In 2003 Alesco New Zealand Ltd (Alesco NZ) bought two other New Zealand companies. Its Australian owner, Alesco Corporation (Alesco), funded the acquisitions by advancing the purchase monies of $78 million. In consideration Alesco NZ issued a series of optional convertible notes (OCNs or notes). The notes were non-interest bearing for a fixed term and on maturity the holder was entitled to exercise an option to convert the notes into shares. Between 2003 and 2008 Alesco NZ claimed deductions for amounts treated as interest liabilities on the notes in accordance with relevant accounting standards and a determination issued by the Commissioner against its liability to taxation in New Zealand. In the High Court Heath J upheld1 the Commissioner’s treatment of the OCN funding structure as a tax avoidance arrangement under s BG 1 of the Income Tax Act 1994 and the Income Tax Act 2004 (the ITA).
Alesco NZ appeals that finding and two consequential findings. The amount at issue is about $8.6 million. Included within that figure are revised assessable income tax, shortfall penalties and use of money interest. However, Alesco NZ’s appeal has wider fiscal consequences. The Commissioner has treated similar funding structures used by other entities as tax avoidance arrangements. Decisions on those disputed assessments await the result of this litigation. The Commissioner estimates that over $300 million is at issue including core tax and penalties plus accruing use of money interest.
Two other features of this appeal require emphasis. First, in contrast to a number of recent cases on tax avoidance, the Commissioner does not impugn the underlying commercial transactions. She accepts that Alesco NZ’s acquisitions were not made for the purpose or effect of avoiding tax and that the company had to raise funds to enable completion. Her challenge is to the permissibility of the OCN funding mechanism actually deployed or what is called an intermediate step in implementing the underlying transactions.
Second, the Commissioner accepts that when viewed in isolation from the statutory anti-avoidance provisions the OCN structure complied technically with the relevant financial arrangements rules, the deductibility provisions relating to expenditure and interest then in force, together with the spreading formula provided by the Commissioner’s determination known as G228 (an instrument issued by the Commissioner to provide a method for assessing income and costs on debt instruments under the financial arrangements rules, to which we shall return in more detail).
The meaning, purpose and effect of the financial arrangements rules, and the regime they introduced in 1985 for the purpose of assessing the income returns and deductibility of costs on particular debt instruments, are at the heart of this appeal.
Relevant facts
In January 2003 Alesco agreed to purchase for $46 million the shares in a New Zealand company, Biolab Ltd, a distributor of medical laboratory equipment. This sum was later increased to $55 million by a supplementary payment. Alesco nominated its New Zealand subsidiary, Alesco NZ, as the purchaser. While the purchase monies were to be raised in Australia, Alesco’s board had not then decided on the appropriate funding structure.
Judgement from the Court of Appeal:
A Alesco NZ’s appeal is dismissed.
B Alesco NZ must pay costs to the Commissioner for a complex appeal on a band B basis and usual disbursements. We certify for two counsel.
Judgement from the Supreme Court:
A Leave to appeal is granted.
B The approved grounds of appeal are whether, in light of the principles laid down by this Court in Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue and other cases on tax avoidance:
(i) the structure used by the applicants for funding the transactions is a tax avoidance arrangement;
(ii) the Commissioner’s application of shortfall penalties was a proper exercise of the relevant statutory powers;
(iii) the Commissioner’s reassessments were a proper exercise of the relevant statutory powers.