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12 Dec 2011
Appeal Status

Optional convertible notes can be tax avoidance arrangements

2011 case note – Court held optional convertible notes can be tax avoidance arrangements - determination G22, tax avoidance, reconstruction, abusive tax position.

Alesco New Zealand Ltd and Ors v Commissioner of Inland Revenue


The Court held that the use of particular optional convertible notes (OCNs) was a tax avoidance arrangement because the arrangement was an artificial device and it was not within Parliamentary contemplation.

Impact of decision

This is an important judgment for the Commissioner. The final result of this case will most probably influence the outcome of other, similar cases. The total amount of tax across all similar OCN cases is approximately $226 million plus use-of-money interest.


Alesco New Zealand Ltd ("Alesco NZ") and certain subsidiaries challenged the Commissioner's assessments were made as a result of him declaring an arrangement void as a tax avoidance arrangement. The assessments disallowed interest deductions and loss offset elections and imposed abusive tax position shortfall penalties.

Alesco NZ is a wholly owned subsidiary of Alesco Corporation ("Corporation"), an Australian company. The arrangement involved the use of OCNs in an intra-group situation to finance the acquisition of two businesses in New Zealand.

Alesco NZ issued OCNs to Corporation in return for advances totalling $78 million for a term of 10 years. At maturity, Corporation had the option of being repaid the $78 million or converting the OCNs into shares in Alesco NZ. No interest was payable on the OCNs.

At the relevant times the Commissioner's Determination G22 was applicable. The application of Determination G22 to the terms of the OCN resulted in deemed interest expenses for Alesco NZ in the 2003 to 2008 years.


Following Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, Heath J held that the test of whether the tax advantages obtained were permissible is whether Parliament could have contemplated that the financial arrangement rules would be used to obtain the interest deductions claimed.

The High Court held that the OCNs were tax avoidance arrangements. There were three reasons for this. First, the OCNs were designed to enable Alesco NZ to claim interest deductions without any corresponding return of taxable income. Secondly, the arrangement was an artificial device designed only to secure a tax advantage in New Zealand that could not otherwise have been obtained. Thirdly, the Court found that the deductions claimed were not within Parliamentary contemplation because no real interest expense was incurred and the notional interest claimed did not represent a real economic cost.

On the issue of reconstruction, the Court accepted the Commissioner's contention that he had the discretion to counteract the tax advantage as he thought fit. He was not obliged to apply what Alesco NZ said would have occurred if the avoidance arrangement had not been entered into.

On the issue of shortfall penalties, the Court found that Alesco NZ entered into the arrangement with a dominant purpose of avoiding tax. It was therefore liable for an abusive tax position shortfall penalty.

Tax Administration Act 1994