United Touring Fiji Ltd v Commissioner of Inland Revenue [2002] FJCA 45; ABU0069U.2001S (29 November 2002)

IN THE COURT OF APPEAL, FIJI ISLANDS
ON APPEAL FROM THE HIGH COURT OF FIJI

CIVIL APPEAL NO. ABU0069 OF 2001S
(High Court Civil Action No. 5 of 1998s)

BETWEEN:

UNITED TOURING FIJI LIMITED
Appellant

AND:

COMMISSIONER OF INLAND REVENUE
Respondent

Coram: Reddy, P
Smellie, JA
Penlington, JA

Hearing: Wednesday, 20th November 2002, Suva

Counsel: Mr. R. A. Smith for the Appellant
Mr. A.V. Bale for the Respondent

Date of Judgment: Friday, 29th November 2002

JUDGMENT OF THE COURT

This appeal concerns the deduction for tax purposes, under s.19(b) of the Income Tax Act Cap. 201 Rev. 1985 of certain payments called “representation fees” paid by a Fiji Company to a related entity in Japan between 1990 and 1993.

Section 19(b) provides:

In determining total income, no deductions shall be allowed in respect of .............

“(b) any disbursement or expense not being money wholly and exclusively laid out or expended for the purpose of the trade, business, profession, employment or vocation of the taxpayer;”

The appeal comes before this Court after a hearing in the Court of Review where the appellant United Touring Fiji Limited (UTC), the tax payer, was successful in over turning the assessments of the Commissioner and a subsequent appeal to the High Court which was allowed. The present appeal is against the later judgment delivered by Pathik J. on 11 August 2000.

Background

The Appellant is a well established in bound travel agent which arranges and conducts tours for overseas visitors in Fiji. At all material times the appellant was a subsidiary of a company called Tourism International which was owned by a United Kingdom conglomerate called British Electric Tradition International (BET). The apellant’s representative office in Japan was a company called UTIJ. At all material times it was also owned by BET. UTIJ was therefore, for tax purposes, a related entity in relation to any payments made by the appellant to UTIJ.

UTIJ booked clients for the appellant in Japan and provided representatives services for the appellant such as negotiating tour packages with other agents, debtors management and handling other administrative matters on its behalf.

For these services the appellant paid UTIJ what were called representation fees. In essence they were agency fees.

In the period 1984 to 1990, the amounts remitted by the appellant to UTIJ varied from between 1.9 million yen per month in 1984 to 2.4 million yen per month in 1987. By 1990 the monthly payment had risen to 3 million yen. In a letter dated 12 November 1990 Tourism International advised the appellant that as from 1 January 1991 its:

“Contribution to the Japanese office will increase from 3 million yen to 4 million yen per month.”

The appellant’s monthly payments were remitted with the approval of the Reserve Bank and the Commissioner. Any balance over and above the monthly payments was dealt with in a current account in the books of the appellant.

The annual accounts for the fiscal years 1990, 1991, 1992 and 1993 showed the following amounts as “overseas representation fees.”:

Fiscal Year Amount
1990 $579,344.00
1991 $619,582.00

1992 $812,137.00

1993 $895,533.00

In 1994 the appellant was sold to a Fiji Company called Manzoa Limited which was owned by an experienced New Zealand travel business man, a Mr. Russell White. About the same time UTIJ was also sold, and thereafter the two companies ceased to be related companies for tax purposes. The new owner of the appellant, however continued to employ the same method in relation to representation fees as used hitherto.

After the change of ownership of the appellant the Commissioner noted the overseas representation fees paid by the appellant to UTIJ and regarded them as “huge.” As the result he instituted an investigation in 1995. The Commissioner sought detailed information from the appellant as to make up of the fees paid by the appellant to UTIJ. The Commissioner’s investigator, a Mr Norris, claimed that he was suspicious of a possible fraud on the revenue. He suspected that capital was being exported from Fiji to Japan in the guise of expenses.

