Alesco New Zealand Ltd and Ors v Commissioner of Inland Revenue

JurisdictionNew Zealand
CourtHigh Court
JudgeHeath J
Judgment Date12 Dec 2011
Neutral Citation[2011] NZHC 1750
Docket NumberCIV 2009-404-4528 CIV 2011-404-4025 CIV 2009-404-2145

[2011] NZHC 1750

IN THE HIGH COURT OF NEW ZEALAND

AUCKLAND REGISTRY

CIV 2009-404-4528

CIV 2010-404-4693

CIV 2011-404-4025

CIV 2009-404-2145

Under the Tax Administration Act 1994

In the Matter of the Income Tax Act 1994

Between
Alesco New Zealand Ltd and Ors
Plaintiffs
and
Commissioner of Inland Revenue
Defendant
Counsel:

L McKay, R G Simpson and M McKay for Alesco NZ Ltd

B W F Brown QC, M S R Palmer, J H Coleman and R L Roff for Commissioner of Inland Revenue

L McKay, PO Box 3067, Shortland Street, Auckland

B W F Brown QC, PO Box 5161, Wellington

J Coleman, PO Box 10201, Wellington

Challenge to CIR's decision that the plaintiff companies were involved in a tax avoidance arrangement and against imposition of shortfall penalties — plaintiff was a subsidiary of an Australian company — whether amortised interest deductions claimed by plaintiff arising out of the use of optional convertible notes in intra-group arrangements to fund business acquisitions was a tax avoidance arrangement under sBG1 Income Tax Act 1994 (arrangement void) — whether the imposition of shortfall penalty of 50% under s141D (abusive tax position) was appropriate.

Held: It was common ground that the notes constituted an “arrangement” as defined in sOB1 IA (any contract or understanding carried into effect). It was clear that once Alesco Corp made the decision to acquire the two businesses, its sole motivation was to find and employ the most tax effective structure, whether in NZ or Australia or both. Viewed objectively, the arrangement was necessarily one that directly or indirectly relieved Alesco NZ from liability to pay income tax or reduced directly or indirectly, its liability to income tax through the ability to claim interest deductions and to offset losses among members of its group.

The fact that the notes were used to finance the acquisitions on the most tax effective terms meant there was no question of tax advantages being derived on a merely incidental basis. The test of whether tax advantages were permissible was whether Parliament could have contemplated that the financial arrangement rules would be used to obtain interest deductions in the circumstances of this case.

The real nature of the transaction effected through the notes was that intercompany advances by Alesco Corp to Alesco NZ were driven solely by tax purposes. The notes were nothing more than a means of obtaining NZ tax benefits. At the time the notes were issued, Alesco Corp owned 100% of Alesco NZ's capital. Had it exercised the option to convert debt to shares, there would have been no change to Alesco's status as a wholly owned subsidiary. Further there was no negotiation as this process could not take place when terms of a subscription were foisted on a subsidiary by its parent. The protections agreed between parent and subsidiary were no more than window dressing. The arrangement was artificial. Further the economic reality of the transaction was that no economic cost was actually incurred. Alesco NZ as a result of the subscription did not incur any actual expense on an annual basis during the period of the issue of the notes until maturity.

Therefore the interest deductions claimed were not contemplated by Parliament because:

  • • there was an absence of any match between expenditure incurred and income to be returned;

  • • the arrangement was an artificial device designed to secure a tax advantage that could not otherwise have been obtained;

  • • no real interest expense had been incurred and the notional interest claimed had not represented a real economic cost. Further the notes had no inherent commercial value to an arm's length third party as there would have been a need to negotiate important terms that went beyond the terms of the subscription agreements.

It was clear that once the arrangement was treated as void, the purpose of the Commissioner's decision to reconstruct was to counteract any tax advantage achieved. The tax position taken was not, when viewed objectively, “about as likely as not to be correct” under s141B(1) IA (failed to meet standard of being about as likely as not to be correct). The taxpayer's belief that the position taken was correct was irrelevant ( Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue). The notes were artificial, there had not been any actual interest expense incurred and the option component had no real economic value. Taking an unacceptable tax position was prerequisite to a find of an abusive tax position under s141D IA. Viewed objectively Alesco NZ had entered into the arrangement with a dominant purpose of avoiding tax which met the definition of an abusive tax position under s141D IA. The shortfall penalties met the statutory criteria.

Challenges dismissed.

