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IRD's latest tax avoidance win puts offshore investment at risk

Decision could garner the taxman $800 million – but has been slammed as being inconsistent with the IRD's own guidelines and as a threat to overseas investment.

Rob Hosking
Mon, 12 Dec 2011

Inland Revenue has won its landmark case against building supply group Alesco.

The decision – which is estimated to ultimately affect a large number of Australian-owned firms and could garner the taxman $800 million – has been slammed as being inconsistent with the IRD's own guidelines and as a threat to overseas investment in New Zealand.

At the heart of the case was Alseco's use of optional convertible notes (OCNs) – a funding mechanism used by a number of other Australian-owned firms including RadioWorks and TVWorks.

It is estimated that about $800 million is at stake if the IRD is able to collar the other firms using OCNs.

In this particular case, tax owning, penalties and use of money interest totals about $8.6 million.

OCNs are a form of hybrid financing which provides the investor with the right to either be repaid in cash, when the note matures or the option to receive shares to discharge the debt.

Such notes allow an investor to accept a lower interest yield in return for the opportunity to participate in any increase in the issuer‘s wealth at the time of conversion, while the issue has the ability to raise funds at a lower rate.

The notes are not traded in a public market, and in the case of Alesco were held by Alesco's Australian parent company.

IRD's difficulty with the use of the notes that there was a "deemed interest" deduction claimed – which was allowed by the IRD's guidelines at the time.

However, the IRD argued against Alesco that the OCNs were simply "an interest free advance with a valueless option attached, dressed up in the form of a valuable option and a discounted debt."

Justice Paul Heath accepted the IRD's approach, stating that there was no economic cost actually incurred to the company which matched the tax deduction claimed.

"Rather, Alesco NZ had the use of an interest free loan from its parent from the time of advance to the maturity date. Alesco NZ, as a result of the subscription agreements, would not (and did not) incur any actual expense on an annual basis during the period from the issue of the notes until maturity."

The decision - which is expected to go to the Court of Appeal – has been slammed by tax practitioners.

Alesco had a genuine acquisition it needed to fund and it was entitled to use OCNs to fund that acquisition, said Ernst & Young tax partner Jo Doolan.

"Yes, it got advice about how to provide long-term finance in a tax effective way, but it is hard to imagine any major company would not consider tax in the context of its acquisitions process. In fact, a company would be required to do so."

Any other finance would have caused interest costs, and these could have been claimed as tax deductions, she said.

"So nothing was gained through the zero coupon OCN that would not have otherwise been automatically achieved through any type of debt.

"On this type of analysis, where companies have a choice of injecting equity or debt, and debt provides an interest deduction that equity does not, will the choice to debt fund in any form now be tax avoidance?"

The wider issue is the question of certainty for overseas investors in New Zealand, she said.

"We are an importer of capital and rely on overseas companies investing in NZ. One has to question whether this type of uncertainty is in our best interests.

It is all very well to use the anti avoidance rules to slam-dunk transactions and to collect more tax, however if this means we lose out of offshore investment, then we have all lost."

Rob Hosking
Mon, 12 Dec 2011
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IRD's latest tax avoidance win puts offshore investment at risk