Alesco New Zealand Ltd and Ors v Commissioner of Inland Revenue

• Jurisdiction: New Zealand
• Judge: Heath J
• Judgment Date: 12 December 2011
• Neutral Citation: [2011] NZHC 1750
• Docket Number: CIV 2009-404-4528 CIV 2011-404-4025 CIV 2009-404-2145
• Court: High Court
• Date: 12 December 2011

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

[2011] NZHC 1750

CIV 2009-404-4528

CIV 2010-404-4693

CIV 2011-404-4025

CIV 2009-404-2145

IN THE HIGH COURT OF NEW ZEALAND

AUCKLAND REGISTRY

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.

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

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 2002, Alesco Corporation was contemplating the acquisition of industrial businesses in New Zealand. Two targets were identified. One, Biolab Ltd (Biolab),

was primarily involved in the distribution of medical laboratory equipment. The other, Robinson Industries Ltd (Robinson), produced and distributed laundry tubs, kitchen air extractor systems and rangehoods. Alesco Corporation made a commercial decision to acquire the two businesses. Having done so, it was necessary to determine the entity that would effect the purchases and the way in which the transactions could be financed

8 Alesco Corporation nominated Alesco NZ to purchase 100% of the shares in Biolab. The purchase price was $46 million. Of that sum, $6,040,280 was satisfied by Alesco Corporation assuming a debt owed by Biolab (Aust) Pty Ltd (Biolab Australia). Later, a contractually agreed “earn-out” payment of $9,191,000 became payable, making the total purchase price $55,191,000.

9 The major shareholder in Robinson declined to give the warranties sought by Alesco Corporation, in relation to the sale of shares. As a result, Alesco Corporation arranged for Alesco NZ to acquire the Robinson business. That was done through Alesco NZ's wholly owned subsidiary, Robinhood Ltd (Robinhood). The purchase price was $28,653,345, payable as to $27,850,000 on settlement on 30 April 2003 and an “earn-out” payment of $1 million in August 2004.

10 There was nothing artificial about the acquisitions or the way in which Alesco Corporation raised money to finance them. Real businesses were acquired with real money. Alesco Corporation raised something in the order of $85 million through debt and equity financing, to enable the transactions to be completed.

11 The Commissioner's tax avoidance concerns are focussed squarely on the intermediate arrangements that were put in place, by which Alesco Corporation made the inter-company advances to Alesco NZ to enable the purchases to be settled in New Zealand.

12 Understandably, to lessen its transaction costs, Alesco Corporation was keen to ensure that the inter-company financing arrangements were structured in the most tax-effective way. Advice was taken from its business and tax advisers, KPMG, in both Australia and New Zealand. 6 Following receipt of that advice, Alesco Corporation decided to use a form of optional convertible note to record payments totalling $78 million to Alesco NZ.

13 The Notes 7 were issued by Alesco NZ, in favour of Alesco Corporation. The sum of $78 million was paid to Alesco NZ in three tranches, each pursuant to a separate Note. The purchase price for the shares in Biolab was funded in two segments, one in March 2003 and one in September 2003, reflecting the two stages of payment of approximately $41 million and $9 million respectively. Another advance, in April 2003, was made to acquire the Robinson assets.

14 Each of the Notes contained debt and equity components. KPMG advised Alesco Corporation that this type of financial instrument would allow Alesco NZ to claim interest deductions in New Zealand.

The choice of inter-company financing structure

15 At material times during 2003, Mr Alan Fonseca was Alesco Corporation's Group Financial Controller. From then until July 2008, he was its Chief Financial Officer. Mr Fonseca gave evidence about the basis on which the Alesco Corporation board decided to structure the internal funding arrangements.

16 In 2002 and 2003, Mr Fonseca had responsibility for the Alesco Group's funding management and banking/borrowing arrangements. He was responsible for reporting to Alesco Corporation's...