Privy Council Appeal No. 44 of 2003

Edgewater Motel Limited and Others	Appellants
	v.
The Commissioner of Inland Revenue	Respondent

	FROM

	THE COURT OF APPEAL OF NEW ZEALAND
	---------------

	JUDGMENT OF THE LORDS OF THE JUDICIAL
	COMMITTEE OF THE PRIVY COUNCIL,
	Delivered the 26th July 2004
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	Present at the hearing:-
			Lord Nicholls of Birkenhead
Lord Hoffmann
Lord Hope of Craighead
Lord Scott of Foscote
Lord Walker of Gestingthorpe
		  	[Delivered by Lord Hoffmann]
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1.	The issues in this case are, first, whether a mortgagee who sells land under the power of sale is liable for the GST payable upon the sale and, second, whether he is entitled, as against subsequent encumbrancers, to reimburse himself out of the proceeds of sale.

2.	In December 1999 Belman Holdings Ltd (“Belman”), as first mortgagee of a freehold property, sold it for $1,057,500. It paid GST of £117,500 to the Inland Revenue, and then, out of the proceeds of sale, reimbursed itself for the GST payment and discharged its own debt. The balance which it paid to the appellant Edgewater Motel Ltd (“Edgewater”) as second mortgagee was insufficient to discharge the latter’s debt.  The mortgagor was insolvent. 

3.	Edgewater says that Belman was not obliged to pay the GST until its own debt and that of any subsequent encumbrancer had been paid. It claims to have been entitled to be paid the $117,500 as surplus proceeds of sale instead of the Inland Revenue.  To recover this sum, it commenced proceedings against Belman (who, having been paid off, was not particularly concerned with who got the $117,500) and the Inland Revenue, who resisted the claim.

4.	Section 5(2) of the Goods and Services Tax Act 1985 deals with the situation in which one person has a power to sell “goods” (an expression which for this purpose includes land) belonging to another person towards satisfaction of the latter’s debt.  In such a case, the goods are “deemed to be supplied in the course or furtherance of a taxable activity carried on by [the mortgagor]” unless the sale would not have been a taxable supply if the mortgagor himself had sold the goods: see section 5(2)(a) and (b).

5.	Section 17 then deals with the consequences of such a deemed supply.  By paragraph (a) of subsection (1), the person selling the property (that is to say, the mortgagee) must make a special return to the Commissioner, to the exclusion of any return by himself or the mortgagor.  Paragraph (b) then says that the mortgagee shall “pay to the Commissioner the amount of tax charged on that supply”.  By subsection (2), the tax is recoverable as a debt due to the Crown.

6.	This language could hardly be clearer.  Although a sale by a mortgagee is deemed to be a supply in the course of a taxable activity carried on by the mortgagor, it is the mortgagee who must pay the tax.  But Baragwanath J ((2002) 20 NZTC 17) felt able to read section 17(1)(b) as if the obligation to pay the Commissioner was qualified by the words “if there is any money left over after paying off any charges on the property”.  On the facts of the present case, the deficiency in Edgewater’s security meant that the implied qualification completely excluded the Commissioner’s claim against Belman. As section 17(1) also says the mortgagor must exclude the tax from any return of its own, it would at first sight appear that no one was liable for GST.  But Baragwanath J remedied this anomaly by a further implication that the mortgagor should be liable for any GST which had not been paid by Belman.  So the Commissioner was left with the consolation of being able to prove in the liquidation.

7.	The Court of Appeal ([2003] 1 NZLR 425) held that this was not what the Act meant. They said that section 17(1)(b) must be given its natural meaning rather than one which Baragwanath J acknowledged to be “strained”.  Edgewater appealed to the Privy Council and Mr Judd QC urged upon their Lordships that Baragwanath J had been right.  

8.	Mr Judd’s main submission, which was accepted by the judge, was that the ordinary meaning of section 17(1)(b) would produce a conflict with section 104 of the Land Transfer Act 1952, which regulates the application of the proceeds of sale arising on a sale by a mortgagee.  The order of priorities is:
“(a)	… the expenses occasioned by the sale:
  (b)	… the money then due or owing to the mortgagee;
  (c)	… subsequent registered mortgages or incumbrances (if any) in the order of their priority.”

9.	Mr Judd said that GST was not an expense occasioned by the sale. It was a tax levied on the supplier. Ordinarily, the Crown would have no priority over secured creditors for its claim to GST. It has only the limited preference against unsecured creditors conferred by section 42 of the 1985 Act. If the mortgagor had sold the property, both Belman and Edgewater would have been entitled to insist on payment in full before releasing their security.  The Crown would have enjoyed no preference against either of them. Why should the position be different because the sale was by the mortgagee rather than the mortgagor?

10.	Their Lordships consider that the answer to this rhetorical question is: because that is what section 17 says.  There is no conflict between section 17 and section 104 of the 1952 Act because section 17 does not purport to interfere with the order of priorities laid down by section 104.  It does not say that the mortgagee must pay the GST out of the proceeds of sale or out of any particular fund.  It simply says that he must pay the GST.  As section 17(2) says, it creates a debt.  The Crown has no concern with how the payment of this debt affects the distribution of the proceeds of sale.  In claiming payment of the GST, the Crown is not seeking to assert a priority in the distribution of the assets of the mortgagor, any more than an estate agent instructed by the mortgagee and claiming commission on the sale. The claim lies directly against the mortgagee.

11.	Mr Judd said that it was anomalous that the mortgagee would have to pay without any right to deduct input tax to which the mortgagor may have been entitled.  That is true, but the other side of the coin is that the mortgagor would be entitled to deduct the input tax from any other taxable supplies or, if there were not enough, to claim a refund.  So the Crown, as Mr Judd accepted, would be no better off.  The only improvement in the Crown’s position arises from substituting a debtor who is likely to be solvent and in funds for a debtor who might be insolvent.  But their Lordships consider that this is precisely what section 17 was intended to do.

12.	Once the mortgagee has paid the GST, the question of the priority of his claim for reimbursement will arise.  Their Lordships consider that it is plainly an “expense occasioned by the sale” within the meaning of paragraph (a).  It is an obligation imposed upon the mortgagee by virtue of his having sold the property.  He is therefore entitled to deduct it from the proceeds before payment of his own debt and is accountable to subsequent encumbrancers only for the balance.

13.	Their Lordships will therefore humbly advise Her Majesty that the appeal should be dismissed with costs. 

1.