New Zealand vs Frucor Suntory, September 2020, Court of appeal, Case No [2020] NZCA 383

Frucor Suntory (FHNZ) had deducted purported interest expenses that had arisen in the context of a tax scheme involving, among other steps, its issue of a Convertible Note to Deutsche Bank, New Zealand Branch (DBNZ), and a forward purchase of the shares DBNZ could call for under the Note by FHNZ’s Singapore based parent Danone Asia Pte Ltd (DAP).

The Convertible Note had a face value of $204,421,565 and carried interest at a rate of 6.5 per cent per annum. Over its five-year life, FHNZ paid DBNZ approximately $66 million which FHNZ characterised as interest and deducted for income tax purposes.

The tax authorities issued an assessment where deductions of interest expenses in the amount of $10,827,606 and $11,665,323 were disallowed in FY 2006 and 2007 under New Zealand´s general anti-avoidance rule in s BG 1 of the Income Tax Act 2004. In addition, penalties of $1,786,555 and $1,924,779 for those years were imposed.

The tax authorities found that, although such deductions complied with the “black letter” of the Act, $55 million of the $66 million paid was in fact a non- deductible repayment of principal. Hence only interest deduction of $11 million over the life of the Arrangement was allowed.

  1. These figures represent the deduction disallowed by the Commissioner, as compared to the deductions claimed by the taxpayer: $13,250,998 in 2006 and $13,323,806 in 2007.
  2. Based on an allegedly abusive tax position but mitigated by the taxpayer’s prior compliance history.
  3. In so doing, avoiding any exposure to shortfall penalties for the 2008 and 2009 years in the event it is unsuccessful in the present proceedings. The income years 2004 and 2005, in which interest deductions were also claimed under the relevant transaction are time barred.
  4. Which I will refer to hereafter as $204 million without derogating from the Commissioner’s argument that the precise amount of the Note is itself evidence of artifice in the transaction.
  5. As the parties did in both the evidence and the argument, I use the $55 million figure for illustrative purposes. In fact, as recorded in fn 3 above, the Commissioner is time barred from reassessing two of FHNZ’s relevant income tax returns.

The issues

The primary issue in the proceedings is whether s BG 1 of the Act applies to the Arrangement.

Two further issues arise if s BG 1 is held to apply:

(a) whether the Commissioner’s reconstruction of the Arrangement pursuant to s GB 1 of the Act is correct or whether it is, as FHNZ submits, “incorrect and excessive”; and

(b) whether the shortfall penalties in ss 141B (unacceptable tax position) or 141D (abusive tax position) of the Tax Administration Act 1994 (TAA) have application.
The key parties

The High Court decided in favor of Frucor Suntory

The decision was appealed to the Court of Appeal, where a decision in favor of the tax authorities has now been issued.

The Court of Appeal set aside the decision of the High Court in regards of the tax adjustment, but dismissed the appeal in regards of shortfall penalties.

We have already concluded that the principal driver of the funding arrangement was the availability of tax relief to Frucor in New Zealand through deductions it would claim on the coupon payments. The benefit it obtained under the arrangement was the ability to claim payments totalling $66 million as a fully deductible expense when, as a matter of commercial and economic reality, only $11 million of this sum comprised interest and the balance of $55 million represented the repayment of principal. The tax advantage gained under the arrangement was therefore not the whole of the interest deductions, only those that were effectively principal repayments. We consider the Commissioner was entitled to reconstruct by allowing the base level deductions totalling $11 million but disallowing the balance. The tax benefit Frucor obtained “from or under” the arrangement comprised the deductions claimed for interest on the balance of $149 million which, as a matter of commercial reality, represented the repayment of principal of $55 million.

NZ v Frucor September 2020

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