KPMG replied on the appellant’s behalf. The appellant asserted that the representation fees consisted of the costs of the services rendered by UTIJ for the appellant and that they were determined by negotiation between the appellant and the Japanese Company at the beginning of each financial period. The appellant advised the Commissioner that UTIJ, in 1995, was now a private Japanese company, that the appellant did not have any relationship with it and that accordingly it was unable to provide any details of UTIJ’s revenue and costs.

KPMG submitted a schedule which showed that of the total sales in Japan between 1989 and 1995 an average of 7.5% was derived by the Japanese company as agent for the appellant by way of representation fees. The significance of this information will emerge later in the judgment.

Further correspondence and meetings took place between the appellant, KPMG and the Commissioner’s representatives. In a letter to the Commissioner dated 17 August 1995 KPMG on the appellant’s behalf, asserted:

“It should be noted that UTC Fiji was purchased from a UK public company by the present owners in March 1994. From records available to the current owners, the historical fees appear to fall ......within normal market criteria because they are within the universally accepted parameters relative to sales volume.”

KPMG concluded its letter by stating:

“Accordingly our clients advise that the representation fees paid to UTIJ is fair and within the universally accepted parameters, relative to sales volume which obviously received your approval (Commissioner of Inland Revenue’s) at the time of payments.”

The Commissioner was still not satisfied with the information which had been supplied to him by the appellant. In a letter dated 16 October 1996 he advised the appellant.

“The main area of concern however is with respect to representation fees claimed when UTC and UTIJ were related parties. It has been stressed by UTC that amounts remitted to Japan for the periods 1990 to 1994 represent an arm’s length price because the same basis (4m yen per month) had initially been adopted for the 1995 year when parties were unrelated. This represents a reimbursement of costs plus a small profit margin consistent with a mark-up for travel agents. It is therefore agreed that the tax clearance requests granted to remit 36m yen for 1990, 39m yen in 1991, and 48m yen for 1992 to 1994 would be considered arm’s length and thus allowable. Any additional claim (eg accrued marketing and/or representation fees to Japan) is deemed excessive and will be disallowed as an income tax deduction.

After converting Japanese yen to Fijian currency, this will result in an overclaim of representation fees of $194,800; $196,586; $301,970 and $253,548 for the 1990 to 1993 years respectively. No adjustment is required for the 1994 year because the claim for 48m yen has been correctly converted to Fijian currency and there were no further claims (eg: Accrued marketing expenses) that would be considered non-arm’s length.” (The emphasis is ours).

A compromise settlement was sought by the Commissioner but this did not occur. On 3 December 1996 the Commissioner issued the tax assessments which are now in issue. He disallowed the deductions set out in his letter to the taxpayer of 16 October 1996 (which we have set out above). The Commissioner disallowed the amounts which we have underlined. It is to be noted that they were only part of the monies paid by the appellant to UTIJ in the years in question.

The appellant objected to the assessments. The objection was disallowed by the Commissioner. The appellant thereupon appealed to the Court of Review.

The Court of Review Appeal:

In order to put the judgment under appeal to this Court in its proper perspective it is necessary for us to refer in a little detail to the appeal to the Court of Review and its decision. There were two issues for decision by the Court of Review:

(a) What amounts the appellant paid to a related entity UTIJ for the representation services provided by the latter; and

(b) Were those amounts deductible under s.19(b) of the Income Tax Act.

The amounts paid for representation fees in the years in question were not disputed by the appellant. The contest was on the second issue.

From the outset the appellant accepted that it had the onus of establishing on the balance of the probabilities the amounts disallowed by the Commissioner were deductible under s.19(b). In other words the appellant had to establish that the Commissioners assessment was incorrect and by how much. See Buckley and Young Ltd. v. Commissioner of Inland Revenue (1978) 3 NZTC 61 (CA).

