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 ...

“Shipping Investor Cyprus” was a limited liability company domiciled in Cyprus. In the financial years 2010 and 2011 it received interest income from convertible bonds subject to German withholding tax. “Shipping Investor Cyprus” had no substance itself, but an associated company, also domiciled in Cyprus, had both offices and employees. The dispute was whether “Shipping Investor Cyprus” was entitled to a refund of the German withholding tax and whether this should be determined under the old or the new version of Section 50d(3) of the German Income Tax Act (EStG). The court of first instance concluded that “Shipping Investor Cyprus” claim for a refund was admissible because the old version of the provisions in Section 50d (3) EStG was contrary to European law. The tax authorities appealed this decision. Judgement of the National Tax Court The National Tax Court found that a general reference to the economic activity of another group company in the country of residence of the recipient of the payment was not sufficient to satisfy the substance requirement. According to the court, the lower court had not sufficiently examined whether the substance requirements of Section 50d (3) EStG – in its new version – were met. On this basis, the case was referred back to the lower court for a new hearing. Click here for English translation Click here for other translation ...

A Luxembourg-based limited company (LU) held a 30% stake in an Austrian stock company operating an airport. LU employed no personnel and did not develop any activities. The parent company of LUP was likewise resident in Luxembourg. LUP had business premises in Luxembourg and employed three people. All of the shares in LUP were held by a company in the British Cayman Islands in trust for a non- resident Cayman Islands-based fund. In 2015, the Austrian Company distributed a dividend to LU. LU was not yet involved in the Austrian corporation “for an uninterrupted period of at least one year” thus withholding tax was withheld and deducted. A request for refunding of the withholding tax was denied by the tax office because the dividend was distributed to recipients in a third country and the tax authorities regarded the structure as abusive. LU then appealed the decision to the Federal Fiscal Court. The Court held that the appeal was unfounded, because the tax office rightly assumed that the structure was abusive within the meaning of Austrian tax rules. LU then filed an appeal to the Austrian Administrative High Court (VwGH). The High Court overruled the Federal Fiscal Court and found that LUP had actually developed activities. An economic reason for the set-up of a company structure- for example, the professional management of long-term investments in the EU by a management holding with several employees (the LUP as the Luxembourg parent company of the appellant) – exists even if the desired economic goal would have been achieved otherwise (i.e. with a holding company located outside the EU). According to the Court, an economic reason for a set-up exists if the economic objective, as put forward in this case, was better and safer to achieve. Thus, the structure was not abusive. Click here for English translation Click here for other translation ...

Italien fashion group, Dolce & Gabbana, had moved ownership of valuable intangibles to a subsidiary established for that purpose in Luxembourg. The Italian Revenue Agency found the arrangement to be wholly artificial and set up only to avoid Italien taxes and to benefit from the privileged tax treatment in Luxembourg. The Revenue Agency argued that all decision related to the intangibles was in fact taken at the Italian headquarters of Dolce & Gabbana in Milan, and not in Luxembourg, where there were no administrative structure and only one employee with mere secretarial duties. Dolce & Gabbana disagreed with these findings and brought the case to court. In the first and second instance the courts ruled in favor of the Italian Revenue Agency, but the Italian Supreme Court ruled in favor of Dolce & Gabbana. According to the Supreme Court, the fact that a company is established in another EU Member State to benefit from more advantageous tax legislation does not as such constitute an abuse of the freedom of establishment. The relevant criteria in this regard is if the arrangement is a wholly artificial and as such does not reflect economic reality. Determination of a company’s place of business requires multible factors to be taken into consideration. The fact, that the Luxembourg company strictly followed directives issued by its Italian parent company is not sufficient to consider the structure as abusive and thus to relocate its place of effective management to Italy. A more thorough analysis of the activity carried out in Luxembourg should have been performed. According to the Supreme Court something was actually done in Luxembourg. Click here for English translation Click here for other translation ...

A tax assessment based on Japanese CFC rules (anti-tax haven rules) had been applied to a Japanese Group’s (Denso), subsidiary in Singapore. According to Japanese CFC rules, income arising from a foreign subsidiary located in a state or territory with significantly lower tax rates is deemed to arise as the income of the parent company when the principal business of the subsidiary is holding shares or IP rights. However, the CFC rules do not apply when the subsidiary has substance and it makes economic sense to conduct business in the subsidiary in the low tax jurisdiction. According to the Supreme Court, total revenue, number of employees, and fixed facilities are relevant in this determination. The Singapore subsidiary managed it’s own subsidiaries or affiliates in other territories, and while the income from services to logistics in those territories represented 85% of its revenue, between 80% and 90% of it’s income came from dividends from its subsidiaries and affiliates. The Supreme Court held that the Singapore subsidiary had conducted a broad range of businesses – including finance and logistics – with the economically rational purpose of streamlining its ASEAN operations, and thus set aside the CFC taxation. Click here for English translation ...

