FRUCOR SUNTORY NEW ZEALAND LIMITED v COMMISSIONER OF INLAND REVENUE [2018] NZHC 2860

FRUCOR SUNTORY NEW ZEALAND LIMITED v COMMISSIONER OF INLAND REVENUE [2018]NZHC 2860 [5 November 2018]IN THE HIGH COURT OF NEW ZEALANDAUCKLAND REGISTRYI TE KŌTI MATUA O AOTEAROATĀMAKI MAKAURAU ROHECIV-2012-404-0219[2018] NZHC 2860BETWEEN FRUCOR SUNTORY NEW ZEALANDLIMITEDPlaintiffAND COMMISSIONER OF INLANDREVENUEDefendantHearing: 2, 3, 4, 5, 9, 10 and 11 July 2018Appearances: L McKay, M McKay and J Q Wilson for the PlaintiffJBM Smith QC, J Norris, L K Worthing for the DefendantJudgment: 5 November 2018JUDGMENT OF MUIR JThis judgment was delivered by me on Monday 5 November 2018 at 2.30 pmPursuant to Rule 11.5 of the High Court Rules.Registrar/Deputy RegistrarDate:Solicitors:Bell Gully, AucklandCrown Law, WellingtonTable of ContentsIntroduction [1]The issues [5]The key parties [7]Diagram of the key steps [12]The Note and the Forward Purchase — Outline [13]The Note [13]The Forward Purchase [16]Subsidiary documents [18]The Convertible Note guarantee [19]Mutual acknowledgment as to the lowest price of shares [20]The Forward Purchase guarantee [22]The cashflows, share issues and transfers [23]The commercial context of the Arrangement [27]The basis of the Commissioner's assessments [37]Approach in statement of position dated 25 January 2011 [42]Approach of Adjudication Unit, 22 November 2011 [45]The Commissioner's expert evidence [49]Comparison of experts' approach with accounting treatment [76]The tax avoidance framework [80]Section DB 7 and the financial arrangements rules [96]The wider quest for legislative intention — the group approach [117](a) The imposition of NRWT on dividend, interest and royalty flows [120](b) The transfer pricing regime [123](c) The thin capitalisation regime [128]The three regimes in a wider context [130]What is the "Arrangement"? [136]Assessment in light of the Ben Nevis factors [140]The manner in which the Arrangement was carried out [141]The role of all the relevant parties and their relationship to the Taxpayer [142]The economic and commercial effect of the documents [149]Artificiality and contrivance [158]The Commissioner's "no cost" argument [173]Was therefore s BG 1 appropriately invoked? [194]In the alternative: was this merely incidental tax avoidance? [205]Reconstruction — s GB 1 [212]In the alternative: would liability for penalties arise? [213]Result [223]Costs [224]Introduction[1] This case concerns application of the much-litigated general anti-avoidancerule in s BG 1 of (relevantly) the Income Tax Act 2004 (the Act).[2] In issue are deductions of $10,827,606 and $11,665,323 which weredisallowed in the 2006 and 2007 income tax years respectively.1 In addition, theCommissioner has imposed shortfall penalties of $1,786,555 and $1,924,779 for thoseyears.2 The outcome of the case also governs the taxpayer's liabilities in the 2008 and2009 income tax years for which it has not claimed what would be broadly equivalentdeductions but in respect of which it has issued notices of proposed adjustment seekingto do so.3[3] The claimed deductions arise in the context of an arrangement (theArrangement) entered into by Frucor Holdings Ltd (FHNZ) involving, among othersteps, its issue of a Convertible Note (the Note) to Deutsche Bank, New ZealandBranch (DBNZ) and a forward purchase of the shares DBNZ could call for under theNote by FHNZ's Singapore based parent Danone Asia Pte Ltd (DAP).[4] The Note had a face value of $204,421,5654 and carried interest at a rate of 6.5per cent per annum. Over its five-year life, FHNZ paid DBNZ approximately$66 million which FHNZ characterised as interest and deducted for income taxpurposes. The Commissioner says 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.5 She has invoked s BG 1 to treat the $55 millionas non-deductible, allowing an interest deduction of $11 million only over the life ofthe Arrangement.1 These figures represent the deduction disallowed by the Commissioner, as compared to thedeductions claimed by the taxpayer: $13,250,998 in 2006 and $13,323,806 in 2007.2 Based on an allegedly abusive tax position but mitigated by the taxpayer's prior compliancehistory.3 In so doing, avoiding any exposure to shortfall penalties for the 2008 and 2009 years in the eventit is unsuccessful in the present proceedings. The income years 2004 and 2005, in which interestdeductions were also claimed under the relevant transaction are time barred.4 Which I will refer to hereafter as $204 million without derogating from the Commissioner'sargument that the precise amount of the Note is itself evidence of artifice in the transaction.5 As the parties did in both the evidence and the argument, I use the $55 million figure for illustrativepurposes. In fact, as recorded in fn 3 above, the Commissioner is time barred from reassessingtwo of FHNZ's relevant income tax returns.The issues[5] The primary issue in the proceedings is whether s BG 1 of the Act applies tothe Arrangement.[6] Two further issues arise if s BG 1 is held to apply:(a) whether the Commissioner's reconstruction of the Arrangementpursuant to s GB 1 of the Act is correct or whether it is, as FHNZsubmits, "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[7] The key parties to the Arrangement were FHNZ, DBNZ and DAP. In addition,several other entities had subordinate roles as I will discuss later.[8] FHNZ is the successor company to Danone Holdings NZ Limited (DHNZ)which is the company named as issuer of the Note. On 30 January 2009, DHNZchanged its name to FHNZ and on 19 May 2009 amalgamated with the plaintiff (thennamed Frucor Beverages Limited).[9] For convenience, I intend to refer to FHNZ throughout as the party whichissued the Note, made payments to DBNZ through the Note's life and which, insatisfaction of the relevant liability, issued shares to DBNZ at the conclusion of theNote's five-year term.[10] During all periods relevant to the dispute FHNZ was wholly owned by DAP,itself part of the multinational Danone Group of which the ultimate parent is GroupeDanone SA, a French-based company. As indicated, DAP entered into a ForwardPurchase Agreement with DBNZ.[11] DBNZ is the New Zealand branch of Deutsche Bank AG a banking andfinancial services company based in Germany. DBNZ entered into the two primarytransactions which feature in the dispute namely the Note (with FHNZ) and theForward Purchase Agreement (with DAP).Diagram of the key steps[12] The key steps on entry into the Arrangement, the money flows which occurredduring the life of the Arrangement and the steps taken at maturity are best representeddiagrammatically:The Note and the Forward Purchase — OutlineThe Note[13] On 14 March 2003 FHNZ and DBNZ entered into a Convertible Note Deedwhereby DBNZ agreed to pay FHNZ $204 million for issue by FHNZ of a ConvertibleNote.[14] The key terms of the Deed were as follows:(a) The Note was denominated in New Zealand dollars.6(b) It matured on the fifth anniversary of the issue date (being 18 March2008).7(c) FHNZ paid interest at 6.5 per cent per annum in respect of the principalamount of the Convertible Note, payable semi-annually in arrears.8(d) Redemption of the Note was governed by cls 5.1 and 5.2 in terms:5.1 Redeemed for cash: subject to clause 5.2 on the MaturityDate the Company shall satisfy the principal obligations ofthe Company in respect of the Note by paying to the Investoran amount equal to the Redemption Amount.5.2 Conversion: if, but only if, the Investor has given theCompany written notice not less than 10 Business Days priorto the Maturity Date that it elects to have all the obligationsof the Company in respect of the Principal Amount satisfiedby the issue of the Shares then the Company shall issue to theInvestor the Shares by not later than 4 pm (time being of theessence) on the Maturity Date and those obligations shall besatisfied in full by such issue.(e) The option to convert to shares was not detachable from the Note.(f) The Note did not confer on the holder any right to attend or vote at anymeeting of FHNZ.96 Clause 1.1.7 Clause 1.1.8 Clause 3.1 in the definitions of interest payment date, interest period and interest rate in cl 1.1.9 Clause 2.3.[15] FHNZ issued a Note Certificate with respect to the Note on 18 March 2003(the issue date).The Forward Purchase[16] DAP entered the Forward Purchase with DBNZ on 14 March 2003 in respectof the shares that DBNZ would receive on maturity of the Note if it so elected. Thekey terms of the Forward Purchase Agreement were as follows:(a) DAP agreed to pay $149 million to DBNZ on 18 March 2003.10(b) DBNZ agreed that, if it elected to convert the Note and receive theshares, it would transfer those shares to DAP.11(c) In the event DBNZ elected to convert but FHNZ failed to issue theshares (and instead repaid the principal in cash), DBNZ would pay suchsum to Campagnie Gervais Danone (CGD) (another Danone Groupcompany), with CGD assuming all of DBNZ's obligations under theDeed, including delivery of the Shares to DAP, as a novationcounterparty.12(d) In the event DBNZ did not elect to convert for shares, then it would payto DAP the $204 million principal received from FHNZ together withan additional amount reflecting the tax imposed by Singapore on thedifference between the $149 million paid under the Forward PurchaseAgreement and the $204 million received.13[17] The Commissioner's expert, Professor Lewis Evans calculated such potentialSingaporean tax liability as $13.9 million. This was not disputed by FHNZ, nor did itdispute that in all but a "Doomsday" scenario the tax "gross up" provisions in cl 3.4would mean that DBNZ would inevitably call for conversion to shares.10 Clause 3.1 and the definition of purchase price in cl 1.1.11 Clause 3.212 Clause 3.3.13 Clause 3.4. The additional amount was calculated by reference to a formula in cl 3.4.Subsidiary documents[18] These were threefold.The Convertible Note guarantee[19] On 14 March 2003 Groupe Danone SA (the ultimate parent company) enteredinto a first demand guarantee for the benefit of DBNZ. Under that document GroupeDanone SA guaranteed the payments made by FHNZ under the Convertible Note Deedup to a maximum of $250 million. In return it received a fee equal to 0.10 per cent ofthe $204 million principal amount advanced to FHNZ. This fee was payable by DBNZunder the Convertible Note Deed.Mutual acknowledgment as to the lowest price of shares[20] On the same date DBNZ, DAP and CGD executed a mutual acknowledgmentthat the lowest price of the FHNZ shares under the Forward Purchase was $204 million(the face value of the Note).14[21] It is common ground that such acknowledgement confirmed, pursuant to thefinancial arrangements rules in the Act an income tax deduction to DBNZ equal to thedifference between the $149 million received from DAP under the Forward Purchaseand the $204 million acknowledged lowest price of the shares it transferred to DAP atmaturity.The Forward Purchase guarantee[22] Again on 14 March 2003, Groupe Danone SA entered into a further guaranteefor the benefit of DBNZ in terms of which it guaranteed the payments made by DAPunder the Forward Purchase up to a maximum of $67 million. No fee was payable byDBNZ for this guarantee.14 For the purposes of s EH 48(3) of the Income Tax Act 1994, the equivalent of s EW 32 of the 2004Act with which these proceedings are concerned.The cashflows, share issues and transfers[23] These occurred exactly as anticipated by the transaction documents andinvolved:(a) DBNZ paying FHNZ $204 million on subscription for the Note.(b) DAP simultaneously paying DBNZ $149 million under the ForwardPurchase Agreement for the shares which DBNZ had the option oftaking on the Note's maturity.(c) FHNZ paying periodic interest at the rate of 6.5 per cent per annum onthe $204 million subscription amount up to the maturity date of theNote.(d) DBNZ paying a guarantee fee of 0.10 per cent on a periodic basis toGroup Danone during the currency of the Note.(e) DBNZ electing to convert the Note for shares on maturity, receiving1,025 shares from FHNZ; and(f) DBNZ transferring 1,025 shares to DAP in satisfaction of obligationsunder the Forward Purchase.[24] As to application of the subscription monies ($204 million), immediately upontheir receipt in 2003 FHNZ paid:(a) $60 million to DAP by way of a repurchase of 400 shares (therebyreducing its share capital from $150 million to $90 million); and(b) $144 million to Danone Finance SA (the treasury function of theDanone Group) by way of repayment of earlier advances made by thatcompany.1515 I discuss initial debt-equity arrangements more fully later in my judgment.