NRS Media Holdings Limited v CIR - Deduction nexus returned to orthodoxy
In NRS Media Holdings Limited v CIR  NZCA 472 the Court of Appeal has overturned the decision of the High Court that denied NRS deductions related to its derivation of exempt foreign dividend income. The Court found that the distinction of language on which the High Court had relied to find against the taxpayer was not supported by case law or by legislative history. Moreover the expenditure in question could not properly be characterised as capital and on deductible.
The case involves an examination and explanation of the provision allowing a deduction for expenditure incurred by a company in deriving an exempt foreign dividend and the two limbs of the general deduction permission. Those two limbs refer, first, to expenditure incurred in deriving income and, secondly, to expenditure incurred in the course of carrying on a business for the purpose of deriving income. The argument by the Commissioner was that the first limb of the general permission required a closer connection with the derivation of income than the second. Accordingly, because the section allowing a deduction in relation to foreign dividend income used the same language as the first limb, a close and direct connection with the derivation of foreign dividends was required before a deduction would be allowed.
The High Court decision on this point had been greeted with considerable surprise. The reasoning accepted by the Judge and reviewed in the Court of Appeal was difficult for anyone with a passing knowledge of the way the general permission was intended to operate, to accept. The Court of Appeal has set the record straight. Along the way it also dealt with the Commissioner’s argument that the expenditure in question was capital in nature and therefore non-deductible, an argument that the High Court had not needed to deal with because of its primary conclusion.
The expenditure in question was incurred on payroll and consultants, marketing and travel, rent and occupancy and overheads, all said by NRS to be directed at maximising dividend returns from its overseas subsidiaries and discharging its governance obligations. NRS set the strategic plan for its group as a whole and monitored the implementation of that and the business activities undertaken by its subsidiaries. Its claim was based on the argument that expenditure in doing these things was incurred in deriving the dividends paid to it by the subsidiaries.
The Court of Appeal canvassed authorities of longstanding and held that both limbs of the general permission, and therefore the special deduction related to foreign dividends, refer to “whatever is productive of the assessable income,“ citing the High Court of Australia in Ronpibon Tin NL v FCT (1949) 78 CLR 47.
The legislative history relating to the treatment of foreign dividends was then considered but it was found not to support any suggestion that the nexus between income and deductions should be narrowed. Aspects of the treatment of foreign dividends that were an oversight, because of the way the regime had changed over time, did not support the Commissioner’s argument that a different and closer nexus was required for a deduction.
Finally, the Court dealt with the argument that the expenditure was capital. Essentially the Revenue’s argument was that the expenditure was incurred to improve capital assets, namely the subsidiaries themselves. NRS countered by saying that this was an attempt to rerun arguments over the deduction of interest where there was both a capital and a revenue outcome in prospect. Cases such as Brierley and Pacific Rendezvous make it clear that as long as the revenue outcome for which the expenditure is incurred can be said to apply to the whole of the outlay, it does not matter that there is a collateral capital benefit. However the Court did not accept the analogy with the interest cases, because it said Parliament had retained the capital limitation when providing for a deduction in relation to foreign dividends. So it looked at the matter on first principles. This writer is not convinced that the Court was right to dismiss the analogy with the interest cases because the permission for deducting interest also coexisted with the capital limitation. Be that as it may, the Court of Appeal found on first principles that the expenditure by NRS was to facilitate the operations of its subsidiaries rather than improve their capital position. The expenditure comprised outlays that were regular and recurrent and so were manifestly revenue in nature.
The High Court decision was, with respect, an aberration. It is good that it has been corrected. It is also good that a silly attempt by the Commissioner to deny deductions has been scotched. In this writer’s view, they were clearly intended to be available to a taxpayer investing in companies overseas, from which exempt dividends would be earned.
© G D Clews, 2019