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05 Mar 2013
Appeal Status

Court of Appeal confirms OCN arrangement is tax avoidance

2013 case note – Court of Appeal confirms optional convertible notes arrangement is tax avoidance - economic cost, abusive tax position.

Alesco New Zealand Ltd and Others v Commissioner of Inland Revenue


The Court of Appeal has confirmed that the optional convertible notes ("OCNs") arrangement entered into by the Alesco group, to claim deductions for interest using Determination G22 and the financial arrangement rules, was a tax avoidance arrangement. The Court also held the "abusive tax position" shortfall penalties were correctly imposed.

Impact of Decision

This is an important judgment for the Commissioner. Other taxpayers have entered into similar arrangements. This case will most probably influence the outcome of those cases. The total amount of tax across all OCN cases is over $300 million including use-of-money interest.


Alesco New Zealand Ltd ("Alesco NZ") and certain subsidiaries appealed against the High Court's decision (Alesco New Zealand Ltd v Commissioner of Inland Revenue [2012] 2 NZLR 252 (HC)) that upheld the Commissioner's assessments declaring the 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 ("the 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 the Corporation in return for advances totalling $78 million for a term of 10 years. At maturity, the 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 applied. The application of Determination G22 to the terms of the OCN resulted in deemed interest deductions for Alesco NZ in the 2003 to 2008 years (inclusive).


The Court of Appeal unanimously dismissed Alesco NZ's appeal, essentially on the same grounds as the High Court dismissed its challenge.

Alesco NZ advanced a threshold argument. It argued that tax avoidance can only be determined by having regard to the tax position hypothetically obtainable under other business or funding structures (a counterfactual). The Court disagreed and held the question is whether the particular arrangement had the effect of avoiding tax. The definition provisions in the Income Tax Act do not allow for a hypothetical point of reference. In any event, Alesco NZ did not establish an evidential foundation for a counterfactual position.

The Court held that a question that lay at the heart of the appeal was whether Alesco NZ suffered an economic cost commensurate with its claimed deductions. If Alesco NZ did not incur an economic cost, the question became whether its use of the financial arrangement rules and Determination G22 to claim deductions for expenditure incurred fell outside Parliament's contemplation.

The Court held that Alesco NZ did not actually pay interest but obtained a reduction in tax liability as if it had. Alesco NZ failed to prove that its use of the financial arrangement rules and Determination G22 to claim deductions were within Parliament's contemplation. It had engaged in tax avoidance.

On the issue of reconstruction, the Court held that the Commissioner has broad discretion. The Commissioner may have regard to an alternative funding arrangement but she is not obliged to, and should not, where the tax advantage can be counteracted simply by disallowing the impermissible deductions.

On the issue of shortfall penalties, the Court held that it is required to view the arrangement objectively and not have regard to Alesco NZ's intentions in taking its tax position. The Court held that there was no purpose for the arrangement except to secure a tax advantage. Accordingly, Alesco NZ entered into the arrangement for the dominant purpose of avoiding tax and was liable for a shortfall penalty for taking an "abusive tax position".

Income Tax Act 1994, Income Tax Act 2004