[25] So summarised, the cashflows disclose the genesis of the Commissioner'sargument under s BG 1. She says that because the $204 million paid by DBNZ for theNote (and on which interest accrued at 6.5 per cent) was funded as to $149 million byDAP's forward purchase of the shares to be issued under the Note,16 DBNZ's advancewas, in an economically and commercially real sense, $55 million only and the $66million nominally paid as interest on the Note over its five-year term in factrepresented repayment of the principal with $11 million of interest only on theamortising debt. In the result, she disallowed deduction of what she calculated to bethe principal repayments totalling $22,492,929 in the two income years in issue.[26] In summary FHNZ's riposte is that there is no basis to suggest the arrangementas documented is not "economically real". It says the Commissioner's approachwrongly assesses the arrangement's economic effects at a group or consolidated level,contrary to fundamental principles involving the taxation of New Zealand subsidiariesof foreign companies, and incorrectly treats the shares issued by FHNZ as valueless.The commercial context of the Arrangement[27] This was provided by FHNZ's sole witness Mr Stanley Marcello Jnr who wasthe Senior Regional Tax Manager of DAP between April 2015 and November 2016.[28] Mr Marcello was not personally involved in the transaction at its inception.Indeed he only joined the Danone Group in 2006. Consistent with the authoritiesrequiring the test in s BG 1 to be applied objectively and without reference to theintentions or motives of any party to the impugned arrangement, he confined himselfto providing a linking narrative based on the primary transaction documents.17 In theevent, his evidence was largely uncontentious.[29] Significantly, Mr Marcello described the initial $297,522,000 acquisition byFHNZ of Frucor Beverages Ltd and its subsidiaries in January 2002 as having beenfunded by way of:16 Itself funded as to $60 million by the capital reduction.17 In the manner recognised as appropriate by Alesco New Zealand Ltd v Commissioner of InlandRevenue [2013] NZCA 40, [2013] NZLR 175 at [27].(a) equity of $150 million from DAP, provided on the issue of 1,000 sharesby FHNZ to DAP; and(b) a loan from Danone Finance SA for the balance of the purchase priceunder an "Agreement for Operations carried out within Danone CashManagement" (the Cash Management Agreement).[30] Under the Cash Management Agreement Danone Finance SA maintained acurrent account for FHNZ which was subject to interest at the "market rate" being themonthly average EURIBOR/LIBOR rate over one month plus 1/8th of one per cent.[31] FHNZ's statutory accounts to 31 December 2002 record that total advancesunder the Cash Management Agreement were, at that time, $143,924,000 and it iscommon ground that, in the period down to repayment from the Note issue, interest of$9,840,466 accrued and was properly deductible to FHNZ. In turn, the interestpayment was subject to New Zealand non-resident withholding tax (NRWT) for whichDanone Finance SA received a credit against its French tax liability on the interest.[32] So-described it will be apparent that the initial funding model involved analmost even split between debt and equity on FHNZ's balance sheet immediatelyfollowing the acquisition.[33] Almost immediately after the acquisition of Frucor Beverages was settled,however, the Danone Group started to investigate alternative funding structures. Thisis evident from a January 2002 presentation by Deutsche Bank entitled "EfficientFinancing Alternatives for Danone in New Zealand". That document states in itsExecutive Summary:Deutsche Bank understands that Danone is currently looking at variousalternatives to (re)finance the acquisition of the New Zealand beveragecompany Frucor Beverages Group Ltd in connection with its (NZ$ 294million) take-over offer of all the shares of New Zealand's largest juice maker.[34] DBNZ proposed two alternative structures, both of which it said had beenexecuted in New Zealand and had received "positive rulings from New Zealand taxadvisors" being:(a) a convertible note structure; and(b) a structure based on the sale and lease-back of registered trademarks.[35] The convertible note structure emerged as the preferred refinancing approach.Early iterations had the Forward Purchase undertaken by a United Kingdom orEuropean Danone subsidiary but ultimately DAP was identified as the entity mostappropriate.[36] Referring to contemporaneous documents, Mr Marcello identified the reasonsadvanced at the time for the transaction as being:(a) The convertible nature of the note enabled retention of funds within theNew Zealand company to facilitate growth as recorded in acontemporaneous Danone memorandum in terms:The use of Convertible Notes enables [FHNZ] to save cashflows(in order to invest and grow faster) as there should be no repaymentof the debt but a conversion to shares as opposed to a standardfinancing.18(b) It would increase FHNZ's equity capital at maturity of the transactionby $204 million, resulting in an expanded capital base to support furtherinvestments as recognised in a further contemporaneous Danonememorandum in terms:[DAP] to make a capital increase of NZD 215 M [an earlierindicative transaction figure corresponding to the eventual $204million] in five years while investing only NZD 150 M [$149 million]today. The NZD 215 M [$204 million] of capital increase in [FHNZ]could be necessary in five years to be able to raise new debts to makeinvestments in New Zealand or Asia.(c) It would produce an offshore taxation advantage in comparison toalternative funding structures. This was identified as early as DBNZ'sJanuary 2002 Efficient Financing document which noted both that:18 Assuming DBNZ elected to take shares which, as indicated, was a reliable assumption in theabsence of some unexpected circumstance.The coupons paid by NZ entity on the convertible would be fullydeductible:There should be no capital gains tax on the acquisition of the NZ shares (provided such shares are not sold).(d) Such offshore position was subsequently confirmed by advice dated9 May 2002 from PricewaterhouseCoopers Singapore in terms thatDAP would not be subject to Singaporean tax on the difference betweenthe $149 million paid to DBNZ at the commencement of the transactionand the $204 million of shares received on maturity. In his evidenceMr Marcello contrasted this position with that applying to the previousloan from Danone Finance SA under the Cash Management Agreement.In that context the interest deductions which FHNZ was entitled to takegave rise to taxable income in France. The Arrangement thereforeallowed for FHNZ to preserve its New Zealand tax deductions forinterest paid on debt funding (albeit formerly subject to NRWT) whilealtering the Danone Group's offshore tax treatment of its funding ofFHNZ.(e) It provided committed five-year funding to FHNZ at a fixed rate ratherthan the floating rate charged under the Cash Management Agreement.This aspect was identified in the same memorandum referred to in subpara (a) above:The use of the Convertible Note enables [FHNZ] to hedge itsinterest rate and liquidity on the medium term as it is a fixed ratemedium term financing (versus a floating rate short term financing upto now). Our International Treasury confirms that a financing througha bilateral bank line would have been more expensive.Other internal and contemporaneous memoranda variously describe thearrangement as providing "a cost of funding more alternatives thanFrucor would have obtained from plain borrowings" and that the"benefits obtained" included "Financing Cost: extremely attractive forNZD financing".(f) It was consistent with the Danone Group's policy to create a naturalcurrency hedge for cashflows generated outside Europe by funding therelevant investments with local debt. This was referenced in an undatedbut contemporaneous Danone Group memorandum identifying "whythe Group needs to hedge its cashflows from foreign investments byfunding such investments with local debt" and the fact that refinancingthrough issue of convertible notes "answers to the objectives of theabove policy". In a further Danone Group internal memorandum, dated11 March 2003 the same point was made in terms:"Benefits obtainedNZD financing: putting a debt in the same currency as cash-flows ofthe company acquired provides us with a natural hedging;furthermore, interest are [sic] located in the same country as operatingincome.(g) To better balance the debt to equity position of the New Zealand groupduring the term of the Note by application of part of the Note proceedsto the repurchase of shares from DAP. In the memorandum referred toin sub para (a) above this was stated as "the purpose of the transaction"and it was to enable an "increase [in] value creation for the NewZealand Group".19 Likewise in an undated Frucor Beverages Ltdmemorandum, which in its terms appears to have been prepared shortlyafter the Arrangement came to an end and within the 2008 tax year, the"key commercial divisions" of the transaction were stated to include:To attain a more appropriate debt to equity level for the New ZealandGroup.2019 I record the content of the Memorandum, as Mr Marcello did, without elevating declaredsubjective purpose at the time to a relevant consideration in terms of application of s BG 1.20 The other identified "drivers" are noted as:• Securing fixed term funding at a lower cost of borrowing under a convertible note facility thanunder a more expensive syndicated loan structure.• To fund the New Zealand operations in a manner consistent with Groupe Danone's policy forsubsidiaries to self-finance as much as possible and prevent any shares being held by an entityoutside the Danone Group by use of a forward purchase agreement.It was common ground between the parties that as a result of therepurchase of shares the debt-equity ratio on FHNZ's balance sheetincreased from approximately 50:50 to approximately 63:37.The basis of the Commissioner's assessments[37] The Commissioner reassess FHNZ's income tax position on the basis that s BG1 permits her to treat $55 million of the payments made by FHNZ on the Note asrepayment of non-deductible loan principal.[38] As FHNZ submits, the Commissioner's case is "not grounded in the argumentthat the Arrangement gave rise to income tax deductions that did not exist before thearrangement was entered into and was accordingly, for that reason alone, a taxavoidance arrangement". Nor could it because, limited only by the thin capitalisationrules,21 it was always open to the Danone Group to introduce additional debt fundingto FHNZ and to retire a portion of its equity funding. And as Mr Marcello said inevidence (which I accept), broadly equivalent tax deductions to those claimed underthe Arrangement would have been available if the initial financing under the CashManagement Agreement had been retained.22[39] Rather the Commissioner has, at various times, advanced two principal andone now-abandoned alternative approach to application of the anti-avoidanceprovisions.23[40] The abandoned alternative approach was introduced in the Commissioner'srevised Notice of Proposed Adjustment dated 22 October 2010. It was premised on arejection by the Court of her primary argument that the (greater) portion of FHNZ'sclaimed interest deductions should be denied. It assumed a deeply discounted zero-21 Which do not limit the amount of debt that may be introduced but only the deduction of interestpaid on that debt. I will refer to these rules in greater detail later.22 Mr Marcello's reconstruction of interest payable under the Cash Management Agreement, had itbeen retained, indicated deductions of $10,619,354 in the 2006 year and $11,263,777 in the 2007year. This compares with claimed deductions under the Arrangement (on the higher principal sumof $204 million) of $13,250,998 and $13,323,806 respectively and the interest deductions allowedby the Commissioner of $2,423,392 and $1,658,483 based on her reconstruction.23 FHNZ's submission being that the several changes in the Commissioner's approach reflectadversely on the reliability of her avoidance analysis.coupon bond with a face value of $204 million, an issue price of $149 million andNRWT on the deemed accretion of deductible interest over the term of the bond.[41] The remaining approaches are those advanced in the Commissioner'sstatement of position dated 25 January 2011 and in the Adjudication Report dated 22November 2011 issued by the Commissioner's Adjudication Unit.24Approach in statement of position dated 25 January 2011[42] Under this approach the Commissioner argues the presence of the ForwardPurchase Agreement reduces the "real" or "economic" amount borrowed by FHNZfrom $204 million to a "net loan" of $55 million with a commensurate reduction ininterest entitlements.