In 2009 the English company EDF Energy UK Ltd (EDFE), a wholly-owned subsidiary of SAS Electricité de France International (SAS EDFI), issued 66,285 bonds convertible into shares (OCAs) for a unit nominal value of EUR 50,000. SAS EDFI subscribed to all of these OCAs for their nominal value, i.e. a total subscription price of EUR 3,314,250,000. The OCAs had a maturity of five years, i.e. until October 16, 2014, and could be converted into new EDFE shares at the instigation of the subscriber at any time after a three-year lock-up period, i.e. from October 16, 2012. Each bond entitled the holder to receive 36,576 EDFE shares after conversion. The annual coupon for the OCAs was set at 1.085%. In this respect, SAS EDFI determined, on the basis of a panel of bond issues of independent comparables, the arm’s length rate that should be applied to conventional bonds, i.e. 4.41% (mid-swap rate and premium of 1.70%), 490 million according to the “Tsiveriotis and Fernandes” model, so that the sum of the present value of the flows of the “debt” component of the bond and the value of the “conversion” option is equal to the subscription price of the OCAs. SAS EDFI recognised the annual interest received at a rate of 1.085% on the bonds as income, thus subject to corporate income tax, i.e. 36 million euros. The tax authorities considered that the “conversion” component had a zero value for SAS EDFI and that, given the terms of the loan – in this case, via the OCA mechanism – and the context of the issuance transaction, the reduction in the interest rate applied compared with the arm’s length rate of 4.41% to which SAS EDFI was entitled, made it possible to achieve a transfer of profits, In the case of SAS EDFI, the difference between the interest rate of 4.41% and the rate corresponding to the actual remuneration recorded had to be reintegrated in order to determine its taxable income. Before the appeal judge, the Minister of Action and Public Accounts contested any value to the “conversion” component on the double ground, on the one hand, that the OCAs issued by EDFE having been subscribed by its sole shareholder, the financial profit that SAS EDFI can hope to make by subscribing and then converting the OCAs into new shares mechanically has a value of zero, since it would be offset by a loss of the same amount on the value of the EDFE shares held prior to this conversion, and on the other hand, that since the OCAs issued by EDFE were subscribed by its sole shareholder, the financial benefit that SAS EDFI can hope to make by subscribing and then converting the OCAs into new shares has a value of zero, since it would be offset by a loss of the same amount on the value of the EDFE shares held before this conversion, on the other hand, since the objective sought by SAS EDFI was not that of a “classic” financial investor and the decision to convert or not the OCAs into new shares will not be taken solely in the interest of the subscriber with a view to maximising his profit, the valuation of the “conversion” component of the OCAs based solely on such an interest is not relevant and, since the financial impact of a conversion was then random, this component must necessarily be given a value close to zero. Not satisfied with the assessment, Electricité de France brought the case to court. The Court of first instance held in favour of the tax authorities. An appeal was then filed by Electricité de France with the Administrative Court of Appeal (CAA). In a decision issued 25 January 2022 the Administrative Court of Appeal overturned the decision from the court of first instance and found in favor of Electricité de France. “…since the Minister for Public Action and Accounts does not justify the zero value of the ‘conversion’ component he refers to, SA EDF and SAS EDFI are entitled to maintain that he was wrong to consider that, by subscribing to the OCAs issued by EDFE, for which the interest rate applied was 1.085% and not the borrowing rate for traditional bonds of 4, 41%, SAS EDFI had transferred profits to its subsidiary under abnormal management conditions, and the amounts corresponding to this difference in rates had to be reintegrated to determine its taxable results pursuant to Article 57 of the General Tax Code and, for EDFE, represented hidden distributions within the meaning of c. of article 111 of the same code which must be subject to the withholding tax mentioned in 2. of article 119 bis of the same code” An appeal was then filed by the tax authorities with the Conseil d’État, which in November 2022 annulled the decision from the CAA and found in favor of tax authorities and remanded the case to the Administrative Court of Appeal. Judgement of the Administrative Court of Appeal In accordance with the guidance provided in the 2022 Judgement of the Conseil d’État, the Court decided in favor the tax authorities. Excerpt (English translation) “On the existence of an indirect transfer of profits: Regarding the application of tax law: 2. On the one hand, under the terms of the first paragraph of article 57 of the general tax code, applicable to corporate tax matters under article 209 of the same code : ” For the establishment of the income tax due by companies which are dependent on or which have control of companies located outside France, the profits indirectly transferred to the latter, either by increase or decrease in purchase or sale prices, or by any other means, are incorporated into the results recorded by the accounts (…) “. It follows from these provisions that, when it notes that the prices invoiced by a company established in France to a foreign company linked to it – or those invoiced to it by this foreign company – are lower – or ...