We now refer to some salient evidence adduced in the Court of Review. Shaun Williams was the first witness for the appellant. He had been the Regional Director of BET for Asia Pacific, between 1991 and 1993. Part of his evidence was the real foundation in the appellant’s case. He deposed that the representation fees paid by the appellant to UTIJ could not have been bettered at that time in Japan. That was the same point as had been made by KPMG in the correspondence with the Commissioner before the assessments in issue were made. That correspondence was before the Court of Review. Williams also deposed that a general services agent in Japan would charge 15 to 20% plus establishment fees. This was in contrast to the average of 7.5% in the period 1989 - 96 to which we earlier referred. William’s evidence on this point was not challenged in cross-examination. The Commissioner did not later lead any evidence to the contrary. We shall return to this point later in the judgment.

Russell White the new owner of the appellant described the arrangement as to representation fees as “excellent.” He said that the appellant continued on the same basis until the Reserve Bank approval was withdrawn after the commencement of the investigation. At that stage the appellant changed to the more common arrangement between travel agents under which the Japanese company deducted its fees in Japan from the gross sales and then remitted the balance.

One Bishu Deo, the KPMG partner responsible for the 1990 to 1994 audit of the appellant’s accounts and books was the next witness for the appellant. He deposed

to the accuracy of the appellant’s accounts.

The last witness for the appellant was one Arun Sani the appellant’s financial controller. He deposed that monthly payments of 4m yen were made and that the balance consisted of 6% commission which were dealt with in a current account as we have recorded earlier.

Mr Norris was the sole witness for the Commissioner. He recognized that the deductibility of the representation fees must be examined against the arms-length principle. He referred to his acceptance of the 4m yen per month and his rejection of the excess. He chose the cost plus method to test whether the disallowed payments were at arms length. Ultimately he opined “this is not arms-length; the amount in excess 4m yen per month”. Under cross examination it is emerged that he had had suspicions of fraud on the Revenue because he thought that it was strange that the gross sales were remitted to New Zealand without any deduction. It also emerged that he rested his initial attack on, the absence of withholding tax, a stance which he later abandoned. He then regarded the amounts which passed through the current account not being at arms-length. He stated:

”No evidence that it is an arm’s length transaction. You need a break up of all the expenses.”

The appellant in summarising its case submitted to the Court of Review:

(a) the appellant could not have done adequate business in Japan without services in that country of the kind supplied by UTIJ;

(b) the services in Japan of the kind and standard supplied by UTIJ would not have been available from any other source at as good a price.

(c) the services of the kind and standards supplied by UTIJ could have not been supplied at a better price by UTIJ.

(d) the non retention of any money in Japan, as could so easily have been done, indicated an absence of any fraudulent intent or purpose;

(e) on the basis of all the evidence the appellant had discharged the onus incumbent on it to establish deductibility.

The Commissioner on the other hand submitted;

(a) the case was noticeable for the lack of information and documentation made available to the Commissioner by the appellant;

(b) there was no document recording any agreement between the two companies and there was no explanation as how the representation fees were calculated;

(c) the appellant has failed to discharge the onus;

Judgment of the Court of Review

The Court of Review delivered a reserved decision. It found on the evidence:

(a) UTC and UTIJ were associated companies.

(b) Originally BET fixed the amount to be paid by its Fiji subsidiary to its Japanese subsidiary.

(c) The payments were not the more usual arrangement in the worldwide travel industry whereunder a principal in one country of an agent in another country deducts all the expenses and commission and then remits the balance to its principal.

(d) All the payments required the approval of both the Reserve Bank and the Commissioner.

The Court of Review addressed the issue of whether the transactions were at “arm’s length.” It accepted that the OECD publication “Transfer Pricing Guidelines for Multi-National Enterprises and Tax Administrations” was not part of the law of Fiji but that it was nevertheless “instructive reading.” The Court referred to Article(b)(ii) para. 4.16 in that publication. This was concerned with the onus of proof in relation to the administrative approaches dealing with the avoiding and resolving of price-fixing disputes. That provision states:

“In practice, neither countries nor taxpayers should misuse the burden of proof in the manner described above. Because of the difficulties with transfer pricing analyses, it would be appropriate for both taxpayers and tax administrations to take special care and to use restraint in relying on the burden of proof in the course of the examination of a transfer pricing case. More particularly, as a matter of good practice, the burden of proof should not be misused by tax administrations or taxpayers as a justification for making groundless or unverifiable assertions about transfer pricing.”