[43] Because of the acknowledged receipt by FHNZ of $204 million and itsapplication by way of capital return and repayment of facilities under the CashManagement Agreement, the Commissioner recharacterizes the $149 million as apayment made directly by DAP to FHNZ by way of an equity injection for which nodeduction arises. That approach is premised on the fact that under the ForwardPurchase, DBNZ would, having elected to take shares, hold them for a scintilla in timeonly before transferring them to DAP. In the result, the Commissioner characterisesDAP as having "paid for shares which it knew it would receive in the future" so thatthe payment should be seen as "an equity injection in substance" despite the sharesnot being issued or received for five years.[44] On this basis the Commissioner defines the "real" arrangement as being:(a) A $55 million advance from DBNZ to FHNZ repaid as to both principaland interest on an amortising basis over the term of the Note, withpayments of $55 million comprising principal, and interestdeductibility limited to $11 million.24 The parties agree that since this Court operates as a "hearing authority" for the purposes of theTax Administration Act 1994, my jurisdiction is not limited by either of the positions referred to(s 138P). In argument Mr Smith QC stated that the first alternative "remains on the table" but that"the Commissioner's primary argument is theory 2".(b) A $149 million advance subscription by DAP for the issue of equity inFHNZ in five years' time, with no income tax implications either inrespect of FHNZ's receipt of the sum, its retention for the five-yearperiod or issue of the shares at the conclusion of the Arrangement.(c) The aggregate $204 million being available to FHNZ for the term ofthe Note.(d) Liabilities in respect of that $204 million being fully discharged byFHNZ through the issue of shares in five years' time.Approach of Adjudication Unit, 22 November 2011[45] The Adjudication Unit appears not to have been persuaded by the approachadopted in the statement of position. It clearly regarded the approach as involving arecharacterisation which breached the "economic equivalence" prohibition confirmedin Commissioner of Inland Revenue v Europa Oil (NZ) Ltd25 and other authoritativedecisions under s BG 1, including the High Court and Court of Appeal decisions inAccent Management Ltd v Commissioner of Inland Revenue, later known in theSupreme Court as Ben Nevis26 (all as endorsed in the Commissioner's owninterpretation statement on s BG 1).27[46] Its alternative position was, as I consider Mr L McKay fairly puts it, to regardFHNZ's position as essentially the "reflex" of DBNZ's economic position.Accordingly, the Adjudication Unit considered:(a) DBNZ's economic outlay on the subscription was $55 million only(having received the $149 million prepayment from DAP).25 Commissioner of Inland Revenue v Europa Oil (NZ) Ltd [1971] NZLR 641 (PC) at 648 per LordWilberforce.26 Accent Management Ltd v Commissioner of Inland Revenue (2005) 22 NZTC 19.027 (HC) at[135]–[142]; and Accent Management Limited v Commissioner of Inland Revenue [2007] NZCA230, (2007) 23 NZTC 21.323 (CA) at [97]–[100] and [118].27 Public Rulings Unit, Office of the Chief Tax Counsel Tax avoidance and the interpretation ofsections BG 1 and GA 1 of the Income Tax Act 2007 (IS13/01, 13 June 2013).(b) in return for that economic outlay, DBNZ received $66 million ininterest over the term of the Note and, having regard to its initial outlay,this resulted in a net return of $11 million in economic terms.(c) FHNZ's economic position was equivalent. It received $204 millionfrom DBNZ and paid $66 million to it. It also issued shares to DBNZon termination of the arrangement which, although they representedconsideration such as to discharge FHNZ's obligations under the Note,had no economic cost to FHNZ.[47] The Adjudication Report noted:3.188 This leaves the $66 million the Taxpayer paid to Deutsche Bank. TheTaxpayer argues that the entire $66 million was its [interest] costunder the Note. However, this is inconsistent with Deutsche Bank's$75 million economic cost under the note and its $11 million return.Deutsche Bank's $11 million return under the Arrangement suggeststhat only $11 million of the Taxpayer's $66 million outgoingrepresents a cost to the Taxpayer. The $55 million balance appears tobe repayment of part of the $204 million lent under the Note 3.191 The balance of the $204 million (that is $204 million less $55million, being $149 million) does not appear to be repaid by theTaxpayer other than by issuing of shares. There was no costassociated with the issuing of shares. This left the Taxpayer with a$149 million gain.[48] This alternative approach does not involve recharacterisation of DAP's $149million payment to DBNZ as prepayment of equity to FHNZ. Indeed the approachtreats DAP's payment as being made to DBNZ so as to reduce its economic exposureto $55 million. It is because DBNZ is seen to have an economic outlay of $55 millionand an economic return on that outlay of $11 million that FHNZ's claim for deductionof the full $66 million is said to be "inconsistent" with DBNZ's position.The Commissioner's expert evidence[49] The Commissioner called two expert witnesses: Professor Lewis Evans andProfessor Moorad Choudhry. Professor Evans is an Emeritus Professor of Economicsat Victoria University of Wellington. He holds a doctorate in economics and has hada distinguished career in that field, including a Fellowship of the Law and EconomicsAssociation of New Zealand and a Distinguished Fellowship of the New ZealandAssociation of Economists. Professor Choudhry is an Honorary Professor of theUniversity of Kent Business School. He has a doctorate in financial economics and,in combination with his successful career in the banking industry, has publishedextensively on the subject of banking and financial products.[50] Both experts gave evidence on the commercial and economic effects of thetransactions (or aspects of them) in issue in the proceedings.[51] Professor Evans considered that, overall, the transaction "had the effect of the[Danone] Group borrowing and repaying $55.4 million over five years and renderinginterest and principal repayment tax deductible." He estimated that $11.1 million ofthe $66.5 million coupon repayments were properly characterised as interest, with theremaining amounts being repayment of principal.[52] He defined the transaction to consist of "the actions specified in theConvertible Note Deed, the Forward Purchase Deed, the two guarantees and the FeeArrangements". He explicitly excluded "transfers that can be considered ancillary tothe transaction" including the use to which FHNZ put the $204 million it receivedfrom DBNZ and the $89 million third-party financing received from BNP Paribas.[53] He calculated that at the close of the transaction the Danone Group experiencedan economic cost of $2.1 million, reflecting the fees paid to enter the arrangement.[54] However, he further explained that, "while the transaction provides a negativepre-tax value to the Danone Group, it is significantly positive on a post-tax basis." Heconsidered this to be the case irrespective of the form of settlement (by shareconversion and transfer, novation or cash payment) and attributed such result to thefact that the coupon payments were fully tax deductible.[55] In the case of conversion and transfer he stated that:(a) Adopting a discount rate of 6.4 per cent28 and discounting to the dateof closure of the transaction (18 March 2003), the pre-tax cost to theDanone Group was $2,092,793.(b) Because in his view the "issuance and concomitant transfers of shareshave no cost to the entity that is FHNZ" the value of that entity"increases substantially" from the CN transaction. He identified thatincrease as $146,041,192 on a discounted basis, all attributable to"transfers within the Danone Group".29(c) On a post-tax basis30 and assuming full deductibility for the couponpayments the transaction enhanced the value of the Danone Group byapproximately $14.9 million at the date of closure (with a $162,252,097uplift in value to FHNZ, a $149 million reduction in value to DAP anda $611,000 increase to Groupe Danone SA.31(d) Assuming that the coupon payments of $55.4 million in fact constitutedprincipal payments of $44.3 million and interest payments of $11.1million (which was the Professor's thesis) and that only the latter wasdeductible (as the Commissioner contends), the post-tax value to theDanone Group would have been approximately negative $1.4 millionat the date of closure.[56] Accordingly, he concluded that:The value of the Danone Group is enhanced by approximately $16.2 millionby principal repayment deductibility of the coupon payments: being thedifference between the present value of $14.9 million with full deductibilityand $1.4 million with interest only deductibility.[57] The Professor posited that this resulted in the New Zealand tax base subsidisingthe borrowing, at "social, equivalently economic, cost to New Zealand."28 Being the difference between the coupon rate of 6.5 per cent and the guarantee fee of 0.1 per cent.29 Derived from DAP's payment of $149 million.30 Using a post tax discount rate of 4.29 per cent being 6.4 per cent less tax of 33 per cent.31 Being the guarantee fees it received.[58] In the case of novation, Professor Evans identified the same $16.2 millionenhancement to the Group on a post-tax basis and the same pre-tax cost of $2.1million, with the only significant change being that "FHNZ's value from the[convertible note] transaction changes to negative because of the $204.4 millionpayment at settlement".[59] Under the cash repayment alternative, Professor Evans calculated the amountrequired to be paid by DBNZ to DAP as $218.3 million.32 Having regard to the $204.4million paid by FHNZ to DBNZ under this scenario, the Professor noted that "thischanges the economic effects of the transaction assessed on a pre-tax basis".The transaction is now positive on a pre-tax basis for the Danone Group andnegative to the DBNZ group, in the order of $8.1 million in present valueterms at the date of closure . However, Singaporean taxation affects thepost-tax outcome.[60] On a post-tax basis and assuming a Singaporean tax rate of 20 per cent33 heagain concluded that from the perspective of the Danone Group there would have beena $16.2 million (discounted) advantage arising from what he termed "full deductibilityversus interest only deductibility".[61] However, the Professor calculated DBNZ's position to be materially worseunder the cash settlement option — identifying a "value fall" of $8.1 million on a pre-tax basis and $9.9 million on a post-tax basis.[62] And, as with the novation option, settlement by cash payment meant thatFHNZ's "value" from the transaction changed to negative.34[63] This can be contrasted with Professor Evans's view that, under the shareconversion and transfer option, FHNZ suffered no economic cost when it issued sharesto DBNZ, and suffered no further economic cost when those shares were transferred32 His calculation assumed that no acceleration event had occurred and that the applicableSingaporean tax rate at the relevant time was 20 per cent.33 Professor Evans acknowledged in his brief that he understood the relevant Singaporean tax ratevaried between 2003 and 2008 (reducing over that time from 22 to 18 per cent) but nothing turnedon this variation.34 The corresponding value "uplift" being to CGD in the case of novation and DAP in the case ofcash settlement.to DAP — an opinion which formed one of the pillars of the Commissioner's s BG 1argument. In his brief of evidence the Professor put the position as follows:87. The economic cost is measured by changes in the cash surplus ofFHNZ going to its shareholders. There is no economic cost to FHNZin the issuance of shares per se. There will be dilution of per-sharepayments to the share owners (dividends per share) but not of theaggregate company dividend that is available for distribution toowners. For there to be an economic cost or benefit the issuance andtransfer would have to effect some change in decisions that affectedthe value of FHNZ. There is no reason to expect differentmanagement because of the act of issuing the shares. Setting asidethe small cost of the legal process of issuance there is no obviousrationale for the issuance and associated dilution of per-share dividendto have economic costs or effects for FHNZ.88. DAP did not suffer an economic cost when the [convertible note]converted to shares. I have explained that the issuance of additionalshares in FHNZ would have de minimis legal costs, but otherwise nocosts to the shareholders. In addition the act of transfer of shares toDAP had no economic or commercial costs (excepting de minimislegal costs) for either FHNZ or DAP. DAP owned the shares beforeand after the issuance and transfer of the shares. The issue and transferof shares simply shuffled the ownership records of DAP. They were,with the legal process cost caveat, costless and had no effect on theownership and control of FHNZ, or DAP.