IR having a bad run

Two recent cases, one High Court and the other in the Court of Appeal, were found in favour of the taxpayer. Naturally the focus of the cases were quite specific (although I often find the narrative still useful to understand both the Commissioners and our judicial Overseers current line of thinking), so they may or may not be of interest to you.

The first case dealt with the use of optional convertible notes (“OCN”) (remember Alesco), with both domestic and offshore parties involved, some of which were not related to the NZ based borrower, in particular, the NZ based subscriber (lender) to the OCN’s (although ultimately via the arrangement the shares would end up in the NZ borrower’s Singapore parent’s hands). IR attempted to smell a rat (which was never really there), and denied deductions claimed by the NZ borrower with respect to the OCN’s it had issued, submitting the arrangement was not “economically real”, was therefore tax avoidance and that shortfall penalties for either an unacceptable tax position or an abusive tax position should be applied.

The High Court disagreed with IR and found for the taxpayer, determining the arrangement was certainly one that was contemplated by Parliament, it was economically real, and itself was distinctly different from the arrangements exhibited in Alesco, where a zero-interest coupon rate was used. Additionally, and interestingly, the Court said that even if tax avoidance had been proved, there was no basis for shortfall penalty imposition as the taxpayer was always credibly in a position to challenge the relevance of the economic analysis on which the Commissioner relied.

The second case dealt with a now repealed provision of the income tax legislation, which provided a deduction for expenditure incurred in deriving an exempt dividend. So in essence it was a nexus question, to which the Commissioner formed a view that the expenditure was not incurred by the taxpayer to the extent of the connection required by the legislative provision, in deriving the exempt dividend income received from the taxpayer’s offshore subsidiaries. It should be noted here that the taxpayer lost their case in the High Court.

On appeal in the Court of Appeal however, the High Court decision was overturned. The Appeal court took the view that the nexus was indeed sufficient to establish deductibility, the expenditure clearly in respect of activities the taxpayer undertook to facilitate the operational performance of its subsidiaries, thereby generating the dividend income streams. Furthermore, the capital limitation did not apply to the expenditure incurred, because it represented recurrent and regular business expenses as opposed to improving the capital of the respective subsidiaries.

Long may the losing streak continue!  

A Week in Review; Monday, 12 November 2018