In 2009 the English company EDF Energy UK Ltd (EDFE), a wholly-owned subsidiary of SAS Electricité de France International (SAS EDFI), issued 66,285 bonds convertible into shares (OCAs) for a unit nominal value of EUR 50,000. SAS EDFI subscribed to all of these OCAs for their nominal value, i.e. a total subscription price of EUR 3,314,250,000. The OCAs had a maturity of five years, i.e. until October 16, 2014, and could be converted into new EDFE shares at the instigation of the subscriber at any time after a three-year lock-up period, i.e. from October 16, 2012. Each bond entitled the holder to receive 36,576 EDFE shares after conversion. The annual coupon for the OCAs was set at 1.085%. In this respect, SAS EDFI determined, on the basis of a panel of bond issues of independent comparables, the arm’s length rate that should be applied to conventional bonds, i.e. 4.41% (mid-swap rate and premium of 1.70%), 490 million according to the “Tsiveriotis and Fernandes” model, so that the sum of the present value of the flows of the “debt” component of the bond and the value of the “conversion” option is equal to the subscription price of the OCAs. SAS EDFI recognised the annual interest received at a rate of 1.085% on the bonds as income, thus subject to corporate income tax, i.e. 36 million euros.. The tax authorities considered that the “conversion” component had a zero value for SAS EDFI and that, given the terms of the loan – in this case, via the OCA mechanism – and the context of the issuance transaction, the reduction in the interest rate applied compared with the arm’s length rate of 4.41% to which SAS EDFI was entitled, made it possible to achieve a transfer of profits, In the case of SAS EDFI, the difference between the interest rate of 4.41% and the rate corresponding to the actual remuneration recorded had to be reintegrated in order to determine its taxable income. Before the appeal judge, the Minister of Action and Public Accounts contested any value to the “conversion” component on the double ground, on the one hand, that the OCAs issued by EDFE having been subscribed by its sole shareholder, the financial profit that SAS EDFI can hope to make by subscribing and then converting the OCAs into new shares mechanically has a value of zero, since it would be offset by a loss of the same amount on the value of the EDFE shares held prior to this conversion, and on the other hand, that since the OCAs issued by EDFE were subscribed by its sole shareholder, the financial benefit that SAS EDFI can hope to make by subscribing and then converting the OCAs into new shares has a value of zero, since it would be offset by a loss of the same amount on the value of the EDFE shares held before this conversion, on the other hand, since the objective sought by SAS EDFI was not that of a “classic” financial investor and the decision to convert or not the OCAs into new shares will not be taken solely in the interest of the subscriber with a view to maximising his profit, the valuation of the “conversion” component of the OCAs based solely on such an interest is not relevant and, since the financial impact of a conversion was then random, this component must necessarily be given a value close to zero. Not satisfied with the assessment, Electricité de France brought the case to court. The Court of first instance held in favour of the tax authorities. An appeal was then filed by Electricité de France with the Administrative Court of Appeal (CAA). In a decision issued 25 January 2022 the Administrative Court of Appeal overturned the decision from the court of first instance and found in favor of Electricité de France. “…since the Minister for Public Action and Accounts does not justify the zero value of the ‘conversion’ component he refers to, SA EDF and SAS EDFI are entitled to maintain that he was wrong to consider that, by subscribing to the OCAs issued by EDFE, for which the interest rate applied was 1.085% and not the borrowing rate for traditional bonds of 4, 41%, SAS EDFI had transferred profits to its subsidiary under abnormal management conditions, and the amounts corresponding to this difference in rates had to be reintegrated to determine its taxable results pursuant to Article 57 of the General Tax Code and, for EDFE, represented hidden distributions within the meaning of c. of article 111 of the same code which must be subject to the withholding tax mentioned in 2. of article 119 bis of the same code” An appeal was then filed by the tax authorities with the Conseil d’État Judgement of the Supreme Administrative Court The Supreme Administrative Court annulled the decision from the CAA and found in favor of tax authorities. Excerpts “(…) 4. It follows from the statements in the judgment under appeal that the court first found that the interest rate agreed between EDFI and its subsidiary in 2009 was lower than the rate that would remunerate bond financing in an arm’s length situation. Secondly, it considered that the granting to EDFI of an option to convert its shares into shares of the financed company could be valued in the same way as the granting of the same option in the context of a transaction between companies with no capital ties. The court deduced that the interest rate in dispute, including the value of this option, did not constitute an indirect transfer of profits abroad. 5. However, the situation arising from the grant to the sole shareholder of the company financed of an option to convert the bonds he has subscribed to into shares of the company is, by its very nature, not comparable to an arm’s length situation, since the value of this option, consisting exclusively in the opening of an option to acquire a fraction of the company’s capital ...

