IRD Wins Benchmark Tax Case

December 13, 2011 New Zealand Taxation

Tax Ruling New ZealandThe Inland Revenue Department has won a new court case, clarifying the tax treatment of Optional Convertible Notes in New Zealand.

On December 12th the Inland Revenue Department won a tax avoidance case against the building supply company Alesco, sending the signal that certain structures involving the use of Optional Convertible Notes could be ruled as means of evading taxes. Alesco, which is a subsidiary of an Australian kitchen supply company, will now be required to pay the Inland revenue Department approximately NZD 8.6 million in unpaid taxes, shortfall penalties and use of money interest payments.

The legal proceedings against Alesco involved the company’s use of Optional Convertible Notes (OCN), which are a hybrid instrument which offer the option payments in cash or as equity at maturity. According to Alesco the OCNs bore an interest cost, which was claimed to be a deduction. However, the IRD argued that the OCNs were “an interest free advance with a valueless option attached, dressed up in the form of a valuable option and a discounted debt.”

The legal action against Alesco was seen as a test case for the Inland Revenue Department, as it prepares to follow similar action against 16 other Australian owned subsidiary companies which were allegedly misusing OCNs. According to IRD estimates, the legal proceedings could lead to the recovery of a cumulative NZD 300 million in unpaid taxes and associated penalties.

The court ruling is already being met with degree of skepticism from tax practitioners. Ernst & Young tax partner Jo Doolan commented on the result, saying that the court’s decision could lead to a degree of uncertainty in the minds of foreign companies financing their New Zealand subsidiaries. He added that that lowering tax evasion was a positive action, but it should not come at the cost of lowering New Zealand levels of incoming investment.

Photo by DES Diethylstilbestrol