

The grounds for the Appellants objection are set out in paragraph 11 of the case stated, and to which the Appellant has raised no objection. These grounds are stated as follows:

"The grounds of my objection are as detailed in the earlier correspondence between us concerning this matter. Put shortly (as required by Section 28(2)(b) of the Income Tax Act 1972), no turnover tax was at any time charged by my firm to my clients. It was a term of the contract between such client and my firm that those clients meet payment of Cook Islands government turnover tax payable in respect of my firm's accounts. It was a further term of such contract that turnover tax would not form part of the gross fees payable to my firm; but would be paid into the Ross Holmes Law Partnership's trust account, and paid from that trust account on the client's behalf to the Cook Islands government. Accordingly turnover tax paid by clients of my firm to my firm were not gross income as defined in Section 4(1) of the Turnover Tax Act 1980,"

Following the filing of that statement an agreed statement of facts was acknowledged by both the Appellant and the Respondent in December 1993. Of the 15 paragraphs in the case stated, only four were not accepted by the Appellant. For the purposes of this judgment, I accept the challenge by the Appellant to clauses 4, 5, 13 and 15. In addition, I accept his agreement on all the other clauses in the case stated.

TURNOVER TAX ACT 1980

Clause 17(2) of the Turnover Tax Act 1980 defines this tax as follows:

"Turnover tax shall be payable by persons on account of their business and other activities in the Cook Islands measured by the application of rates against values of products, gross proceeds of sales or gross income."

In this particular case the Appellant concedes that the partnership carried on business in the Cook Islands, and concedes that turnover tax is payable on gross income. The Appellant's argument however, is that the turnover tax being collected as a separate item is not included in the partnership's gross income as described in Section 17(2) above.

The next section of the Act to consider is Section 19. That provides that:

"Every person engaging or continuing within the Cook Islands in any profession...shall pay a tax levied and assessed at a rate equivalent to...."

Once again the Appellant concedes that the partnership was engaged in the profession of the law, but does not concede that the partnership has to pay the turnover tax provided for by Section 19.

The question therefore comes down to the interpretation of gross income as defined by Section 4(1) and 4(3) of the Act. Section 4(1) defines gross income as meaning the gross receipts, cash or accrued of the tax payer received as reward for personal services. Section 4(3) then provides for exemptions from the words "gross income". There is no question that the Appellant has received payment for services rendered. This whole case is about the Appellant prior to undertaking an engagement entering into a contract with each individual client whereby terms of payment etc are defined and liability for turnover tax as the client's responsibility is spelt out in a form of contract which I shall now consider in further detail.

CLIENT ENGAGEMENT CONTRACT

This is a lengthy document which sets out the partnership responsibilities for providing a legal service and the client's responsibility for payment of those services and the manner of payment. In connection with this appeal we are concerned only with Clause IIB which, in part, provides as follows:

"It is the client's responsibility to meet payment of all Cook Islands government turnover tax payable in respect of the firm's accounts, such turnover tax shall not form part of the gross fees payable to the Ross Holmes Partnership, but shall be paid into the Ross Holmes Law Partnership's trust account and paid from that trust account on behalf of the client to the Cook Island’s government for such turnover tax."

Attached to this contract is a schedule setting out the hourly rate charged by Mr Holmes namely $165.000 which shows its being discounted to $120.00 for prompt payment. In addition to that hourly rate there is provision for an initial retainer to be pay [sic] on account of the work to be undertaken. The Appellant claims that those fees only constitute the gross fees, that the liability for turnover tax has been contracted to each of the individual clients served by the partnership.

The question immediately arises as to whether such a contract is contrary to Section 19 of the Turnover Tax Act. That section referred to above imposes liability for payment of that tax upon the services rendered by Appellant from time to time. The legislature certainly does not impose any liability on the client of the Appellant which is the purport of the contract the Appellant arranges for clients to sign. The question really then for this Court to decide is whether a person is entitled to contract out of the legislative provisions of an Act; and whether in this instant case the Appellant has successfully avoided payment of turnover tax as provided for by Section 19 of the Act, and transferred such liability from the Appellant to its client.