Frucor Suntory (FHNZ) had deducted purported interest expenses that had arisen in the context of a tax scheme involving, among other steps, its issue of a Convertible Note to Deutsche Bank, New Zealand Branch (DBNZ), and a forward purchase of the shares DBNZ could call for under the Note by FHNZ’s Singapore based parent Danone Asia Pte Ltd (DAP). The Convertible Note had a face value of $204,421,565 and carried interest at a rate of 6.5 per cent per annum. Over its five-year life, FHNZ paid DBNZ approximately $66 million which FHNZ characterised as interest and deducted for income tax purposes. The tax authorities issued an assessment where deductions of interest expenses in the amount of $10,827,606 and $11,665,323 were disallowed in FY 2006 and 2007 under New Zealand´s general anti-avoidance rule in s BG 1 of the Income Tax Act 2004. In addition, penalties of $1,786,555 and $1,924,779 for those years were imposed. The tax authorities found that, although such deductions complied with the “black letter” of the Act, $55 million of the $66 million paid was in fact a non- deductible repayment of principal. Hence only interest deduction of $11 million over the life of the Arrangement was allowed. These figures represent the deduction disallowed by the Commissioner, as compared to the deductions claimed by the taxpayer: $13,250,998 in 2006 and $13,323,806 in 2007. Based on an allegedly abusive tax position but mitigated by the taxpayer’s prior compliance history. In so doing, avoiding any exposure to shortfall penalties for the 2008 and 2009 years in the event it is unsuccessful in the present proceedings. The income years 2004 and 2005, in which interest deductions were also claimed under the relevant transaction are time barred. Which I will refer to hereafter as $204 million without derogating from the Commissioner’s argument that the precise amount of the Note is itself evidence of artifice in the transaction. As the parties did in both the evidence and the argument, I use the $55 million figure for illustrative purposes. In fact, as recorded in fn 3 above, the Commissioner is time barred from reassessing two of FHNZ’s relevant income tax returns. The issues The primary issue is whether s BG 1 of the Act applies to the Arrangement. Two further issues arise if s BG 1 is held to apply: (a) whether the Commissioner’s reconstruction of the Arrangement pursuant to s GB 1 of the Act is correct or whether it is, as FHNZ submits, “incorrect and excessive”; and (b) whether the shortfall penalties in ss 141B (unacceptable tax position) or 141D (abusive tax position) of the Tax Administration Act 1994 (TAA) have application. In 2018 the High Court decided in favor of Frucor Suntory This decision was appealed to the Court of Appeal, where in 2020 a decision was issued in favor of the tax authorities. The Court of Appeal set aside the decision of the High Court in regards of the tax adjustment, but dismissed the appeal in regards of shortfall penalties. “We have already concluded that the principal driver of the funding arrangement was the availability of tax relief to Frucor in New Zealand through deductions it would claim on the coupon payments. The benefit it obtained under the arrangement was the ability to claim payments totaling $66 million as a fully deductible expense when, as a matter of commercial and economic reality, only $11 million of this sum comprised interest and the balance of $55 million represented the repayment of principal. The tax advantage gained under the arrangement was therefore not the whole of the interest deductions, only those that were effectively principal repayments. We consider the Commissioner was entitled to reconstruct by allowing the base level deductions totaling $11 million but disallowing the balance. The tax benefit Frucor obtained “from or under” the arrangement comprised the deductions claimed for interest on the balance of $149 million which, as a matter of commercial reality, represented the repayment of principal of $55 million.” This decision was then appealed to the Supreme Court. Judgement of the Supreme Court The Supreme Court dismissed the appeal of Frucor and ruled in favor of the tax authorities both in regards of the tax adjustment and in regards of shortfall penalties. Excerpt “[80] The picture which emerges from the planning documents which we have reviewed is clear. The whole purpose of the arrangement was to secure tax benefits in New Zealand. References to tax efficiency in those planning documents are entirely focused on the advantage to DHNZ of being able to offset repayments of principal against its revenue. The anticipated financial benefits of this are calculated