[64] Significantly, however, even in respect of the cash novation option35 ProfessorEvans considered that the coupon payments would still exhibit features of principalpayment deductibility for the Danone Group from an economic perspective.[65] I accept FHNZ's submission that while this may be correct from the Professor'seconomic perspective, it cannot be correct as a matter of New Zealand tax law or beconsidered consistent with Parliamentary intent. The Commissioner could have noobjection to a deduction accruing to FHNZ for the full $66 million of coupon paymentsunder the novation or cash settlement alternatives. In both such cases the $66 millionwould simply represent the price of the money, borrowed and ultimately repaid by thesame taxpayer, over the life of the instrument. The fact that Professor Evans'seconomic perspective suggests that such an arrangement would involve principalpayment deductibility does tend to emphasise the divergence between his economic35 And presumably also cash settlement option.model, itself premised on a group approach, and Parliament's assumed intentionsabout the operation of New Zealand's tax rules. I consider that a significant caveat interms of what importance I should place on the Professor's evidence.[66] Professor Choudhry's evidence drew broadly consistent conclusions to that ofProfessor Evans.[67] He considered the transaction unconventional in a number of material respects.For a start he said that convertible bonds and notes were characteristically priced onthe basis of a "volatility play" with the borrower benefiting from obtaining funding atan interest rate that is lower than it otherwise would be if it issued straight "vanilladebt" and the lender acquiring the right to shares at a potentially cheaper price than ifit subscribed at the time of the note's maturity. He suggested that none of theseconsiderations influenced the pricing of the DBNZ note.[68] In his view an unrated and unlisted wholly-owned subsidiary would neverfeasibly be able to use a convertible bond to raise funds because, unless the companywas the subsidiary of a listed parent and that parent was itself considered a proxy forits subsidiary's position,36 there would be no share price volatility to observe and thusno way to value the embedded option in the bond.[69] He said it would also be usual for a company raising money through aconvertible bond to identify, by way of an offer document, the purpose for which thefunds were to be used and that this was not the case here. And, in a related point hedrew a comparison with the orthodox situation where the amount of the bond is linkedto some specific capital requirement and is in a rounded sum. The face value of theDBNZ bond, he said, "was arrived at in what can only be described as an unorthodoxand not market conventional fashion", which worked backwards from the coupon rateresulting in a principal amount Professor Choudhry described as "a very exactnumber" that "is not commonly how conventional bond issue notional amountsconvertible or otherwise are arrived at in the market".3736 A proposition with obvious limitations.37 The evidence established that the value of the Note was established by adding the present valueof five years' worth of coupons (priced by the Deutsche Bank swaps desk in London) to theForward Purchase payment amount of $149 million. The resultant amount was $204,421,565.[70] And significantly, he relied on what he considered to be the unorthodox mannerin which the note was priced, contrasting:(a) The typical case where the issuer is listed or an exchange, is rated andhas "a transparent share price" and where the rate is set by taking thebaseline coupon (the ordinary rate for a vanilla fixed coupon bond) andmaking an adjustment downwards based on the value of the embeddedoption in the bond (which is itself a function of the volatility of theshare price and the time to conversion); and(b) The pricing in this case, which was simply referenced off the NZDswap curve with a spread of 30 basis points as "expected for an A1/A+rated borrower".38[71] Professor Choudhry's views also aligned with those of Professor Evans whenit came to the "economic substance" of the transaction:33. Because of the number of parties connected to the deal, it is illogicalto view the transaction economically as a standalone one or from theviewpoint of the bond issuing entity alone. The deal included DAP,DBNZ, the novation counterparty CGD, and Groupe Danone (theultimate parent of FHNZ). When the transaction is viewed from awider perspective, FHNZ has paid interest of $11.09 million on aborrowing of $55.42 million. In addition, FHNZ benefits from aninterest-free injection of cash, via the [forward purchase]arrangement, of $149 million for 5 years from its parent DAP.[72] And he took a similar position to Professor Evans in respect of the absence ofeconomic cost to FHNZ on the issue of shares to DBNZ saying:55. Issuing shares to the Note holder on maturity had no effect, economicor otherwise, because the shares were transferred simultaneously toits existing parent DAP, who already owned 100% of the shares inFHNZ. I can deduce no economic cost to FHNZ in this circumstance.57. From a practical economic and control (ownership) viewpoint therewas no cost or impact from the conversion of the note debt to sharesin FHNZ. This does not mean there would have been no book-keeping impacts, primarily accounting entries in the general ledger,38 Which FHNZ effectively was with the Groupe Danone SA guarantee.but this has no practical impact from an economic cost and ownershipviewpoint; there was no cash flow cost at all.[73] Significantly, both experts considered the economic effects of the transactionon the Danone Group as a whole. Professor Evans referred to the Danone Group asconsisting of FHNZ, DAP, Groupe Danone SA, CGD and Danone Finance SA. Incross-examination, he explained that the economic costs or benefits to a company inturn required reference to its shareholders and that his approach was "a summary wayof treating the commercial and economic performance of the company as being thebenefit to the shareholders, in the absence of externalities". Indeed he went furtherand said that "to me the company is the shareholders", a proposition which is open toobvious objection as a statement of legal principle.39[74] Likewise Professor Choudhry said:[T]his was a transaction involving three group entities designed to facilitate aparticular desired outcome above and beyond securing term funding. As such,it would not be logical from a banking perspective to view this transactionpurely with regard to one legal entity. It is the consolidated impact that mustbe considered.[75] However, as the following extract from his cross-examination confirmed, heaccepted that, looked at as a separate entity, FHNZ had received and applied the fullamount of the note and that the interest paid by it reflected a coupon rate of 6.5 percent on the sum advanced:Q. If we just stay with Frucor Holdings again on that separate entitybasis, would you agree that Frucor Holdings received 204 millionfrom DBNZ?A. Oh yes absolutely. In my view there's no doubt about that. Itissued paper to DBNZ and received 204 million, yes.Q. And again from [a] Frucor Holdings New Zealand entity standpointthere's nothing in your term on several occasions this morning nothingnominal about that 204?A. Are you asking me if it's real money?Q. Yes.A. Oh yes.39 See s 15 of the Companies Act 1993, confirming that a company is a legal entity in its own rightseparate from its shareholders.Q. And it is real to the extent of 204 million?A. Well, yes, FHNZ from my reading of the documents, FHNZ receives204 million on issue date from DBNZ, yes.Q. And it's also from paragraph 39 of your evidence accepted by you thatit spent 204 million?A. Yes that my – from the documents that's what it appeared to havedone, yes.Q. And this time from paragraph 31 of your evidence, I think it'saccepted by you that on an entity basis it paid 66 million for its use ofthat 204—A. It made a coupon of six and a half per cent on 204 million, yes.Q. Aggregating around 66 million?A. That's right, yes.Comparison of experts' approach with accounting treatment[76] The "group" approach adopted by Professors Evans and Choudhry wasreflected in the consolidated accounts for Danone. In his brief of evidenceMr Marcello explained that the Danone Group (including FHNZ) adopts InternationalFinancial Reporting Standards (IFRS) to prepare its financial statements. IFRS 10requires an entity that controls one or more other entities to present consolidatedfinancial statements. IFRS 10 defines "consolidated financial statements" as:40The financial statements of a group in which the assets, liabilities, equity,income, expenses and cash flows of the parent and its subsidiaries arepresented as those of a single economic entity.(Emphasis in original).[77] By contrast, FHNZ's own accounts were prepared on a "standalone basis" andreflected the gross cash flows it received under the transactions.[78] In the result, the evidence (including not only the financial statements but anumber of internal documents, emails and spreadsheets) uniformly establishedreference to a "net loan" of $55 million in the context of documents concerning DBNZ,40 IFRS Foundation "IFRS 10: Consolidated Financial Statements" at A477.DAP or the Danone Group generally. And in the context of FHNZ they referred in asimilarly uniform way to the full face value of the borrowing namely $204 million.41[79] In FHNZ's submission all this says is that although Professor Evans' andProfessor Choudhry's "group" approach was mandated (and followed) at aconsolidated accounting level, such is the limit of its applicability. It was not relevantin terms of FHNZ's accounting treatment at an entity level and, even more particularly,is not relevant to the principal inquiry under s BG 1 for the reason that, in applyings DB 7 and the financial arrangements rules, Parliament did not intend a "group"approach. I expand on this submission in subsequent sections of this judgment. Indoing so, however, I emphasise that FHNZ did not submit that the tax treatment of thearrangement must necessarily replicate the accounting treatment. That would be topromote a long-discredited view. Rather the argument about accounting methodologywas advanced to illustrate the areas of consistency and difference between accountingtreatment and expert evidence.The tax avoidance framework[80] As indicated, the Arrangement was governed by the provisions of the 2004 Act.Under s BG 1(1) of the Act, "[a] tax avoidance arrangement is void as against theCommissioner for income tax purposes." The Commissioner may then "counteract"the "tax advantage that a person has obtained" under pt G of the Act.42 This is knownas "reconstruction".[81] The Act defines "arrangement", "tax avoidance" and "tax avoidancearrangement" in s OB 1 (definitions). An arrangement is "an agreement, contract,plan, or understanding (whether enforceable or unenforceable), including all steps and41 There is one exception. One document, an "approval paper" prepared by DBNZ, referred to FHNZreceiving net funds equal to the difference between the convertible note and the forward purchase.But that document reflected a different structure to the transaction than the one ultimately adopted.At the time it was suggested that FHNZ would use the entire forward purchase amount (then$154m) towards repayment of its establishment equity (i.e., the $154m would be immediately paidfrom DAP to DBNZ, DBNZ to FHNZ and FHNZ back to DAP). This feature of the transactiondid not eventuate, with FHNZ instead only redeeming $60m of its establishment equity in orderto rebalance its debt to equity position. I do not therefore consider the netted figures referred toin this document are materially relevant to the Arrangement as it eventuated.42 Income Tax Act 2004, s BG 1(2).transactions by which it is carried into effect".43 The definition is broad and the partiesagree that the transaction amounts to an arrangement.