A tax assessment based on Japanese CFC rules (anti-tax haven rules) had been applied to a “TH Corp”‘s, subsidiary in Singapore. According to Japanese CFC rules, income arising from a foreign subsidiary located in a state or territory with significantly lower tax rates is deemed to arise as the income of the parent company when the principal business of the subsidiary is holding shares or IP rights. However, the CFC rules do not apply when the subsidiary has substance and it makes economic sense to conduct business in the subsidiary in the low tax jurisdiction. Judgement of the court. According to the court, total revenue, number of employees, and fixed facilities are relevant in this determination. The Court held that the Singapore subsidiary had conducted a broad range of businesses – including finance and logistics – with the economically rational purpose of streamlining its ASEAN operations, and thus set aside the CFC taxation. Excerpt “Satisfaction of the substance and control criteria (a) According to the above-mentioned findings, A1 rents an office in Singapore and uses it for the regional control business. Therefore, it can be said that A1 has fixed facilities in Singapore, the country where its head office is located, which are deemed to be necessary for the conduct of its main business, the regional control business. Therefore, it satisfies the substantive criteria (Article 6-6(4) and (3) of the Act). (b) According to the facts certified above, A1 holds general meetings of shareholders and meetings of the board of directors, executes the duties of officers, and prepares and keeps accounting books in Singapore. Therefore, it can be said that A1 manages, controls and operates its own business in the country where its head office is located, and therefore, the management control standard (Article 66-6 Article 66-6, paragraphs 4 and 3). Conclusion According to the above, A1 satisfies all of the requirements for exemption from application, namely, the business criterion, the country of domicile criterion, the substance criterion and the control criterion. Therefore, the plaintiff is exempted from the application of Article 66-6(1) of the Measures Act in each of the fiscal years in question.” Click here for English translation Click here for other translation ...

The legislation on ‘controlled foreign companies’ in force in the United Kingdom provided for the inclusion, under certain conditions, of the profits of subsidiaries established outside the United Kingdom in which a resident company has a controlling holding. The UK tax authorities thus claimed from the parent company of the Cadbury Schweppes group, established in the United Kingdom, tax on the profits made by one of the subsidiaries of the group established in Ireland, where the tax rate was lower. The Court was asked to consider whether this legislation was compatible with the provisions of the Treaty on freedom of establishment (Articles 43 and 48 EC). The Court recalled that companies or persons could not improperly or fraudulently take advantage of provisions of Community law. However, the fact that a company has been established in a Member State for the purpose of benefiting from more favourable tax legislation does not in itself suffice to constitute abuse of the freedom of establishment and does not deprive Cadbury Schweppes of the right to rely on Community law. The Court then analysed the legislation in terms of freedom of establishment. According to settled case-law, although direct taxation falls within the competence of the Member States, they must none the less exercise that competence consistently with Community law. The Court noticed the difference in the treatment of resident companies depending on whether the CFC legislation was or was not applicable: in the first instance the company is taxed on the profits of another legal person, whereas this is not the case in the latter instance (that is, when a resident company has a subsidiary taxed in the United Kingdom or a subsidiary established in another Member State where the tax rate is higher than in the United Kingdom). The Court noted that the separate tax treatment is such as to hinder the exercise of freedom of establishment, dissuading a resident company from establishing, acquiring or maintaining a subsidiary in a Member State with a lower tax rate. The Court pointed out that a national measure restricting freedom of establishment may be justified only where it specifically relates to wholly artificial arrangements aimed at circumventing the application of the legislation of the Member State concerned and does not go beyond what is necessary to achieve that purpose. In order to find that there is such an arrangement there must be, in addition to a subjective element, objective and ascertainable evidence – with regard, in particular, to the extent to which the CFC physically exists in terms of premises, staff and equipment – that the incorporation of this subsidiary does not reflect economic reality, that is to say it is not an actual establishment intended to carry on genuine economic activities in the host Member State. The tests conducted under the national legislation must incorporate these factors if they are to be compatible with Community law. The Substance Test 67 As suggested by the United Kingdom Government and the Commission at  the hearing, that finding must be based on objective factors which are ascertainable by third parties with regard, in particular, to the extent to which the CFC physically exists in terms of premises, staff and equipment. 68 If checking those factors leads to the finding that the CFC is a fictitious establishment not carrying out any genuine economic activity in the territory of the host Member State, the creation of that CFC must be regarded as having the characteristics of a wholly artificial arrangement. That could be so in particular in the case of a ‘letterbox’ or ‘front’ subsidiary (see Case C-341/04 Eurofood IFSC [2006] £CR 1-3813, paragraphs 34 and 35). 69 On the other hand, as pointed out by the Advocate General in point 103 of his Opinion, the fact that the activities which correspond to the profits of the CFC could just as well have been carried out by a company established in the territory of the Member State in which the resident company is established does not warrant the conclusion that there is a wholly artificial arrangement ...