solely by reference to New Zealand tax rates. The only relevance of the absence of a capital gains liability in Singapore was that this tax efficiency would not be cancelled out by capital gains on the contrived “gain” of DAP under the forward purchase agreement. [81] There were many elements of artificiality about the funding arrangement. Of these, the most significant is in relation to the note itself. [82] Orthodox convertible notes offer the investor the opportunity to receive both interest and the benefit of any increases in the value of the shares over the term of the note. For this reason, the issuer of a convertible note can expect to receive finance at a rate lower than would be the case for an orthodox loan. [83] The purpose of the convertible note issued by DHNZ was not to enable it to receive finance from an outside investor willing to lend at a lower rate because of the opportunity to take advantage of an increase in the value of the shares. The shares were to wind up with DAP which already had complete ownership of DHNZ. As well, Deutsche Bank had no interest in acquiring shares in DHNZ. Instead, it had structured a transaction that generated tax benefits for DHNZ in return for a fee. Leaving aside the purpose of obtaining tax advantages in New Zealand, the convertible note ...

In 2009 the English company EDF Energy UK Ltd (EDFE), a wholly-owned subsidiary of SAS Electricité de France International (SAS EDFI), issued 66,285 bonds convertible into shares (OCAs) for a unit nominal value of EUR 50,000. SAS EDFI subscribed to all of these OCAs for their nominal value, i.e. a total subscription price of EUR 3,314,250,000. The OCAs had a maturity of five years, i.e. until October 16, 2014, and could be converted into new EDFE shares at the instigation of the subscriber at any time after a three-year lock-up period, i.e. from October 16, 2012. Each bond entitled the holder to receive 36,576 EDFE shares after conversion. The annual coupon for the OCAs was set at 1.085%. In this respect, SAS EDFI determined, on the basis of a panel of bond issues of independent comparables, the arm’s length rate that should be applied to conventional bonds, i.e. 4.41% (mid-swap rate and premium of 1.70%), 490 million according to the “Tsiveriotis and Fernandes” model, so that the sum of the present value of the flows of the “debt” component of the bond and the value of the “conversion” option is equal to the subscription price of the OCAs. SAS EDFI recognised the annual interest received at a rate of 1.085% on the bonds as income, thus subject to corporate income tax, i.e. 36 million euros.. The tax authorities considered that the “conversion” component had a zero value for SAS EDFI and that, given the terms of the loan – in this case, via the OCA mechanism – and the context of the issuance transaction, the reduction in the interest rate applied compared with the arm’s length rate of 4.41% to which SAS EDFI was entitled, made it possible to achieve a transfer of profits, In the case of SAS EDFI, the difference between the interest rate of 4.41% and the rate corresponding to the actual remuneration recorded had to be reintegrated in order to determine its taxable income. Before the appeal judge, the Minister of Action and Public Accounts contested any value to the “conversion” component on the double ground, on the one hand, that the OCAs issued by EDFE having been subscribed by its sole shareholder, the financial profit that SAS EDFI can hope to make by subscribing and then converting the OCAs into new shares mechanically has a value of zero, since it would be offset by a loss of the same amount on the value of the EDFE shares held prior to this conversion, and on the other hand, that since the OCAs issued by EDFE were subscribed by its sole shareholder, the financial benefit that SAS EDFI can hope to make by subscribing and then converting the OCAs into new shares has a value of zero, since it would be offset by a loss of the same amount on the value of the EDFE shares held before this conversion, on the other hand, since the objective sought by SAS EDFI was not that of a “classic” financial investor and the decision to convert or not the OCAs into new shares will not be taken solely in the interest of the subscriber with a view to maximising his profit, the valuation of the “conversion” component of the OCAs based solely on such an interest is not relevant and, since the financial impact of a conversion was then random, this component must necessarily be given a value close to zero. Not satisfied with the assessment, Electricité de France brought the case to court. The Court of first instance held in favour of the tax authorities. An