The Court of Review then commented that the Commissioner’s investigator had used the burden of proof as a justification for making unverifiable assertions. The Court was strongly critical of him. It stated that he had:

“....insisted that the appellant should produce evidence of detailed particulars of how UTIJ apportioned its expenditure, how it actually expended it, on which organisations, from which countries in the world, with which other companies did it claim expenditure and so on. He badgered the Appellant to get information to justify his assertions, on the grounds that the onus was on the Appellant. He certainly did not follow the OECD proposals.

During his evidence, it became clear to the Court that the witness really had no definite evidence upon which to disallow the deductions.”

The Court of Review concluded its Judgment by finding:

“I do not consider the evidence, on its own and in the face of the Appellant’s evidence, that the Appellant and UTIJ were associated companies at the relevant times, is sufficient to say that they were not at arms-length when the agreement for payment of fees and commission was reached.

Association by itself is not enough. It is too easy to believe that international conglomerates cheat the tax system of each country in which they operate. I fully understand the frustration which Mr Norris no doubt feels on occasion while carrying out his duties to the best of his ability, but in this case, there is only suspicion.”

The appellants appeal was allowed and the assessments were over turned.

The Commissioner’s Appeal to the High Court

The Commissioner thereupon appealed to the High Court under s.69 of the Income Tax Act. The two principal grounds of appeal were that the Court of Review had erred:

(a) In failing to hold that the disallowed amounts of representation fees for the four years in question were prohibited from deductibility by section 19(b) of the Income Tax Act; and

(b) In failing to apply the onus of proof as required by section 71(2) of the Income Tax Act.

In summary in support of the appeal the Commissioner contended that it had been incumbent on the appellant to establish deductibility by showing that its dealings were at arms-length. The Commissioner argued (i) that the appellant had failed to provide the relevant information when lawfully and properly demanded by the Commissioner (ii) that it had failed to show that the payments in excess of 4m yen per month were at arms-length; (iii) and that accordingly the appellant had failed to discharge the onus of establishing that the representation fees were deductible.

The appellant submitted that the Court of Review had correctly found that the appellant had proved that the representation fees were deductible.

The appellant pointed out (i) that the unchallenged evidence established that the representation fees “were proper business expenses paid for services that could not have been got any cheaper;” (ii) that the appellant had obtained UTIJ’s services at an arms-length price; and (iii) that the appellant’s accounts disclosed all its expenses and that the accounts were fully and properly audited.

Judgment Under Appeal

The Judge, Pathik J., delivered a reserved judgment on 11 August 2000. That is the judgment which is under an appeal in this Court. The underlying theme of the judgment was the absence of valid information in the disclosures by the appellant to the Commissioner - a point which received great emphasis in the argument of the Commissioner. The Judge referred to two provisions in the Income Tax Act: s.50(1) which authorises the Commissioner to demand further information from a tax payer for assessment purposes; and s.109 which provides that every tax payer shall keep proper books of account of all transactions in order to ascertain profit and loss incurred and in order to determine deductible and non deductible expenses.

The Judge regarded as the crux of the matter the absence of information (in response to the Commissioners requests) or a detailed analysis of the representation fees on the part of the appellant.

The Judge referred to the three traditional methods for approaching the issue of transactions being at arms-length: (i) The comparable uncontrolled price method; (ii) The cost plus method; and (iii) The resale price method.

The Judge found that the appellant had not shown to the Commissioner on what basis it had “come up with the amount charged for the services.” He then quoted from the appellants counsels submission in the High Court to the effect that the Commissioner has chosen the cost plus method while the appellant had chosen the comparable uncontrolled price method. The quotation also referred to the unchallenged evidence adduced by the plaintiff that it was impossible to get the services provided by UTIJ “as inexpensively any other way.” Notably the Judge did not make any further reference to any of these matters. Rather he returned to the theme of the absence of information.

