New Zealand vs Frucor Suntory, September 2022, Supreme Court, Case No [2022] NZSC 113

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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 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.

In 2018 the High Court decided in favor of Frucor Suntory

This decision was appealed to the Court of Appeal, where in 2020 a decision was issued in favor of the tax authorities.

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 totaling $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 totaling $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.

This decision was then appealed to the Supreme Court.

Judgement of the Supreme Court

The Supreme Court dismissed the appeal of Frucor and ruled in favor of the tax authorities both in regards of the tax adjustment and in regards of shortfall penalties.


“[80] The picture which emerges from the planning documents which we have reviewed is clear. The whole purpose of the arrangement was to secure tax benefits in New Zealand. References to tax efficiency in those planning documents are entirely focused on the advantage to DHNZ of being able to offset repayments of principal against its revenue. The anticipated financial benefits of this are calculated solely by reference to New Zealand tax rates. The only relevance of the absence of a capital gains liability in Singapore was that this tax efficiency would not be cancelled out by capital gains on the contrived “gain” of DAP under the forward purchase agreement.

[81] There were many elements of artificiality about the funding arrangement. Of these, the most significant is in relation to the note itself.

[82] Orthodox convertible notes offer the investor the opportunity to receive both interest and the benefit of any increases in the value of the shares over the term of the note. For this reason, the issuer of a convertible note can expect to receive finance at a rate lower than would be the case for an orthodox loan.

[83] The purpose of the convertible note issued by DHNZ was not to enable it to receive finance from an outside investor willing to lend at a lower rate because of the opportunity to take advantage of an increase in the value of the shares. The shares were to wind up with DAP which already had complete ownership of DHNZ. As well, Deutsche Bank had no interest in acquiring shares in DHNZ. Instead, it had structured a transaction that generated tax benefits for DHNZ in return for a fee. Leaving aside the purpose of obtaining tax advantages in New Zealand, the convertible note structure that was adopted had no point.

[84] The other elements of artificiality discussed in the High Court and Court of Appeal judgments are functions of this fundamental artificiality. The most significant of these elements is the way in which the value was attributed to various components of the funding arrangement. As we have explained at [29]–[30], as initially proposed, the starting point for attribution of value was to be the face value of the note calculated by reference to the maximum amount that DHNZ could borrow and still meet the thin capitalisation rules, with the values attributed to the other components (the amount paid under the forward purchase agreement and net contribution from Deutsche Bank) to be worked out backwards from this figure. As it happened, the eventual starting point was the amount paid under the forward purchase agreement. Again, the other figures were then worked out by reference to this different starting point and the applicable interest rate.

[85] As is often the case with tax avoidance, there were substantial elements of contrivance, circularity and cancellation. The artificial features of the funding arrangement to which we have just referred are all indications of contrivance. As between DAP, DHNZ and Deutsche Bank, there was complete circularity as to $60 million of the $149 million paid under the forward purchase agreement. As well, if DHNZ and DAP are treated as a group, there was, in economic substance, complete circularity in relation to the $149 million. As to cancellation, the effect of the forward purchase was to cancel the note save as to the liability for $55 million which was to be discharged by DHNZ in the guise of interest payments on an advance of $204 million. There was also further cancellation in relation to $60 million paid by DHNZ back to DAP as a return of capital; this because it was immediately reversed in the management accounts of both companies, leaving DAP “owing” DHNZ $60 million as unpaid capital.

[86] Against this background, the effect of the arrangement was that DHNZ sought to obtain deductions in relation to $55 million in principal repayments. These are provided for in the Act to meet financing expenses and not repayments of principal. DHNZ was thus claiming deductions for expenses which, in economic substance, it had not incurred. This use of the relevant deduction provisions of the Act lay outside of parliamentary contemplation as to the use of those provisions. It was therefore tax avoidance and the Commissioner was entitled to void the arrangement under s BG 1(1).”


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