While capital gains tax has been the big tax talking point so far in 2019, there is an equally important development to follow later this year in relation to tax avoidance.
A tax dispute between the Commissioner of Inland Revenue and a New Zealand based company in the multinational Danone group is currently progressing through the courts. If Danone is successful, it will represent a material change in the tax advisory landscape and should provide increased commercial certainty for taxpayers and their advisers in relation to tax avoidance matters.
The Court of Appeal will hear the Commissioner’s appeal in June of this year following Danone’s success in the High Court at the end of 2018. The fact Danone won in the High Court was somewhat surprising given it has been a while since a taxpayer has won a tax avoidance dispute in the courts and, perhaps most of all, the fact the dispute involves a structured transaction. Many will recall that this class of transaction was the subject of the IRD’s tax avoidance crusade against the large retail banks around ten years ago. The present case relates to the structured funding provided to a Danone New Zealand company for the acquisition of Frucor in 2002.
The current dispute is important given the relative uncertainty that has prevailed in this area for some time for taxpayers and their advisers. Over the last decade or so, Inland Revenue and professional advisers have often had conflicting views around the application of the Supreme Court decision in Ben Nevis which is the leading authority in this area. Inland Revenue has increasingly asserted tax avoidance exists in the context of arrangements that had historically been regarded as commercially routine and benign. A good example is the capitalisation of debt to equity for a company in financial difficulty or the introduction of a holding company as part of a corporate group restructure. This approach led the IRD to go as far as issuing a public statement on avoidance and discretionary trusts and whether the trustees could consider the relative tax positions of beneficiaries before making a distribution.
The question now is whether the IRD has taken this approach too far by asserting tax avoidance in the Danone case. This is not a fact pattern in the same category as the recent Alesco litigation which also involved the issuance of convertible notes. As opposed to Alesco, the primary tax advantage from the Danone structure arose offshore and not in New Zealand and the tax deductions being claimed in New Zealand corresponded to actual cash interest payments. In addition, the use of convertible notes in this case served various commercial purposes as outlined in the evidence given by Danone in the High Court.
If the Court of Appeal rules in favour of Danone later this year, the practical outcome for tax advisers and their clients should be increased certainty in the way business structures and funding arrangements can be established and restructured. More broadly, it should represent confirmation of the principle that tax matters can, and should, sensibly be taken into account in business decision-making.
In the interim, while the High Court judgment is helpful for taxpayers, Ben Nevis remains the leading authority in this area. However, the Danone litigation may very well prove decisive in terms of how the Ben Nevis approach should be interpreted and applied in practice in the future. The most problematic aspect of Inland Revenue’s approach to Ben Nevis has often been to acknowledge that the general anti-avoidance provision should not be applied by reference to economically equivalent arrangements, but then to seek to do that anyway as part of the assessment of the “commercial and economic reality” of an arrangement. The court in the Danone case identified that approach as troublesome and noted that it would mean the prohibition on identification of an economically equivalent arrangement would become almost meaningless. It is hoped that the Court of Appeal will approach the analysis on the same basis and endorse that principle.
So, while the spectre of a capital gains tax has come and gone for the moment, the real tax issue in 2019 is the more intriguing tax avoidance battle that is about to continue in June.