Senior tax practitioners are in shock after the Inland Revenue Department won another key tax avoidance case in the Court of Appeal, with implications for at least 16 companies and some $300 million of back tax, interest and penalties at stake.
The latest decision, issued this morning, throws out the appeal by Australian listed kitchenware maker Alesco Corp against Inland Revenue Department determinations that it owes $8.6 million on avoided tax transactions relating to its purchases of two New Zealand businesses between 2003 and 2008.
Central to Alesco’s appeal were that the Commissioner of Inland Revenue had originally okayed the use of the disputed financial instruments at the heart of the case, known as optional convertible notes (OCN’s), and that there was a real commercial purpose in the transactions to buy the two businesses.
However, a three judge bench led by the president of the Court of Appeal, Justice Paul O’Regan, agreed in all material respects with the High Court judgment of Justice Paul Heath, which found the way Alesco used OCN’s to create a $78 million interest-free loan amounted to tax avoidance.
“The question is whether the taxpayer has truly incurred the cost as intended by Parliament,” the appeal court says in its 54 page judgment, in which costs are awarded against Alesco. “Parliament did not intend that a taxpayer would be entitled to use the financial arrangements rules as a basis for claiming deductions for interest for which the taxpayer was not liable or did not pay.”
Alesco’s argument that it could have structured the purchases in a way that would have cost the New Zealand revenue twice as much as the OCN arrangements was irrelevant, since there was no evidence Alesco considered any other structure, as was any consideration of relevant Australian tax treatments.
The judgment provoked a stinging response from outspoken Ernst & Young tax partner Jo Doolan, who described the IRD’s latest win as “an alarming result.”
“As the shock waves from the Alesco decision reverberate around the tax world, taxpayers and advisers are left with even more uncertainty about the extent to which the Commissioner will go to in using the anti-avoidance provisions to essentially rewrite the tax legislation,” she said.
As a country requiring foreign capital for growth, the decision “reinforces the feeling of many inbound investing corporates that the New Zealand tax environment is too uncertain.”
“It may discourage them from continuing to do business here.”
The IRD has been on a roll with its pursuit of major corporate tax avoidance claims through the courts since securing a $2.2 billion settlement with the four Australian-owned trading banks operating in New Zealand, in 2009.
Among other Australasian corporates caught up in similar OCN cases are Telstra Corp, Toll Holdings, and Ironbridge, the Australian owners Mediaworks, which runs the TV3 and RadioLive networks.
IRD’s litigation manager Karen Whitiskie welcomed the decision.
“When Alesco New Zealand issued OCNs, with zero percent interest coupons attached, to its parent company to fund the purchase of Biolab and Robinson Industries in 2003 and claimed a deduction for ‘interest’ expenditure, it acted outside the intended scope of financial arrangement rules and the relevant Inland Revenue Determination,” she said.
The Court of Appeal found the fact there was a real business purpose to the transaction “will not necessarily protect a transaction from scrutiny where tax avoidance is viewed as ‘a significant or actuating purpose had been pursued as a goal in itself'”.
On claims the company could have structured the purchases another way, the judgment says: “It does not matter that hindsight exercised with the benefit of legal advice in 2011 suggests that interest bearing debt would have been the most fiscally beneficial funding alternative available to Alesco in 2003.”
It dismissed other technical arguments saying “something more would be necessary to persuade us that words can turn a negative into a positive or a pretence into a reality.”
Alesco took its tax advice on the original transactions from KPMG and use PricewaterhouseCoopers partners for expert evidence at trial – a move heavily criticised by the appeal court as part of an “increasing but unacceptable trend of resorting to experts”.
PwC’s Michael Schubert was particularly criticised for failing to objective and adding “unnecessary complication by diverting the true nature of enquiry away from the facts down unproductive paths.”
In the end, the court was satisfied that the OCN arrangements were more than a merely incidental element of the Alesco purchases of New Zealand assets.
“The opposite is true,” the appeal court judges ruled.
Alesco has yet to comment, but a Supreme Court appeal may be in prospect because of the wide-ranging implications of the case for other taxpayers.
“History shows the IRD will take decided cases and try to apply them more widely and aggressively than the courts may have intended,” said E&Y’s Doolan. “We can expect additions to the growing number of tax disputes where the IRD attacks … what were previously considered to be business as usual transactions.”