[82] Tax avoidance is not defined exhaustively; rather the Act says it "includes":44(a) directly or indirectly altering the incidence of any income tax:(b) directly or indirectly relieving a person from liability to pay incometax or from a potential or prospective liability to future income tax:(c) directly or indirectly avoiding, postponing, or reducing any liabilityto income tax or any potential or prospective liability to future incometax[83] Finally, a "tax avoidance arrangement" is defined as follows:45Tax avoidance arrangement means an arrangement, whether entered into bythe person affected by the arrangement or by another person, that directly orindirectly–(a) has tax avoidance as its purpose or effect; or(b) has tax avoidance as 1 of its purposes or effects, whether or not anyother purpose or effect is referable to ordinary business or familydealings, if the purpose or effect is not merely incidental[84] These provisions, taken together, are referred to as the general anti-avoidancerule (or provision). I pause to make a brief observation on the words "purpose oreffect" in the last definition. As will be clear from the discussion that follows, thequestion of tax avoidance is objective. In Glenharrow Holdings Ltd v Commissionerof Inland Revenue, the Supreme Court said that (despite the word "purpose") theinquiry is not into the subjective intentions of the taxpayer but rather involves asking"what objectively was the purpose of the arrangement, which in turn requiresexamination of the effect of the arrangement."46 And so, "working backwards as itwere from the effect, you are able to determine what objectively the arrangement mustbe taken to have had as its purpose."4743 Section OB 1, definition of "arrangement".44 Section OB 1, definition of "tax avoidance".45 Section OB 1, definition of "tax avoidance arrangement".46 Glenharrow Holdings Ltd v Commissioner of Inland Revenue [2008] NZSC 116, [2009] 2 NZLR359 at [36].47 At [38], applying Lord Denning's approach in Newton v Commissioner of Taxation for theCommonwealth of Australia [1958] AC 450 (PC) at 465.[85] The difficulty caused by the broad scope of the general anti-avoidance rule hasbeen extensively discussed.48 It was the subject of detailed comment in the SupremeCourt's judgment in Ben Nevis Forestry Ventures Ltd v Commissioner of InlandRevenue.49 As Tipping and McGrath JJ explained in the majority judgment:50Taxpayers enter into many transactions which have been structured with thepurpose of taking advantage of specific provisions in order to reduce tax.While the general anti-avoidance provision is expressed broadly, its purposecannot be to strike down arrangements which involve no more thanappropriate use of specific provisions. On the other hand, strict compliancewith the requirements of specific provisions cannot have been intended toimmunise all arrangements involving their use against being categorised astax avoidance arrangements, which it was the purpose of the general provisionto avoid.[86] The majority summarised their approach by explaining that appropriate effectmust be given to each of the specific provisions and the general anti-avoidanceprovision — "they work together."51 The focus is on whether the use of the specificprovisions has crossed the line and transformed a "permissible arrangement into a taxavoidance arrangement,"52 The inquiry is one not to be distracted "by intuitivesubjective impressions of the morality of what taxation advisors had set up".53[87] The High Court has previously observed that it is generally unnecessary toreview the law on tax avoidance as it stood before Ben Nevis, except insofar as somedecisions remain material to specific parts of the overall inquiry.54 In this case theparties similarly focused their analysis on Ben Nevis and referred to other cases onlywhen necessary to elaborate on specific aspects of the tax avoidance framework.48 See, for example, Michael Littlewood "Tax Avoidance, the Rule of Law and the New ZealandSupreme Court" [2011] NZ L Rev 35 and the cases and articles cited therein.49 Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2NZLR 289.50 At [12]. Tipping and McGrath JJ wrote on behalf of themselves and Gault J. Elias CJ andAnderson J agreed with the conclusion reached by the majority but expressed reservations aboutthe majority's approach to the interpretation of the relevant provisions.51 At [103]. In John Prebble Fundamentals of Income Taxation (Thompson Reuters, Wellington,2018) at 412, the author describes this tandem approach as "not particularly helpful because theGAAR often overrides a specific provision" and "whenever it is invoked it is dominant".However, he acknowledges as "true that the application of the GAAR is informed by the apparentobjectives of the remainder of the Income Tax Act 2007."52 At [104].53 At [102].54 See BNZ Investments Ltd v Commissioner of Inland Revenue (2009) 24 NZTC 23,582 (HC) at[114] and Westpac Banking Corp v Commissioner of Inland Revenue (2009) 23 NZTC 23,834(HC) at [170].[88] In Ben Nevis the Supreme Court posited a two-stage inquiry to determinewhether an arrangement is a tax avoidance arrangement.[89] First, "[t]he taxpayer must satisfy the court that the use made of the specificprovision is within its intended scope."55 Such is not in issue here. The Commissioneraccepts that the transaction met the "black-letter" of s DB 7 (relating to interestdeductibility) and of the financial arrangements rules in the Act. Both are discussedin more detail below.[90] The outcome of this case therefore depends on the second stage of the inquiry.In terms of the Ben Nevis test, this involves an examination of the use of the specificprovision "in light of the arrangement as a whole."56 The focus is on whether thetaxpayer has used the specific provision "in a way which cannot have been within thecontemplation and purpose of Parliament when it enacted the provision".57[91] It is not necessary, however, for Parliament to have contemplated the specifictransactions in issue. As Wild J said in BNZ Investments Ltd v Commissioner of InlandRevenue:58I agree with Mr Brown's submission for the Commissioner that it is unreal tosuggest that Parliament, when it enacted the deductibility and subventionprovisions and the FTC and conduit regimes, might actually havecontemplated transactions structured as are those in issue in these proceedings.[92] In Ben Nevis the Supreme Court emphasised that enquiries into tax avoidanceare primarily exercises of statutory interpretation. Ascertaining whether the use ofspecific provision "cross[ed] the line" is to be "firmly grounded in the statutorylanguage of the provisions themselves".59 The Court explained that the general anti-avoidance rule functions:60 to prevent uses of the specific provisions which fall outside their intendedscope in the overall scheme of the Act.55 Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2NZLR 289 at [107].56 At [107].57 At [107].58 BNZ Investments Ltd v Commissioner of Inland Revenue (2009) 24 NZTC 23,582 (HC) at [134].59 Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2NZLR 289 at [104].60 At [106].[93] The statute does not confine the Court's inquiry; rather, the Supreme Courtobserved that "the Commissioner and the courts may address a number of relevantfactors, the significance of which will depend on the particular facts."61 The Courtposited the following examples:62(a) The manner in which the arrangement is carried out;(b) The role of all relevant parties and any relationship they may have withthe taxpayer;(c) The economic and commercial effect of documents and transactions;(d) The duration of the arrangement;(e) The nature and extent of financial consequences the arrangement willhave for the taxpayer;(f) Whether the arrangement was structured so that the taxpayer gains thebenefit of the specific provision in an artificial or contrived way.[94] In some cases artificiality may be indicated not by the structure itself but bythe rates at which a deduction is taken, or for example a salary. In Penny vCommissioner of Inland Revenue, for example, the Supreme Court considered theadoption of "a familiar trading structure" (incorporation of a company and transfer ofpersonal business to that company) "cannot per se be said to involve tax avoidance".63But Parliament could not have been seen to contemplate "using a company structureto fix the taxpayer's salary in an artificial manner."64 A "gross disparity between theprice and size of the purchaser" was also indicative of tax avoidance in GlenharrowHoldings.65 In that case, the Supreme Court explained why a factor such as"commercial effect" is relevant; because "[t]ransactions which are driven by61 At [108].62 At [108].63 Penny v Commissioner of Inland Revenue [2011] NZSC 95, [2012] 1 NZLR 433 at [33].64 At [47].65 Glenharrow Holdings Ltd v Commissioner of Inland Revenue [2008] NZSC 116, [2009] 2 NZLR359 at [54].commercial imperatives are unlikely to produce tax consequences outside the purposeof the legislation".66 Although it would be incorrect to describe underlyingcommercial purpose as immunizing a transaction from challenge under s BG 1, it isnevertheless a significant consideration both at the threshold and potentially "merelyincidental" steps of the inquiry.67[95] A focus on individual factors (like artificiality or commerciality) may indicateParliament's intention but cannot detract from the "ultimate question" which theSupreme Court in Ben Nevis identified as:68 whether the impugned arrangement, viewed in a commercially andeconomically realistic way, makes use of the specific provision in a mannerthat is consistent with Parliament's purpose. If that is so, the arrangement willnot, by reason of that use, be a tax avoidance arrangement. If the use of thespecific provision is beyond parliamentary contemplation, its use in that waywill result in the arrangement being a tax avoidance arrangement.Section DB 7 and the financial arrangements rules[96] The transaction relied on two separate parts of the Act: the interestdeductibility provisions and the financial arrangements rules. Accordingly, Ben Nevismandates that I consider the "intended scope" of both sets of provisos within "theoverall scheme of the Act.69[97] Under s DB 7(1) of the Act, "A company is allowed a deduction for interestincurred." Interest is defined in s OB 1. It "includes expenditure incurred under thefinancial arrangements rules".70 Interest is "incurred" where a legal obligation to makea payment in the future has accrued, the taxpayer is definitely committed to it and it ismore than impending, threatened or expected.71 FHNZ submits that s DB 7 providesfor an "unqualified entitlement"72 to deduct the $66 million in payments made toDBNZ, save only for potential application of s BG 1.66 At [49].67 See, for example, Westpac Banking Corp v Commissioner of Inland Revenue (2009) 23 NZTC23,834 (HC) at [206].68 Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2NZLR 289 at [109].69 At [106].70 Income Tax Act 2004, s OB 1, definition of "interest" at (d)(i).71 Case Y17 (2008) 23 NZTC 13,171 (TRA) at [31]. See also Commissioner of Inland Revenue vMitsubishi Motors New Zealand Ltd [1995] 3 NZLR 513 (PC) at 517.72 The phrase was Mr (L) McKay's.[98] That approach is supported by both policy and pragmatic considerations. Inan article examining the calculation of interest, Sir Ivor Richardson observed:73Dissecting interest payments and receipts on income account so as to excludeany capital elements would be costly and uncertain. There is usually noincentive for tax reporting purposes to depart from the historical position oftreating the full percentage rate of interest as income of the recipient and as arevenue deduction against income of the payer.That characterisation can cause problems where hybrid arrangements maybe mischaracterised as debt (or equity) under corporate law or revenue law(where the Commissioner of Inland Revenue can invoke special legislativeprovisions and the general anti-avoidance provision). [99] The legislative history of s DB 7 indicates that it was intended to providecompanies with a deduction as soon as interest was incurred and without reference tosome of the historic restraints which applied. The Commissioner explained theintroduction of new interest deductibility rules for companies in a Tax InformationBulletin in November 2001:74The general interest deductibility rules for companies have been clarified andsimplified. The changes ensure that interest incurred by most companies isdeductible, subject to the existing thin capitalisation and conduit interestallocation rules. The purpose of these changes is to reduce compliance costs for taxpayers byremoving both the uncertainty that surrounded these tax rules and their needto structure to achieve the same result.For the majority of companies, interest deductions are no longer confined tointerest incurred either in deriving gross income, or in the course of carryingon a business, or in relation to borrowings used to capitalise subsidiaries.[100] Both the section and the policy behind it therefore indicate that a taxpayer isentitled to a deduction for interest that has been incurred whether or not for thepurposes of deriving gross income, carrying on a business or in relation to borrowingsto capitalise subsidiaries. I accept in that context Mr McKay's characterisation of therule as providing the taxpayer with an "unqualified entitlement" to deduction whereinterest is incurred, subject of course to s BG 1.73 Ivor Richardson "The Calculation of Interest" (2014) 20 NZJTLP 231 at 249.74 Inland Revenue Department "Interest Deductibility for Companies" (2001) 13(11) TaxInformation Bulletin 34 at 34.