Inland Revenue's run of judicial wins continues with the Court of Appeal finding in favour of the taxman against trans-Tasman building products company Alesco.

The case is important as it involves the use of optional convertible notes (OCNs), instruments used by a number of offshore companies to finance developments in New Zealand.

The judgment, delivered by Justice Rhys Harrison, appears to take the anti-avoidance regime in New Zealand a step further than previous judgments: Justice Harrison says that even if there is a commercial rationale for the method of financing its investment used by Alesco, that is not enough to get the company off the tax avoidance hook.

Even so, Justice Harrison says that in this case there is no convincing underlying commercial rationale for the arrangement.

The company’s lawyer, Lindsay McKay, argued in court that it “adopted this structure as a mechanism to fund existing financial obligations. This feature contrasts with other tax avoidance cases where the transactions would not have been entered into but for the tax benefits to be achieved,” the court's ruling says.

“However, this distinctive factor does not protect Alesco NZ. The question is whether the particular arrangement, regardless of whether it was the originating or intermediate step, had the purpose or effect of tax avoidance. A structure whereby the parent provided funding to its subsidiary of $78 million for 10 years on an interest free basis, in exchange for the subsidiary issuing to it optional convertible notes, cannot possibly have been chosen for a predominantly commercial purpose.”

“Mr McKay has not identified one, and nor could he.”

The company had adopted the OCN method “solely in pursuit of the goal of tax avoidance, to obtain a taxation benefit whereby the advantage of interest deductions was totally disproportionate to the economic burden.

“The benefit did not naturally attach to or was not subordinate or subsidiary to an identifiable concurrent commercial purpose or effect. Nor was the benefit merely incidental to an underlying commercial purpose or effect; it was the only identifiable purpose and effect of adopting the OCN structure.

“We are satisfied that, but for that benefit, the OCN structure would not have been chosen.”

Alesco, an Australian based firm, used the OCN method in 2003 to finance a $28.6 million buyout of kitchen and laundry goods manufacturer Robinson Industries.

Other firms which have used the OCN method, but which settled earlier disputes with IRD, included Telstra, Toll Holdings and Media Works.