JUDGMENT (NO. 2) OF Heath J

CONTENTS

The proceedings

[1]

An overview

[7]

The choice of inter-company financing structure

[15]

Competing contentions

[38]

The nature of an optional convertible note

[49]

The Notes

[54]

Unwinding the Notes

[62]

The scheme of G22

[69]

Accounting standards

[76]

Tax avoidance: legal principles

[81]

Tax avoidance: Analysis

(a) Tax avoidance arrangement

[91]

(b) Purpose of the financial arrangement rules

[94]

(c) The real nature of the transactions effected through the Notes

[106]

(d) Artificiality, economic cost and value

(i) Artificiality

[112]

(ii) Economic cost

[113]

(iii) Did the option component of the Notes have economic value?

[132]

(e) Were the deductions claimed within Parliamentary contemplation?

[146]

Reconstruction issues

(a) Introductory comments

[149]

(b) The competing positions

[151]

(c) The Court's jurisdiction on reconstruction

[154]

Shortfall penalties

(a) The Commissioner's assessments

[161]

(b) The statutory provisions

[163]

(c) The purpose of the shortfall penalty provisions

[167]

(d) “Unacceptable tax position”

[168]

(e) “Abusive tax position”

[176]

(f) Conclusion

[180]

Result

[181]

The proceedings
1

Alesco New Zealand Ltd (Alesco NZ) and other subsidiary companies 1 challenge decisions of the Commissioner of Inland Revenue (the Commissioner) to declare an arrangement void, under the general anti-avoidance provisions of the income tax legislation. If that were unsuccessful, they also dispute the

Commissioner's re-calculation of assessable income and his decision to impose shortfall penalties.
2

There are four proceedings:

  • (a) In CIV 2009-404-2145, Alesco NZ challenges the Commissioner's decisions to disallow interest deductions totalling $5,687,729, for the 2003, 2004 and 2005 tax years.

  • (b) In CIV 2009-404-4528, Parbury Building Products (NZ) Ltd, Biolab Ltd, Robinhood Ltd and Alesco NZ Trustee Ltd 2 challenge the Commissioner's decisions to reduce loss offsets from Alesco NZ totalling $1,910,846, for the 2003, 2004 and 2005 tax years.

  • (c) In CIV 2010-404-4693:

    • (i) Alesco NZ challenges the Commissioner's decisions to disallow interest deductions totalling $9,277,629, for the 2006, 2007 and 2008 tax years, and

    • (ii) Parbury Building Products (NZ) Ltd, Thermo Fisher Scientific New Zealand Ltd and Concrete Plus Ltd challenge the Commissioner's decisions to reduce loss offsets from Alesco NZ, totalling $4,537,757, for the 2006 and 2007 tax years.

  • (d) In CIV 2011-404-4025, Alesco NZ challenges the assessment of shortfall penalties totalling $2,469,282, for the 2003, 2004, 2005, 2006, 2007 and 2008 tax years.

3

Alesco NZ is a wholly owned subsidiary of Alesco Corporation Ltd (Alesco Corporation), a company listed on the Australian Stock Exchange. At issue are amortised interest deductions claimed by Alesco NZ arising out of the use of optional convertible notes (the Notes), in intra-group arrangements, to finance the

acquisition of two businesses operated by New Zealand based companies. At the direction of Alesco Corporation, those businesses were purchased through Alesco NZ. 3 The money required to fund the acquisitions came directly from Alesco Corporation.
4

For the relevant income years, the interest deductions and loss offset elections made by Alesco NZ and its subsidiaries resulted in a reduction of income tax otherwise payable by New Zealand members of the Alesco Group. As a consequence of treating the financial instruments as void, the Commissioner has disallowed claimed interest deductions for the 2003–2008 years and has reversed loss offset elections for the 2003–2007 income years.

5

Only the 2003–2008 income years are presently in issue. The Commissioner has determined that Alesco NZ's revised assessable income tax for those years is

$4,938,568. Shortfall penalties have been levied, in the sum of $2,469,009. Use of money interest has accumulated; at the end of the hearing, I was told that a sum of approximately $1.2 million was owing. The total amount in dispute in these proceedings is something in the order of $8.6 million.

6

Similar financing structures 4 have been used in other cases. Alesco NZ is one of 16 taxpayers who have challenged decisions made by the Commissioner to treat this form of financing structure as tax avoidance. The aggregate total of core tax and penalties at stake in all of the proceedings, for the 2003–2008 tax years, is approximately $226 million, plus accruing use of money interest. The Commissioner believes that the amount of revenue in dispute is over $300 million. While this is not a designated test case, 5 in a practical sense my decision is likely to influence the course of the remaining proceedings.

An overview
7

In...

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