appeal was then filed by Electricité de France with the CAA. Decision of the Court of Appeal The Court overturned the decision from the court of first instance and found in favor of Electricité de France. “…since the Minister for Public Action and Accounts does not justify the zero value of the ‘conversion’ component he refers to, SA EDF and SAS EDFI are entitled to maintain that he was wrong to consider that, by subscribing to the OCAs issued by EDFE, for which the interest rate applied was 1.085% and not the borrowing rate for traditional bonds of 4, 41%, SAS EDFI had transferred profits to its subsidiary under abnormal management conditions, and the amounts corresponding to this difference in rates had to be reintegrated to determine its taxable results pursuant to Article 57 of the General Tax Code and, for EDFE, represented hidden distributions within the meaning of c. of article 111 of the same code which must be subject to the withholding tax mentioned in 2. of article 119 bis of the same code” Click here for English translation Click here for other translation ...

Sté Paule Ka Holding, was set up as part of a leveraged buy-out (LBO) operation to finance the acquisition of the Paule Ka group, and in 2011 it acquired the entire capital of the group a price of 42 million euros. The acquisition was financed by issuing convertible bonds carrying an interest rate of 8%. The French tax authorities issued an assessment where deductions for certain payments related to the acquisition and part of the interest payments on the bonds were disallowed. Decision from the Administrative court of appeal The Court found in favor of the company in regards to the payment related to the acquisition and in favor of the tax administration in regards to the partially disallowed deduction of interest payments. “It follows from the foregoing that the elements invoked by the administration do not provide proof that the expenditure of EUR 390,227 correctly entered in the accounts was not incurred in the interest of the company Paule Ka Holding. The latter is thus entitled to argue that the administration was wrong to refuse to deduct it in respect of the financial year ended in 2012 and, consequently, to request the reduction of the tax bases and the discharge of the corresponding taxes, including the penalties for deliberate failure to comply as provided for in a) of Article 1729 of the General Tax Code, applied by the administration to this head of rectification.” “...These bonds have a term of ten years, bear interest at a rate of 8%, have a principal amount that is repayable in full at maturity, are not accompanied by any guarantee or security, bear capitalised interest and are convertible at maturity at the rate of one new share with a value of one euro for every 10 OCAs granted. Paule Ka Holding recognised interest on bonds of EUR 2 083 490 for the year ended 2012 and EUR 2 574 298 for the year ended 2013 as an expense. The department questioned the amount of these deductions for the interest paid on the bonds subscribed by Black Tie Luxco by applying the legal interest rate provided for in Article 39(1)(3) of the General Tax Code, i.e. 3.64% and 3.10% for the said financial years. Deductions for the difference in the calculated interest in the amount of EUR 1,092,601 for the financial year ending in 2012 and EUR 908,667 for the financial year ending in 2013 were disallowed. To justify the rate applied to the above-mentioned compulsory loans, Paule Ka Holding produced a study drawn up by the firm Dauge et associés on 30 September 2015. This firm carried out a credit rating of the company, based on an analysis of its financial structure with regard to its balance sheet situation, based on two criteria, the Banque de France rating of the borrower, based on the criteria of earning capacity, financial autonomy The Banque de France rating of the borrower, based on the criteria of earning capacity, financial autonomy, solvency and liquidity, and the estimate of the credit risk of the OCAs issued using the Standard and Poor’s analysis grid, on the basis of the group’s consolidated business plan, to conclude that the rating is estimated at BB-, corresponding to a satisfactory business risk profile and an aggressive financial risk. Based on this rating, it then estimated the credit margin applicable to the OCAs based on the European Commission’s recommendations for estimating reference and discount rates, with margin levels based on credit rating categories. The firm concluded from these elements that the interest rate of 8% seemed appropriate given the profile of the borrower and the characteristics of the bonds issued. However, the study