APPELLANT’S SUBMISSIONS IN SUPPORT

While the case stated was dated 23 November 1993, the Agreed Statement of Facts was arranged in December 1993. The Appellant's submissions in support of its appeal were completed and filed on 31 January 1994. I refer to these dates as Mr Holmes in his submissions, has been somewhat critical of the subsequent delays through the Respondent failing to promptly supply submissions.

The Appellant acknowledges and accepts that were it not for the client contract, turnover tax that it received would have been gross income within the broad definition of Section 4(1) of Turnover Tax Act 1980. However the Appellant submits that in this particular case, because of the contract, Section 4(1) does not apply. Mr Holmes put it this way:

"In this case the turnover tax paid to the Ross Holmes Law Partnership was not a gross receipt of the Ross Holmes Law Partnership as in terms of the client contract the turnover tax paid was to be held in the trust account of the client as the client's property and paid on the client's behalf to the Cook Islands government for turnover tax."

The significance of that statement relies on the client contract by which it is claimed the client's payment of the turnover tax is retained in the partnership's trust account. In other words, the purport of that argument is enhanced by the client's funds being held in a separate account in the Appellant's Trust Account. However that was not the position as conceded in the Statement of Agreed Facts. In Clause 9 of that Statement the Appellant acknowledges that turnover tax was not retained in the trust account but was rather placed in the Appellant's office account, thus becoming part of the partnership's office or drawings account and thus becoming by that very fact a gross receipt of the partnership.

However Mr Holmes makes a significant concession in paragraph 11 of his submissions when he stated as follows:

"The effect of the provision in the Ross Holmes Law Partnership contracts with its clients is to maintain turnover tax liability at ten percent. Were it not for the term of the contract the Ross Holmes Law Partnership would be obliged to pay turnover tax on turnover tax with consequent turnover tax liability of 11 percent."

That concession by Mr Holmes indicates a clear intention to evade liability for turnover tax in respect of the gross income. He acknowledges that there could be a liability to pay turnover tax on turnover tax, and it is this avoidance of liability that the client contract is intended to avoid.

RESPONDENT’S SUBMISSIONS

These submissions were not filed until 9 November 1994 and not unnaturally have been the cause of concern to Mr Holmes. Mr Holmes very promptly replied to those submissions by the Respondent by further submissions on 30 November 1994.

The Respondent submits that the client contract arrangement is but a device to evade the provisions of the Turnover Tax Act 1980. It is further submitted that such an arrangement is contrary to that Act and that the monies paid into the Appellant's partnership account for the express purpose of meeting liability for turnover tax constitutes the gross income as defined in Section 4(1) of the Act.

CONCLUSION

There are exceptions from turnover tax liability provided by Section 4(3) of the Act. The attempt by the Appellant to provide an exclusion or exception not contemplated by the legislature is bound to fail. The Appellant is attempting to contract out of the legislation. Section 19 of that legislation specifically provides that the partnership being engaged in a profession, namely the law, has imposed on it a liability for the payment of turnover tax upon the services it renders. That liability is not that of the partnership's client. Such a contract is nothing more than an attempt to contract out of this specific legislative provision imposing turnover tax on such a professional identity as the Appellant. The attempt fails and the legislation prevails.

The client engagement contract relied on by the Appellant is a device to avoid the provisions of the Turnover Tax Act. It is conceded by the Appellant that the device was "... to maintain turnover tax liability at ten percent...(and not)... turnover tax liability of 11%."

Apart from this acknowledged evasion of turnover tax, the contract purports to place responsibility for payment on the client, but Section 19 imposes responsibility on the person engaged in the profession and not on the client of the person engaged in the profession.

The Appellant does not challenge the assessment of turnover tax which the Respondent, by audit, has stated was not paid. That is the amount of $883.27. The liability for that amount rests on the Appellant and not on the Appellant's client.

There will therefore be judgment in favour of the Respondent for the amount of $883.27 which is held by the Respondent pending the outcome of these proceedings.

The Appellant has referred to the delay in having this matter disposed of. Mr Holmes suggests that in the event of the appeal failing, this would be an appropriate case for no costs being awarded to the Respondent. I agree with Mr Holmes that there has been delay by the Respondent in the filing of submissions. I take that delay into account when fixing the cost at $250.00 in favour of the Respondent.

DILLON J