BusinessDesk: NZ tax case risks deterring Australian investment, Ernst & Young says

By Pattrick Smellie

Australian companies’ willingness to invest in New Zealand businesses will be placed at risk if the Inland Revenue Department wins its latest tax avoidance test case, says Kirsty Keating, an executive director at accounting firm Ernst & Young.

Riding high on a string of recent wins that are reshaping definitions of tax avoidance in New Zealand, the IRD is currently defending its decision to disallow $7.2 million of tax deductions claimed by Western Australian building products firm Alesco Corp., which used optional convertible notes to fund asset purchases in New Zealand in 2003.

As many as nine Australian-headquartered companies are challenging the IRD’s interpretation of the way they used the OCN structure with New Zealand subsidiaries to split funds into a combination of debt and equity, with the debt component triggering tax deductions.

“The outcome could impact on any New Zealand company receiving debt funding from a multi-national parent,” Keating said in a commentary on the Alesco test case, which opened in the High Court in Auckland this week.

Among them are Telstra Corp., Toll Holdings, and the Australian owners of the TV3 network, with tax in dispute totalling more than $233.4 million before interest or penalties. Total challenges could top $800 million if the IRD pursues similar arrangements such as so-called mandatory optional notes.

“It is a fact of commercial life in New Zealand that many businesses are dominated by foreign multi-nationals and that intra-group financing is both commonplace and necessary,” Keating said. “There is a risk that uncertainty arising from the court’s findings could be a deterrent to foreign funding of many New Zealand companies.”

Alesco is arguing it followed the IRD’s own guidelines on the tax treatment of 'hybrid' debt and equity instruments such as OCNs, which allowed the deduction of 'deemed' interest.

However, Deputy Solicitor-General Matthew Palmer told the court yesterday the arrangements were artificial and contrived, and had no purpose other than to avoid tax.

“As a matter of substance, these OCNs are an interest free loan, stapled to a valueless and essentially purposeless warrant,” he said. “Alesco already held that which the option would have given.”

The IRD contended “these OCNs do not exist in the real world, there is no commercial reason to use an interest-free OCN issued at par between a parent and a 100% subsidiary” and the rules on hybrid instruments were intended for arms-length commercial relationships.

Ernst & Young’s Keating argues there are already cross-border tax provisions that target related-party funding, which limit how much debt funding New Zealand companies can have.

“It has always been considered that so long as companies stay within these legislative boundaries, they would be safe," she said.

“The IRD’s arguments here could add a third and (for most) unexpected restriction on related party financing under the general anti-avoidance provisions of the Income Tax Act,” Keating said. “The implications are potentially huge” and could be used to produce the “absurd result” of allowing cash repayments of debt to be challenged.