produced consists of generalities and the data presented in it is not documented. Indeed, the mere reference to a credit rating does not imply that all the companies concerned by this rating have identical repayment capacities, taking into account all the quantitative and qualitative factors specific to each company. Furthermore, it does not appear from this study that the internal rating of Paule Ka Holding, as described, takes sufficient account of the company’s own characteristics, in particular the state of its accounts, its competitive positioning and the quality of its managers and employees. This internal rating does not take into account the possibility of the company receiving external assistance in the event of difficulties in honouring its commitments. Under these conditions, this study is insufficient to justify the rate applied to the bonds in dispute. In addition, Paule Ka Holding has provided examples of companies that took out bonds in the context of LBO transactions for acquisitions dated from May 2011 to June 2012 at rates varying between 7 and 12%, which, according to the company, show that the rate of 8% was a market rate compared with those applied by other companies of comparable size and for loans of the same nature. However, the investigation shows that the bonds presented for comparison have either a shorter duration than those in dispute or are not convertible into shares. Their amount is very different from that issued by Paule Ka Holding, some of which are also associated with “senior” debts. Moreover, the issuing companies, of very different sizes, carry out their activities in different fields from that of Paule Ka Holding, a takeover structure of a group in the high-end ready-to-wear sector. There is nothing to show the conditions under which the loans presented for comparison purposes were established. Under these conditions, since the comparability of the economic conditions has not been demonstrated, the terms of comparison proposed by Paule Ka Holding do not justify the rate applied to the bond loans in dispute. It follows from the foregoing that Paule Ka Holding does not justify the rate it could have obtained from independent financial institutions or organisations for a loan granted under similar conditions with regard to the yield on bond loans from undertakings in comparable economic conditions, for loans constituting a realistic alternative to an intra-group loan, taking into account its own characteristics, in particular its risk profile. It does not therefore ...

This case concerns application of the New Zealand´s general anti-avoidance rule in s BG 1 of the Income Tax Act 2004. The tax authorities issued an assessment to Frucor Suntory NZ Ltd where deductions of interest expenses in the amount of $10,827,606 and $11,665,323 were disallowed in FY 2006 and 2007. In addition, penalties of $1,786,555 and $1,924,779 for those years were imposed. The claimed deductions arose in the context of an arrangement entered into by Frucor Holdings Ltd (FHNZ) involving, among other steps, its issue of a Convertible Note to Deutsche Bank, New Zealand Branch (DBNZ) and a forward purchase of the shares DBNZ could call for under the Note by FHNZ’s Singapore based parent Danone Asia Pte Ltd (DAP). The Note had a face value of $204,421,5654 and carried interest at a rate of 6.5 per cent per annum. Over its five-year life, FHNZ paid DBNZ approximately $66 million which FHNZ characterised as interest and deducted for income tax purposes. The tax authorities found that, although such deductions complied with the “black letter” of the Act, $55 million of the $66 million paid was in fact a non- deductible repayment of principal. Hence only interest deduction of $11 million over the life of the Arrangement was allowed. These figures represent the deduction disallowed by the Commissioner, as compared to the deductions claimed by the taxpayer: $13,250,998 in 2006 and $13,323,806 in 2007. Based on an allegedly abusive tax position but mitigated by the taxpayer’s prior compliance history. In so doing, avoiding any exposure to shortfall penalties for the 2008 and 2009 years in the event it is unsuccessful in the present proceedings. The income years 2004 and 2005, in which interest deductions were also claimed under the relevant transaction are time barred. Which I will refer to hereafter as $204 million without derogating from the Commissioner’s argument that the precise amount of the Note is itself evidence of artifice in the transaction. As the parties did in both the evidence and the argument, I use the $55 million figure for illustrative purposes. In fact, as recorded in fn 3 above, the Commissioner