Fair Trading Act and Tax Warranties
Janus Nominees Ltd v Fairhall  NZCA 280
The Court of Appeal has upheld an appeal from the High Court judgment reported as Janus Nominees Ltd v Fairhall (2008) 23 NZTC 21,978, holding the appellant company was not guilty of misleading conduct under the Fair Trading Act 1986 in respect of a contractual tax warranty.
The tax warranty arose in connection with a contract for the sale of shares in a company to the defendants (the Fairhalls), and stated the vendor had ‘no current tax liability of any kind’. The deal was initially structured as an option entitling Janus Nominees Ltd (“Janus”) to call on the Fairhalls to purchase a residential property. It was then restructured as an acquisition of all the shares in a company called Courageous Holdings Ltd (“Courageous”), the essential asset of which was the residential property.
Various factors, including the warranty, meant the Fairhalls did not realize that Courageous had been registered for GST or had claimed an input tax credit for the original acquisition price of the property. Accordingly, the Fairhalls were not aware of a corresponding liability for output tax in relation to the property.
At the time the balance of the purchase price became payable a year later, the Fairhalls had sold the property to a family trust for $1.55 million, triggering a GST liability of $172,778. As a result, the Fairhalls paid only $128,000 of the remaining $300,000 of the purchase price owing to Janus, withholding $172,000 on the basis that it represented the vendor's obligation to pay the GST output tax liability. Janus did not accept it had any liability for the GST and commenced proceedings for the $172,000.
The Fairhalls denied liability to pay the remaining $172,000 on the basis there was a breach of the Fair Trading Act 1986, among other grounds.
In the High Court the Fairhalls were successful in their claim of misleading and deceptive conduct under the Fair Trading Act 1986. In his judgment Dobson J found that Janus had conducted itself, in trade, in a way likely to mislead or deceive in relation to the potential GST liabilities.
The court first considered whether the warranty was capable of misleading the Fairhalls, finding that it was. That was because, firstly, the transaction related to shares which are exempt from GST under the GST Act 1985. Secondly, a warranty that it had no current liability for GST was capable of misleading the recipient of that warranty into believing that the company was indeed only undertaking activities which were exempt from GST. The judge found the warranty that there were no current tax liabilities was technically incorrect as there was a current GST output tax liability.
The evolution of the tax warranty was also critical. The restructuring of the form of the transaction was accepted by the purchaser on the understanding there was no change to the substance of the transaction. Janus also incorrectly asserted that the company that owned the property was merely a shelf company that did not conduct taxable activities.
Those factors led the Court to find the Fairhalls were in fact misled by the vendor’s conduct and it reasonable for them to have been misled, despite receiving legal advice.
Court of Appeal
The Court of Appeal overturned the High Court’s judgment and found the there was no misleading conduct in terms of section 9 of the Fair Trading Act 1986.
It considered the wording of the tax warranty did not cover a future liability for GST and the original wording of the warranty that the Fairhalls sought to include (that Courageous had no tax liability of any kind) would not have covered a future GST liability either. That was because Courageous had no liability for GST at the time the agreement was entered into or when the transaction was settled. It was held the wording could not be interpreted to apply to a liability that might (or even would) arise at some indeterminate point in the future.
In coming to its decision the Court took into account that ‘these were sophisticated parties, independently advised, and they had included a specific tax warranty in their agreement which did not cover the liability at issue’. In particular the Court noted that section 9 of the Fair Trading Act does not provide a guarantee to purchasers who fail to look after their own interests, and that to impose liability in a case such as this would cut deeply into the principle of caveat emptor.
This judgment suggests the court is only willing to apply the Fair Trading Act 1986 to tax warranties in cases where there is clearly misleading and deceptive conduct, and the sophistication of the parties will be a factor taken into account in that decision. The case emphasizes that tax clauses should be clearly drafted and purchasers should be careful to perform adequate tax due diligence before entering into transactions to avoid unanticipated tax consequences.