[101] Turning then to the financial arrangements rules, these are provided for in sub-pt EW of the Act. The Act identifies three purposes to the rules:75(a) to require the parties to a financial arrangement to accrue over the termof the arrangement a fair and reasonable amount of income derived orexpenditure incurred under the arrangement, and so to prevent thedeferral of income or the advancement of expenditure; and(b) to require the parties to a financial arrangement to disregard anydistinction between capital and revenue amounts; and(c) to require a party to a financial arrangement to calculate a base priceadjustment when the rights and obligations of the party under thearrangement cease.[102] A financial arrangement includes "an arrangement under which a personreceives money in consideration for that person, or another person, providing moneyto any person" either "at a future time" or "on the occurrence or non-occurrence of afuture event, whether or not the event occurs".76 A debt and a debt instrument arespecifically contemplated to be financial arrangements.77[103] Though the financial arrangements rules "require the parties to a financialarrangement to disregard any distinction between capital and revenue amounts",78 theynonetheless recognise the distinction between debt and equity. That is clear from thelist of excepted financial arrangements.79 An "excepted financial arrangement" is nota financial arrangement.80 Excepted financial arrangements include "a share, or anoption to acquire or to dispose of shares",81 but "[a]n excepted financial arrangementmay be part of a financial arrangement."82 In this case the option to acquire sharesitself formed part of a broader financial arrangement which included the Note.[104] Ordinarily a financial arrangement is taxed on the basis that all returns on thearrangement, whether income or capital in nature, are brought to tax.83 It also requires75 Income Tax Act 2004, s EW 1(3).76 Section EW 3(2).77 Section EW 3(3)(a) and (b).78 Section EW 1(3)(b).79 Section EW 5.80 Section EW 4(3).81 Section EW 5(12).82 Section EW 6(1).83 Section EW 15.all income and expenditure related to the arrangement to be spread over the term ofthe arrangement.84[105] A taxpayer must adopt a methodology to calculate income or expenditure overthe term.85 In respect of certain types of financial arrangements this is governed by"determination methods" identified by the Commissioner.86[106] The Taxpayer must further calculate a base price adjustment on the maturity ofthe financial arrangement.87 Such calculation is made by reference to a formula:consideration less income, expenditure and amount remitted.88 Income is incomederived under the financial arrangement;89 expenditure is that which is incurred underthe financial arrangement;90 and an amount remitted is an amount that is remitted bythe person or by law.91 Consideration is "all consideration that has been paid and allconsideration that is or will be payable, to the person for or under the financialarrangement".92 But that definition is adjusted in "particular cases", where a morespecific section applies.93 In this case s EW 32 is more specific. It applies toagreements for the sale and purchase of property and services.94 The value of theproperty or services is to be determined by "the lowest price the parties would haveagreed on for the property or services, on the date the agreement was enteredinto".95[107] The optional convertible note in issue in this case is an example of a hybrid taxinstrument. The reason that is so is explained in The New Zealand Accrual Regime —A practical guide, where the learned authors say:9684 Section EW 14(1).85 Section EW 12.86 Section EW 20.87 Section EW 29(3).88 Section EW 31(5).89 Section EW 31(9).90 Section EW 31(10).91 Section EW 31(11).92 Section EW 31(7).93 Section EW 31(8).94 Section EW 32(1).95 Section EW 32(3). Note [20]–[21] above, where the parties agreed to the lowest price of the sharesat the date the Note was executed.96 Susan Glazebrook and others The New Zealand Accrual Regime — A practical guide (2nd ed,CCH, Auckland, 1999) at 199.In broad terms, a convertible note can be considered to be a debt instrumentwhich provides at least part of the return in the form of shares in a companyor rights to subscribe for such shares. Such instruments have always beenparticularly difficult to bring within an income tax system which operates bydrawing a distinction between the tax treatment of debt and equity. Aconvertible note is a hybrid instrument: it is part equity and part debt. To theextent to which the convertible note offers note holders a share option or aright to shares, the note is an equity instrument. To the extent to which thenote offers coupon interest returns and/or a cash redemption option, it is anormal debt instrument. The hybrid nature of a convertible note means thatit is appropriate to treat the note neither as a debt instrument nor as an equityinstrument.[108] It is inherent in the final sentence of that passage that if taxed under theordinary provisions, "some part of the hybrid instrument is being taxed in a way inwhich it should not be taxed."97 To avoid the potential issues that may result, theCommissioner has issued determinations that relate specifically to convertible notes.[109] The Commissioner's power to issue determinations is contained in pt 5 of theTAA. Determinations are made under s 90 of that Act and apply in principle to afinancial arrangement until a new determination relevant to that arrangement ismade.98 The Commissioner may determine, inter alia, the method to be applied in thedetermination of income derived or expenditure incurred under the financialarrangements rules, or, for example, how certain values are to be determined undercontracts for property.99[110] For the purposes of taxing convertible notes there are two relevantdeterminations: Determination G22 (optional convertible notes) and DeterminationG5C (mandatory convertible notes). The need for two different approaches isexplained in The New Zealand Accrual Regime — A practical guide:100For the purposes of applying the accrual rules to convertible notes, adistinction has to be drawn between notes where conversion into shares ismandatory and notes where it is optional. The distinction is important because,with mandatory convertible notes, the equity component of the note is anagreement to purchase shares. An agreement to purchase shares is not anexcepted financial arrangement (unless it falls within the definition of a short-97 Joanna Khoo "Line in the Sand of the Debt/Derivative Desert: The Tax Treatment of OptionalConvertible Notes" (2011) 17 NZJTLP 209 at 210.98 Tax Administration Act 1994, s 90AA(1).99 Section 90AC(1).100 Glazebrook and others The New Zealand Accrual Regime — A practical guide (2nd ed, CCH,Auckland, 1999) at 200.term agreement for sale and purchase of property); the agreement itself is afinancial arrangement. An alternative is that a mandatory convertible note canbe viewed as a loan which is repaid in shares — again, not an exceptedfinancial arrangement. On the other hand, with respect to optional conversionconvertible notes, the equity component is an option to acquire shares which,as noted at [902], will in general be an excepted financial arrangement.[111] In FHNZ's submission, it is irrelevant which of the two determinations appliedto the subject transaction — because both provided for full deductibility of the $66million paid. To the extent it is germane, I consider determination G22 applied.101[112] The explanation to Determination G22 (which does not form part of thedetermination itself) states:This determination applies to those optional conversion Convertible Noteswhere conversion into company shares is at the option of the holder and theconvertible note is denominated in New Zealand dollars.[113] This passage summarises in brief terms the section of the determinationaddressing its scope102 (which is binding). In this case, the probabilities of DBNZchoosing not to exercise its option do not, in my view, change the fact the conversionwas, on the document itself, "at the option of the holder". The Commissioner did notargue to the contrary.[114] In its terms Determination G22 sets out the method for apportioning the partof the acquisition price of the note attributable to the option to buy shares. It also setsout what amounts are not included in calculating income or expenditure, how the baseprice adjustment is to be calculated and certain principles relating to considerationunder the base price adjustment. As the Court of Appeal explained in Alesco NewZealand Ltd v Commissioner of Inland Revenue, where the taxpayer issued such a note(in that case with a zero coupon):103The OCNs are a financial arrangement. G22 is no more than theCommissioner's prescription for severing and calculating the amount ofAlesco NZ's obligation attributable to the excepted financial arrangement –that is the equity element of the OCNs constituted by the share option. Its legalstatus and effect is limited to providing the appropriate methodology for that101 Determination G22 was later replaced by Determination G22A. The parties also referred to thelatter determination and I will do so to the extent relevant.102 Section 3.103 Alesco New Zealand Ltd v Commissioner of Inland Revenue [2013] NZCA 40, [2013] 2 NZLR145 at [78].purpose. It is not determinative of the underlying question of whether notionalinterest deductions claimed on the debt component of the instrument amountto "expenditure" or "expenditure incurred" in terms of the financialarrangements rules.[115] As to the wider purpose of the financial arrangements rules, Lord Hoffmann,delivering the Board's advice in Commissioner of Inland Revenue v Auckland HarbourBoard, outlined the regime in the following way:104This innovative system was introduced in 1986. It has two main features: first,in principle and subject to exceptions, it taxes the entire yield from a financialarrangement without regard to whether it is income or capital. Secondly, itdeems that yield to be receivable over the expected life of the arrangement. Inits simplest form, it requires the whole of the expected cash return from thearrangement to be calculated, the acquisition price deducted, and thedifference treated as taxable income which will be received evenly over thetax years until maturity. Mr McKay, who appeared for AHB, pointed out thatthis approach required one to discard traditional and intuitive reactions basedupon the principle that income tax is a tax on income. As Glazebrook andOliver say in their book, The New Zealand Accrual Regime (1989) at para 301:"[The traditional] legal/accounting approach to defining whatconstitutes income can be compared with an economic approach.Under economic principles all gains in wealth are generallyconsidered to be 'income' and all reductions in wealth are subtractedfrom income. Whether any 'gain' or 'loss' can be categorised ascapital or revenue assumes no relevance, the only issue is whetherthere is an overall gain or loss of wealth over the period for which theincome is being measured.The accrual regime can be interpreted as a fundamental shift from therest of the income tax regime which operates on traditionallegal/accounting principles. It is a move to a regime where the Actoperates more on economic principles."[116] Those observations about the economic approach under the financialarrangements rules are echoed in the Court of Appeal's judgment in Alesco. Afterreviewing the rules and the Commissioner's power to issue determinations, the Courtstated:105[71] In our judgment, the financial arrangements rules were intended togive effect to the reality of income and expenditure – that is, real economicbenefits and costs. They were designed to recognise the economic effect of atransaction, not its legal or accounting form or treatment. The question iswhether the taxpayer has "truly incurred the cost as intended by Parliament".This construction is reinforced by the relevant addition, in three critical104 Commissioner of Inland Revenue v Auckland Harbour Board [2001] 3 NZLR 289 (PC) at [2].105 Alesco New Zealand Ltd v Commissioner of Inland Revenue [2013] NZCA 40, [2013] 2 NZLR145.provisions, of the word "incurred". In the Mitsubishi Motors case the PrivyCouncil affirmed, with reference to an earlier statutory provision, thatexpenditure is incurred on the premise that it arises pursuant to a legalobligation.