“Accordingly, the taxpayer must establish that the expenses of the Japan office which were reimbursed could be dissected into distinct and several parts, each of which is directly referable to the taxpayer’s business in Fiji. [See Ronpibon Tin No Liability and Federal Commissioner of Taxation [1949] HCA 15; (1948-1949) 78 CLR 47].

In this case the taxpayer has failed to show, on the balance of probabilities, the true amount of expenses reimbursed and that the whole of those expenses were incurred exclusively for the purposes of its business as opposed to the businesses of the Japan office or the other destination offices.

It is not enough for the taxpayer to generally assert that the expenses were incurred for this purpose. The evidence is that the expenses of the Japan office were apportioned between the respective destination offices but there is no explanation as to how this was done and how the individual amounts were calculated.

There is simply no way of knowing whether the amounts remitted by the taxpayer satisfy the right to deduct.”

The Judge held, that the Court of Review was wrong in finding that the representation fees were prohibited from deductibility under s.19(b), that the appellant had failed to discharge the onus of proof in that it had failed to show which of the expenses incurred by UTIJ had a necessary connection to appellant’s business in Fiji in order to be deductible; and that while the OECD convention was a useful guide it did not bar the Commissioner from demanding or obtaining additional information for assessment purposes which he had done and to which he had had an insufficient response. The appeal was therefore allowed.

The appellant now appeals to this Court against that judgment.

The Competing Submissions on this Appeal

Mr Smith for the appellant accepted that the issue for the decision before the Court of Review was whether the appellant had established that the representation fees were wholly and exclusively expended for the purpose of the appellant’s business. He submitted that on the evidence adduced before the Court of Review that Court was entitled to find and did find in favour of the appellant and, that the High Court wrongly over turned that decision. Mr Smith attacked the judgment of Pathik J. on the grounds that the learned Judge confused the onus of proof with the degree of proof. Counsel submitted that the Judge had misdirected himself by being deflected by the arguments of the Commissioner into treating the central issue as being a question of whether appellant as the taxpayer had complied with any obligations placed on it by s.50(1) of the Income Tax

Act (the provision authorising the Commissioner to demand information) Mr Smith pointed that that issue was not before the Court of Review. He submitted that the Judge wrongly and without any justification on the evidence took the view that the appellant had been in breach of its obligations to comply with the Commissioner’s requests for information and that that view had coloured his entire approach to the appeal and had led him, in the event erroneously, to allow the appeal.

Mr Bale on the other hand for the Commissioner sought to uphold the correctness of the judgment under appeal. The foundation of Mr Bale’s entire argument was that the appellant had not provided the information sought by the Commissioner as to the break down of the representation fees and that accordingly the appellant had not established that the representation fees were deductible.

Conclusions on the Appeal

Having carefully considered the record of the proceedings in both the Court of Review and the High Court and the extensive oral and written arguments of counsel submitted to this Court we have come to the clear view that the learned Judge in the High Court misdirected himself, as submitted by the appellant, and that the appeal must therefore succeed. We now set out our reasons for this conclusion.

The amounts paid in representation fees in the years under review were not in dispute. The sole issue before the Court of Review was whether the appellant had proved on the balance of the probabilities that the representation fees were deductible as being expenses wholly and exclusively expended for the purpose of the appellant’s business. The issue was not whether the taxpayer had complied with the Commissioner’s demands or requests for information. That was not the crux of the matter as found by the learned Judge in the High Court.

It is true that requests for information by the Commissioner were made and were answered, albeit to the expressed dissatisfaction of Mr Norris. That evidence was before the Court of Review. It was available to that Court to be brought into the scales along with the other evidence. The appellant, before the assessments in issue were made and then before the Court of Review contended that the fees fell within “normal market criteria because they were within the universally excepted parameters relative to sales volume.” The appellant placed that information before the Commissioner. The latter did not accept it. That then became a factual issue before the Court of Review.

