Frucor Suntory – New Zealand Supreme Court applies the NZ GAAR to treat interest coupons under a convertible loan and forward purchase arrangement as mostly principal

The New Zealand GAAR provided that a tax avoidance arrangement (defined to include an arrangement that has “tax avoidance as its purpose or effect … [or] as 1 of its purposes or effects … if the purpose or effect is not merely incidental”) was void as against the Commissioner. However, Ben Nevis had essentially found that where an arrangement “viewed in a commercially and economically realistic way” did not have the effect of using particular provisions of the NZ Act “in a manner … beyond parliamentary contemplation,” it generally would not be a tax avoidance arrangement. (Thus, the NZ courts got to a somewhat similar result as if there had been a specific statutory safe harbour like ITA s. 245(4), but with more emphasis on economic substance.)

Ignoring interim financing steps, a NZ “Buyco” (DHNZ) in the Danone group financed about ¾ of its acquisition of a NZ target company with a $204 million interest-bearing advance from Deutsche Bank pursuant to a note that was convertible into non-voting shares of DHNZ. Contemporaneously with the advance, the Singapore immediate parent of DHNZ (DAP) paid Deutsche Bank $149 million pursuant to a forward purchase agreement to acquire the shares to be issued on maturity of the note.

William Young J indicated that the economic substance of the arrangements was that Deutsche Bank advanced only $55 million to DHNZ (being the difference between the $204 million advance and the $149 million paid by DAP under the forward purchase agreement) and that the $66 million in “interest” coupons paid by DHNZ to Deutsche Bank over the term of the $204 million advance amounted to repayment of that $55 million and interest on an amortizing basis.

In finding that there was thus a tax avoidance transaction (so that the Commissioner appropriately treated $55 million of the “interest” payments as being non-deductible), he stated:

[T]he effect of the arrangement was that DHNZ sought to obtain deductions in relation to $55 million in principal repayments. These are provided for in the Act to meet financing expenses and not repayments of principal. DHNZ was thus claiming deductions for expenses which, in economic substance, it had not incurred. This use of the relevant deduction provisions of the Act lay outside of parliamentary contemplation as to the use of those provisions.

This decision perhaps has the greatest interest in the context of the announced intention of Finance “to add an explicit economic substance rule to the GAAR.” Its finding that the Parliamentary intent was to provide deductions only for real financing expenses is also somewhat reminiscent of Global Equity (finding that it is an abuse of s. 9 to recognize losses not corresponding with commercial reality).

Neal Armstrong. Summary of Frucor Suntory New Zealand Limited v Commissioner of Inland Revenue, [2022] NZSC 113 under s. 245(4).