[72] These features suggest that Parliament did not intend that a taxpayerwould be entitled to use the financial arrangements rules as a basis forclaiming deductions for interest for which the taxpayer was not liable or didnot pay. The rules were intended to operate as a net regime – that is to bringto tax the amount yielded after deducting the entire economic cost from ataxpayer's entire economic benefit. In the absence of a liability a taxpayerclaiming the benefit of a deduction for interest payments would be purportingto incur that liability without suffering the economic burden. We are satisfiedthat the intended purview of the rules is to exclude notional transactions.The wider quest for legislative intention — the group approach[117] As explained in Ben Nevis, the question of whether a particular application ofspecific rules is consistent with Parliament's purpose requires that the scope of suchrules be considered within the overall scheme of the Act.106[118] The subject transaction had cross-border features which the Commissioneridentifies (particularly in the first theory she advances) as involving funding betweenan offshore parent and a New Zealand subsidiary. In her second theory, equivalentoffshore funding is seen as reducing DBNZ's real economic exposure to $55 million,in respect of which FHNZ's position should, on her approach, be seen as the reflex.[119] Three specific aspects of New Zealand's international tax regime warrantmention at this point:(a) The imposition of NRWT on dividend, interest and royalty flows[120] New Zealand is and has been for many years a net importer of capital, returnson which typically take the form of dividend, interest or royalties. The imposition ofNRWT allows New Zealand to derive tax revenues from such returns. The rate atwhich NRWT is imposed is, in turn, often dictated by relevant Double TaxationAgreements between New Zealand and another jurisdiction. NRWT is an importantmechanism to tax income streams as they leave New Zealand.106 Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2NZLR 289 at 108.[121] NRWT is imposed where a person derives non-resident withholding income,the definition of which is premised on the person not being resident in New Zealand.107I accept the submission of FHNZ that the NRWT regime is premised on the separatetax treatment of related group entities and eschews a consolidated or group approach.NRWT would not and could not be applied if payments of interest, dividends androyalties between a New Zealand subsidiary and offshore group member did not haveseparate recognition for tax purposes.[122] Indeed, the separate entity principle is so fundamental as a base protectionmeasure that it is imposed on a single entity operating in two or more jurisdictionsincluding New Zealand (as, for example, through a New Zealand branch office). So,in the present case, DBNZ, the New Zealand branch of Deutsche Bank AG, would betreated as having separate entity status for taxation purposes.(b) The transfer pricing regime[123] New Zealand domestic law also contains transfer pricing principles to ensuretransfers between related entities (including by way of debt) occur on an arm's lengthbasis. The relevant provisions are now in ss GC 6–GC 14 of the Income Tax Act2007.108 Section GC 6(1) describes the purposes of these provisions as being:To substitute an arm's length consideration in the calculation of a person's netincome if the person's net income is reduced by the terms of a cross-borderarrangement with an associated person for the acquisition or supply of goods,services, or anything else.[124] Accordingly, mirror provisions109 provide that if the amount of considerationpaid by a New Zealand entity is more or less than an arm's length amount, an amountequal to the arm's length amount is treated as the amount payable by the taxpayer forthe purposes of calculating their income tax liability for the relevant tax year.107 Income Tax Act 2004, s NG 2.108 See s GD 13 of the Income Tax Act 1994 and s GD 13 of the 2004 Act. I am satisfied thatParliament's intention under those Acts was identical, for the purpose of the issues I am examining,to that under the 2007 Act provisions.109 Income Tax Act 2007, ss GC 7 and GC 8.[125] The broad policy of these provisions is confirmed by the Commissioner'sTransfer Pricing Guidelines (TPGs) issued in 2000 which, among other things, providethe following high level comments in respect of the operation of the regime:110Key Points• The focus of New Zealand's transfer pricing rules is to ensure that theproper amount of income derived by a multinational is attributed to itsNew Zealand operations• New Zealand has adopted the arm's length principle because it isconsidered the most reliable way to determine the amount of incomeproperly attributable to a mulitnational's New Zealand operations and,because it represents the international norm it should minimise thepotential for double taxation.[126] The TPGs continue by recognising the wider advantages of the regime:11164. The arm's length principle also results in a broad parity of taxtreatment for multinationals and independent enterprises. This avoids thecreation of tax advantages or disadvantages which would otherwise distort therelative competitive positions of either type of entity. In so removing thesetax considerations from economic decisions, the arm's length principlepromotes the growth of international trade and investment.[127] Again I accept FHNZ's argument that the arm's length principle underpinningthe New Zealand transfer pricing rules is itself premised on a separate entityapproach.112(c) The thin capitalisation regime[128] These rules, now in subpart FE of the Income Tax Act 2007,113 apply in respectof debt-funded companies owned or controlled by non-residents so as to limit interestdeductions in circumstances where prescribed debt equity ratios are exceeded. Theratio prescribed in the income years relevant to this proceeding was 75:25.114110 Inland Revenue Department "Transfer Pricing Guidelines" (2000) 12(10) Tax Information Bulletinat 9.111 At 11.112 The same approach also underpins the associated enterprises article of the OECD's Model TaxConvention on Income and on Capital which forms the basis of each of New Zealand's 40 doubletax agreements.113 See Income Tax Act 2004, sub-pt FG.114 Section FG 3.[129] Again, these rules assume individual-entity recognition in a multi-nationalgroup context and again I accept FHNZ's submission that, assuming a group approach,interest payments made by a New Zealand entity to an offshore equity would simplybe disregarded with the result that the rules would be irrelevant.The three regimes in a wider context[130] Each of these three regimes is, as I have indicated, simply reflective of broaderprinciples in the way New Zealand approaches the taxation of cross-bordertransactions. Professor Craig Elliffe captures that point early in his text Internationaland Cross-Border Taxation in New Zealand:115Our current international tax system operates on the basis of attributing arm's-length profit to separate entities which either are resident in, or operate in, ajurisdiction. Many of the concepts of international tax drive off this principlethat you can fairly and appropriately attribute profit to a particular entity. Atsome point in time in the future there may well be a concept of internationaltax under some form of unitary taxation or formulary apportionment ratherthan the current approach of separate entity accounting (the tax systemrespects separate legal identities for a multinational's subsidiaries in variouscountries). Under formulary apportionment a multinational entity doingbusiness in several countries pays tax on a global basis which is subsequentlyapportioned, using a formula, to the various countries in which the business isoperating.[131] The position is taken up in more detail in subsequent sections of the Professor'stext. On the issue of company tax residence he says:116The general definition of separate legal existence from its members is the keytest of what constitutes a company. It is applied to foreign entities operatingin New Zealand in order to determine whether they should be regarded ascorporate taxpaying entities in their own right (opaque) or whether NewZealand taxation should occur at the level of the members/investors(transparent or look-through).115 Craig Elliffe International and Cross-Border Taxation in New Zealand (2nd ed, Thomson Reuters,Wellington, 2018) at 3. Although the text is very recent the position was the same under theIncome Tax Act 2004 — see ch 3 "The New Zealand International Tax Experience — A BriefHistory"..116 At 91. A company, is defined in the Act, as meaning "a body corporate or other entity that has alegal existence separate from its members, whether it is incorporated or created in New Zealandor elsewhere". The definition elsewhere contemplates taking a group-based approach but does soonly for group investment funds (subject to specific tax rules). Non-residents are excluded fromNew Zealand consolidated groups with the result that the consolidated group regime has noapplication to the current proceedings. FHNZ submits that this exclusion further emphasises thatNew Zealand's international tax rules required the recognition, and "not the disregard", oftransactions between New Zealand subsidiaries and their offshore group members.[132] And in relation to the arms-length principle and the individual entityframework which underpins it he says:117OECD countries tax multinational enterprises (MNEs) on the basis of singleentities (that is, even though there is a common economic ownership, eachseparate company has a separate and different legal persona which is subjectto tax). When MNEs apply a separate entity approach to intragrouptransactions, they may not be concerned about the profitability of thosetransactions in the sense that one MNE separate entity approach to intragrouptransactions, they may not be concerned about the profitability of thosetransactions in the sense that one MNE separate entity's loss is another MNEseparate entity's gain. The MNE, because it is the same legal and economicgroup, is somewhat ambivalent about the profitability of each separate entity– it is the overall group of companies and its profitability that is their concern.On the other hand, each country in which the separate entities are located arevery concerned to identify a reasonable means of achieving a sensible and fairallocation of profitability for the entity in their jurisdiction. This is thefundamental problem that transfer pricing seeks to overcome: how can profitsbe shared equitably and the risk of unrelieved double taxation minimised?The OECD have taken the approach that in respect of intragroup transactions,separate entities must be taxed on the basis of an arm's length principle.[133] I accept FHNZ's submission that, central to the Commissioner's case and tothe expert evidence she called, is the proposition that the Arrangement should beexamined in terms of its overall impact at a group or consolidated level looking at thenet external position of entities under common control. The point is most clearlyillustrated by Professor Evans's remark: "to me the company is the shareholders".118And I also accept FHNZ's submission that in a cross-border context there are strongindicators that this was not Parliament's intention.[134] Although Mr Smith QC submitted that this was a mischaracterisation of theCommissioner's case, that she had assessed FHNZ as a stand-alone entity and thatwhat FHNZ described as a "group approach" on the part of the Commissioner'sexperts was no more than an exposition of the commercial and economic effects of theArrangement, the point he makes is in my view more semantic than real. The experts'117 At 849-850. Similar observations appear in Johannes Becker and others Klaus Vogel on DoubleTaxation Conventions (4th ed, Kluwer Law International, The Netherlands, 2015) at 594 and inthe Preface to the 1995 OECD report entitled Transfer Pricing Guidelines for MulinationalEnterprises and Tax Administrations (OECD, Paris, 1995). The Guidelines in turn describe Article9 of the Model Tax Convention on Income and on Capital (which directs that transactions enteredinto between associated enterprises that differ from those that would be entered into betweenindependent parties are to be treated as having been entered on arm's length terms for profitallocation purposes) as the "authoritative statement of the arm's length principle".118 See [73] above.positions in relation to commercial and economic effects of the cash flows, rights andliabilities under the agreement were substantively founded in a group approach andthe Commissioner's submissions were in turn firmly grounded in their evidence. It isirrelevant in that context that only FHNZ has been the subject of an assessment by theCommissioner.