The Court of Appeal has upheld the High Court decision and dismissed Alesco’s appeal. The Alesco New Zealand case is seen as a test for similar disputes with Inland Revenue involving the use of optional convertible notes (OCNs). The outcome of this case will most likely influence the outcome of those other cases. The total amount of tax across all optional convertible notes cases is over $300 million including use-of-money interest.
Alesco New Zealand Limited v Commissioner of Inland Revenue  NZCA 40
Alesco NZ (a subsidiary of Alesco Corporation Ltd) issued optional convertible notes (OCNs) in intra-group arrangements to finance the acquisition of two businesses in New Zealand. The Group had raised funds via a mixture of debt and equity and sought tax advice as to the most effective way to fund the transaction in New Zealand. The notes (issued in tranches), enabled Alesco NZ to acquire $78m in cash in exchange for $78m notes which converted in 10 years time. The effect was that the OCN arrangement was on interest free terms. The Commissioner’s Determination G 22 provided the calculations giving rise to the deductions taken. Under that methodology, $38m was ascribed to the value of the debt as at the time of the initial contract, with the remaining $40m being treated as equity. When Determination G22A was issued (designed to exclude Parents and Subsidiaries from applying the methodology in Determination G22 on a prospective basis), Alesco unwound the notes. A contributing factor to that decision was the Global Financial Crisis which had caused Alesco to review its portfolio of assets. The election was made to convert the notes into shares ahead of the repayment date.
In a unanimous judgment, the Court of Appeal upheld the High Court decision and dismissed Alesco’s appeal, both in respect of the substantive arguments, and on the basis of tax avoidance. The Court was critical on both the Commissioner’s and Alesco’s reliance on expert evidence, which their Honours felt was unnecessary as the basic issues in this case were fairly straight forward. The crux of the decision was that Parliament would not have contemplated deductions to be taken for interest that was not paid. The Court rejected Alesco’s submissions that Determination G22 recognised an economic cost for the OCN transaction. The Court further found that there were no commercial reasons that would justify the choice of the instrument, other than to obtain tax benefits (deductions) for interest that did not actually need to be paid. The court held that “on its plain meaning within its statutory context the word “expenditure” requires an actual outflow of or parting with money or an obligation to make payment…The question is whether the taxpayer has “truly incurred the cost as intended by Parliament”…In the absence of a liability a taxpayer claiming the benefit of a deduction for interest payment would be purporting to incur that liability without suffering the economic burden. The Court of Appeal was satisfied that the intended purview of the rules was to exclude notional transactions.
Alesco New Zealand is seeking leave to appeal to the Supreme Court and lawyer, Lindsay Mckay, has said the application has been filed.