At the hearing before the Court of Review the appellant called evidence in support of its broad based approach - an approach recognised in the OECD guidelines. It was unequivocal evidence to the effect that the appellant could not have obtained the services of UTIJ any more cheaply in Japan. In advancing this evidence the appellant was relying on the comparable uncontrolled method, a recognized method for establishing an arms-length dealing. The appellant accepted throughout that for the tax purposes UTIJ and the appellant were related companies. We have summarised the evidence earlier in this judgment. It was to the clear effect that the arrangement between UTIJ and the appellant could have not been bettered at that time in Japan.

Significantly as we have already noted the evidence for the appellant on this point was not the subject of cross-examination or challenging evidence on the behalf of the Commissioner, and the Judge did not deal with it or the submissions made thereon.

It will be remembered that the Commissioner allowed part of the representation fees as being deductible. His assertion of non-deductibility was in respect of the payments through the current account over and above the monthly payments remitted to Japan. The Commissioner relied on the costs plus method, another recognized approach for establishing an arms-length dealing. As the appellant had not supplied the Commissioner with sufficient information, which was sufficient in the view of the Commissioner; in response to justify the whole of the representation fees the Judge concluded that the appellant could not succeed. Here we think that the learned Judge fell into error. In our view the satisfaction of the onus incumbent on the appellant did not stand or fall on the Commissioner’s view of the sufficiency of the information supplied to the Commissioner.

The Court of Review saw and heard the witnesses for both sides. Mr Bale candidly acknowledged that it was open to the Court of Review to accept the critical unchallenged evidence adduced by the appellant that the services of UTIJ could not have been obtained more cheaply and that once accepted the Court of Review could find in appellants favour. In our view this is clearly what the Court of Review did. That Court noted that there was no evidence that the arrangements between the appellant and UTIJ had resulted in profits not accruing to the appellant when but for those arrangements they would have accrued. The Court of Review was not unmindful of the Commissioner’s demands for information. The Court found however as a fact that those demands were made when the Commissioner had ”no definite evidence upon which to disallow the deductions.” Mr Smith informed us from the bar, and this intimation was not gain - said by Mr Bale, that a breach of s.51 of Income Tax Act by the appellant was not raised as such as an issue in the Court of Review.

Mr Smith drew our attention to other evidence put forward by the appellant which was also not challenged and which in his submission - and in our view correctly so - supported the finding of the Court of Review that the appellant had affirmatively established the deductibility of the representation fees. He pointed to the following matters:

(a) The new owner chose to continue on the same basis.

(b) The overall cost of UTIJ’s services was extremely moderate.

(c) The appellant could have conducted its business in such a way as to make the whole question redundant.

In other words UTIJ could have deducted its fees in Japan and remitted the balance of the sales to the appellant.

(d) The accounts were properly audited and made a full disclosure of the appellants’ expenses.

We do not consider that the learned Judge in the High Court had regard to the way the case was run in the Court of Review in that the final position of the Commissioner was that deductibility had to be tested against the arms-length principle. That is exactly what the appellant did. It advanced its case on a basis that did not commend itself to the Commissioner, but the latter did not challenge the critical evidence led by the appellant. The Court of Review however clearly accepted the approach put forward by the appellant. Had the learned Judge in the High Court considered the appeal in relation to the correct issue, the evidence adduced and the findings of the Court of Review he would have found no basis for allowing the appeal against the finding that the appellant had established the deductibility of the representation fees.

Result and Costs

For the reasons given the appeal is accordingly allowed. The decision of the Court of Review is restored. The assessments in issue are disallowed. There will be costs to the appellant in the High Court and in this Court which we fix at $2,000.00. The costs order in the Court of Review stands.

Reddy, P
Smellie, JA
Penlington, JA

Solicitors:

Munro Leys, Suva for the Appellant
Legal Officer, Inland Revenue Department, Suva for the Respondent