is time barred from reassessing two of FHNZ’s relevant income tax returns. The issues The primary issue in the proceedings is whether s BG 1 of the Act applies to the Arrangement. Two further issues arise if s BG 1 is held to apply: (a) whether the Commissioner’s reconstruction of the Arrangement pursuant to s GB 1 of the Act is correct or whether it is, as FHNZ submits, “incorrect and excessive”; and (b) whether the shortfall penalties in ss 141B (unacceptable tax position) or 141D (abusive tax position) of the Tax Administration Act 1994 (TAA) have application. The key parties The High Court decided in favor of Frucor Suntory The decision was appealed to the Court of Appeal, where a decision in favor of the tax authorities has now been issued. The Court of Appeal set aside the decision of the High Court in regards of the tax adjustment, but dismissed the appeal in regards of shortfall penalties. “We have already concluded that the principal driver of the funding arrangement was the availability of tax relief to Frucor in New Zealand through deductions it would claim on the coupon payments. The benefit it obtained under the arrangement was the ability to claim payments totalling $66 million as a fully deductible expense when, as a matter of commercial and economic reality, only $11 million of this sum comprised interest and the balance of $55 million represented the repayment of principal. The tax advantage gained under the arrangement was therefore not the whole of the interest deductions, only those that were effectively principal repayments. We consider the Commissioner was entitled to reconstruct by allowing the base level deductions totalling $11 million but disallowing the balance. The tax benefit Frucor obtained “from or under” the arrangement comprised the deductions claimed for interest on the balance of $149 million which, as a matter of commercial reality, represented the repayment of principal of $55 million.” ...

This case concerns application of the general anti-avoidance rule in s BG 1 of the Income Tax Act 2004. The tax authorities issued an assessment where deductions of $10,827,606 and $11,665,323 were disallowed in the 2006 and 2007 income tax years respectively. In addition, penalties of $1,786,555 and $1,924,779 for those years were imposed. The claimed deductions arose in the context of an arrangement entered into by Frucor Holdings Ltd (FHNZ) involving, among other steps, its issue of a Convertible Note to Deutsche Bank, New Zealand Branch (DBNZ) and a forward purchase of the shares DBNZ could call for under the Note by FHNZ’s Singapore based parent Danone Asia Pte Ltd (DAP). The Note had a face value of $204,421,5654 and carried interest at a rate of 6.5 per cent per annum. Over its five-year life, FHNZ paid DBNZ approximately $66 million which FHNZ characterised as interest and deducted for income tax purposes. The tax authorities said that, although such deduction complied with the “black letter” of the Act, $55 million of the $66 million paid was in fact a non- deductible repayment of principal. Hence only interest deduction of $11 million only over the life of the Arrangement was allowed. These figures represent the deduction disallowed by the Commissioner, as compared to the deductions claimed by the taxpayer: $13,250,998 in 2006 and $13,323,806 in 2007. Based on an allegedly abusive tax position but mitigated by the taxpayer’s prior compliance history. In so doing, avoiding any exposure to shortfall penalties for the 2008 and 2009 years in the event it is unsuccessful in the present proceedings. The income years 2004 and 2005, in which interest deductions were also claimed under the relevant transaction are time barred. Which I will refer to hereafter as $204 million without derogating from the Commissioner’s argument that the precise amount of the Note is itself evidence of artifice in the transaction. As the parties did in both the evidence and the argument, I use the $55 million figure for illustrative purposes. In fact, as recorded in fn 3 above, the Commissioner is time barred from reassessing two of FHNZ’s relevant income tax returns. The issues The primary issue in the proceedings is whether s BG 1 of the Act applies to the Arrangement. Two further issues arise if s BG 1 is held to apply: (a) whether the Commissioner’s reconstruction of the Arrangement pursuant to s GB 1 of the Act is correct or whether it is, as FHNZ submits, “incorrect and excessive”; and (b) whether the shortfall penalties in ss 141B (unacceptable tax position) or 141D (abusive tax position) of the Tax Administration Act 1994 (TAA) have application. The key parties The Court found in favor of Frucor Suntory ...