The IRD has scored a significant and potentially wide-reaching victory in the Appeal Court, with the upholding of a ruling against Alesco previously appealed by that firm.
The case has the potential to affect disputed tax revenue of more than NZ$300 million, involving disputes by some 16 overseas, mostly Australian, companies that had lowered their tax bills by using New Zealand subsidiaries.
The test case involved the Western Australian firm, Alesco, which bought two New Zealand businesses in 2002 – Biolab and stoveware manufacturer Robinson Industries and then used a structure known as “optional convertible notes” (OCNs) to avoid tax in New Zealand.
The amount at issue in the Alesco case was NZ$8.6 million. Alesco was also ordered to pay costs to the Commissioner of Inland Revenue.
Alesco is Alesco Corporation, an Australian building materials and home products maker. Its local subsidiary, Alesco New Zealand Ltd, issued 78 million OCNs at NZ$1 each to its parent in 2003 and 2004.
The Court of Appeal has ruled in favour of the IRD.
But the local tax advisory community is not impressed.
Jo Doolan, senior tax partner at Ernst & Young, said: “This is an alarming result which shows that even where taxpayers have real businesses behind what they are doing, the Commissioner can still rewrite the tax outcomes, often years after the transaction is finished." Ernst & Young was not involved in the case. The tax advisors for Alesco were KPMG.
"Despite following the Commissioner’s own determination, which gave rise to the impugned tax deductions, the Court of Appeal has ruled Alesco was not entitled to the tax benefits it got under the OCNs because in legal form and economic substance they made what was equal to an interest free loan," Doolan said.
"This is a worrying. It reinforces the feeling of many inbound investing corporates that the NZ tax environment is too uncertain. It may discourage them from continuing to do business here," she said.
Where there is a genuine business purpose to a transaction and the tax deductions are less than would have otherwise arisen under ordinary debt financing, it is difficult to understand why the Commissioner and the courts viewed this unfavourably, Doolan said.
"With recent high-profile corporate insolvencies, and media coverage of job losses, the timing of this decision is unfortunate."
The IRD is pursuing other disputes involving hybrid financing but these are quite different in their terms and tax outcomes.
General principles from Alesco may have wider application but the outcomes of this case do not necessarily create precedents for other cases because they involve market interest rates.
"In my experience, history shows the IRD will take decided cases and try to apply them more widely and aggressively than the courts may have intended. On that basis, we can expect additions to the growing number of tax disputes where the IRD attacks, under the general anti-avoidance provisions, what were previously considered to be ‘business as usual’ transactions.”
"Given New Zealand is a capital importer and relies on overseas investment one can only hope some form of sanity is restored by the appropriate political intervention.," she said.
"What cannot and should not be forgotten is it is the responsibility of those who administer our tax system to create certainty and the ongoing and blatant use of the tax avoidance legislation to correct what can only be seen as sloppy administration of the tax provisions has to stop.
"The Commissioner wrote the determination that outlined how the particular financing instrument was to be treated for tax purposes. This determination did not exclude related-party funding. One would think that taxpayers can and should be entitled to rely on this determination.
"While the politicians and the Commissioner may be tempted to engage in the 'we won you lost eat that' approach, what is most needed is we consider what is best for our economy and for its future growth and this means we cannot and should not continue with this ongoing battle where the tax avoidance rules are being used to essentially rewrite the tax legislation."