[135] That said, however, it is important to emphasise that my observations about theapparent inconsistency of the experts' group approach with Parliament's assumedintention are specific to the arrangement in issue.What is the "Arrangement"?[136] If the test is whether the impugned arrangement, viewed in a commercially andeconomically realistic way, makes use of the specific statutory provisions in a mannerconsistent with legislative purpose, what then is the arrangement?[137] Professor Evans described it in narrow terms as comprising the Note, ForwardPurchase, guarantees and fee arrangement. He excluded the associated borrowingsand repayments. However, the statutory definition is broadly framed in terms:119Arrangement means an agreement, contract, plan, or understanding (whetherenforceable or not), including all steps and transactions by which it is carriedinto effect.[138] In Ben Nevis the Supreme Court held that "tax avoidance can be found inindividual steps or, more often, in a combination of steps" and that "even if all of thesteps in an arrangement are unobjectionable in themselves, their combination may giverise to a tax avoidance arrangement."120 And in Westpac Banking Corp Harrison Jnoted the importance of the Court inquiring "into the transaction as a whole" whichinvolved a "wider inquiry" than that at stage 1 in the analysis (compliance withspecific provisions).121 Moreover, although the Supreme Court framed the test byreference to the "impugned arrangement" it is clear that the inquiry into whetherapplication of specific provisions is consistent with legislative purpose is to be119 Income Tax Act 2004, s OB 1, definition of "arrangement".120 Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2NZLR 289 at [105].121 Westpac Banking Corp v Commissioner of Inland Revenue (2009) 23 NZTC 23,834 (HC) at [188].considered "in the light of the arrangement as a whole"122 not simply by reference tothe impugned part or parts of an arrangement.[139] In my view the mandate to consider the arrangement (however expansively orrestrictively that word is interpreted), in a commercially and economically realisticway, requires reference to the full context in which it occurred and all associated stepsin what might be called "the overall transaction".123 As such I consider argument asto the exact limits of the definition arid and Professor Evans' attempt to minimise thesignificance of FHNZ's simultaneous repayment of capital and retirement of debt tobe unduly restrictive. I do not intend to exclude any part of what I regard as anintegrated transaction from the inquiry I must undertake.Assessment in light of the Ben Nevis factors[140] In Ben Nevis the Supreme Court posited a non-exclusive list of relevant factorsin assessing whether the use of specific provisions falls outside their intended scope.124I have identified these in [93] above. Although the Court made it clear that the statutedoes not confine the Court's inquiry and although there is inevitably some overlap inthe factors identified,125 I consider each of them in turn.The manner in which the Arrangement was carried out[141] There are a number of relevant observations in this respect.(a) The transaction involved real money flows. DAP borrowed theequivalent of NZD 89 million from BNPP, $149 million was paid incash by DAP to DBNZ pursuant to the Forward Purchase Agreement,DBNZ advanced $204 million to FHNZ, FHNZ applied $144 millionof that to repay advances from Danone Finance SA and repurchased122 Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2NZLR 289 at [107].123 This focus on the economic reality of the "transaction" features in the Supreme Court's discussionof the Privy Council decision in Challenge Corp Ltd v Commissioner of Inland Revenue [1986] 2NZLR 513 (PC); refer Ben Nevis at [94].124 Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2NZLR 289 at [108].125 Particularly in terms of the manner in which the arrangement was carried out and examination ofpotential artificiality and contrivance.(for $60 million) 400 of the shares held in it by DAP. Mostsignificantly, FHNZ made actual payments of interest at 6.5 per cent ofthe face value of the note over its five-year term. As ProfessorChoudhry acknowledged all of this was "real money".(b) One aspect of the transaction involved what the Commissioneridentifies as a circularity — that is the repurchase of share capital fromDAP and DAP's simultaneous126 payment under the Forward Purchase(augmented by the advance it obtained from BNPP). I will considerthis more fully in discussing whether there was artificiality orcontrivance in the transaction (the sixth factor identified by theSupreme Court).(c) The manner in which the face value of the Note was fixed and the Notewas priced was unusual, at least in the context of what might be calledorthodox convertible note transactions. I accept Professor Choudhry'sevidence that the most common reason why a corporate will issue debtin this form will typically be to fund some form of expansion orinvestment and that the very particular sum of the Note ($204,421,565)is a strong indicator that the company's medium term corporatefinancing requirements did not drive its face value.(d) Rather the evidence (and in particular an email from DBNZ's Mr ScottBurridge to Groupe Danone SA's Mr Pierre-Andre Terisse dated 7March 2003) establishes that the amount of the Note was fixed byadding to the $149 million under the Forward Purchase, the presentvalue of five years' worth of coupons calculated by reference to thefive-year New Zealand Dollar swap rate.(e) Moreover, because the issuer of the Note was the wholly-ownedsubsidiary of another entity there was no share price volatility toobserve and thus no way that the market could price the embedded126 I use the term "simultaneous" in the sense that the transactions occurred on the same day. Theprecise timing was not in evidence, nor do I consider it significant in terms of the s BG 1 inquiry.option in the bond having regard to its maturity date. Here the couponon the Note was a market rate referenced to the New Zealand Dollarswap curve (which was reasonably volatile in March 2000 butapproximately 6.20 per cent at the time of closing).Professor Choudhry stated in evidence, which was uncontested, that thespread of 30 basis points over the swap note "appears to be as expectedfor an A1/A+ rated borrower, which this bond represented in effectcompared with other corporate bond issues in NZD at the time".127 Heexpressed the further view that the coupon was "essentially what wasrequired to generate bond coupon payments that aggregated to the fiveyear amortising loan value of $55.42 million".(f) However, I do not consider it correct to conclude that just because aparticular instrument (for example, a convertible note) typicallyexhibits certain characteristics when new "debt" is being raised, theabsence of such characteristics in the context of a related partyrefinancing or debt-equity adjustment can be regarded as a significantindicator of avoidance.(g) So, for example, the fact that the pricing of a convertible note will, inthe context of an open market transaction, typically reflect theinvestor's "volatility play" in respect of the issuer cannot in my viewbe elevated to the proposition that, when priced in some other way inthe context of an "off-market transaction", the "manner in which thearrangement was carried out" or the "economic and commercial effectof [the documents and transactions]"128 predicate avoidance. Thatwould be to place convertible notes within a straightjacket of orthodoxywhen there is no reason why they might not be used in a related partytransaction (as they were in Alesco without criticism on that accountalone).129 And although the pricing may have been unorthodox in an127 Note that 0.1 per cent was in turn paid by DBNZ to Groupe Danone SA by way of guarantee fee.128 Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2NZLR 289 at [108]. See also [122].129 It was the taxpayer's attempt to take a deduction in respect of a zero-coupon note issued by asubsidiary to its parent which was rejected in that case.open market context there is no suggestion that the rate was oneartificially increased to maximise deductions.(h) So too, although the very particular sum of the note and the way thiswas arrived at was undoubtedly unusual in the context of a typical openmarket convertible note transaction, I would hesitate before regardingthis as itself an indicator of tax avoidance. The majority's focus in BenNevis is on structuring to "gain the benefit of the specific provision inan artificial or contrived way".130 It is therefore on the relationshipbetween the arrangement and tax outcomes, not whether particularaspects of the transaction may seem unorthodox (or even contrived) insome normative sense. So, in Alesco the Court of Appeal considereditself unpersuaded by evidence, again given by Professor Choudhry,that the OCN's issued in that case contained unusual or unorthodoxterms when compared to arm's length norms, that the optionalcomponent of the OCN's served no commercial purpose as Alesco Corpalready held 100 per cent of the shares in Alesco NZ and that the optioncomponent of the OCN was valueless.131 Although in the High CourtHeath J had considered this to be evidence of artificiality andcontrivance in a Ben Nevis sense, the Court of Appeal dismissed theevidence as "of marginal assistance in determining the Commissioner'sprimary position".132(i) Nevertheless, although the focus is on tax outcomes and not the formof the arrangement per se, form will often beg the question — "but why,if other than to achieve the tax outcomes?" In this case FHNZ answersthat fundamental inquiry by reference to DAP's Singaporean taxposition, as I discuss further in [165].130 Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2NZLR 289 at [108].131 Alesco New Zealand Ltd v Commissioner of Inland Revenue [2013] NZCA 40, [2013] 2 NZLR145 at [53] and [57].132 At [57].(j) The manner in which the arrangement was carried out is also usefullybenchmarked against possible alternative structures as identified byFHNZ in its submissions.133 These included:(i) FHNZ borrowing an additional $60 million under the CashManagement Agreement to achieve its desired debt/equityrebalancing.(ii) DAP (or Danone Finance) lending $204 million to FHNZ forfive years at 6.5 per cent either by way of interest-bearing debtor convertible note.(iii) FHNZ issuing a convertible note to DBNZ on the same termsbut without the Forward Purchase between DBNZ and DAP andDBNZ funding the $149 million Forward Purchase amountinternally or from another bank or third party or by a loan fromDAP or Danone Finance or by a sub-participation by a thirdparty or Danone entity.(k) In each of these cases, FHNZ submitted, in my view uncontroversially,that it would have been entitled to full interest deductibility (totalling$66 million in relation to alternatives (ii) and (iii) and calculated byreference to the relevant floating rate in respect of alternative (i)) andthat s BG 1 could not realistically be invoked to counteract thetransaction.134(l) It further submitted and I accept that in respect of each of alternatives(i) and (ii) (and likewise (iii) with funding or sub-participation by aDanone entity) these alternative arrangements would have given rise toassessable interest in the hands of the relevant offshore Danone entity.By contrast, the distinguishing feature of the transaction entered intowas that, although the same level of deduction was available in New133 Accepting, however, that whether other arrangements would have produced similar tax outcomesto the impugned arrangement will not be determinative.134 A submission which the Commissioner did not challenge.Zealand, the Forward Purchase provisions negated foreign-assessableincome. And in a further submission which I accept, it says thatavoidance of foreign tax is not "tax avoidance" for the purposes of s BG1.135(m) I accept therefore FHNZ's submission that full deductibility for interestpaid by FHNZ is "an entirely normative New Zealand taxation outcomeof related party or third-party debt funding" and that such outcome isnot attributable to any feature of the arrangement that might bedescribed as "unorthodox" or even "artificial or contrived". If directfinancing by DAP (either by convertible note or vanilla interest-bearingdebt) of the full $204 million would have resulted in full interestdeductibility, the question must arise why DAP's indirect financing of$149 million of the $204 convertible note principal should be seen toreduce FHNZ's "real" borrowing amount to $55 million as theCommissioner claims.(n) And these alternative funding models also serve to place in perspectivethe "group" approach adopted by Professors Evans and Choudhry andreflected in IFRS 10, because although a $204 million loan by DAP(whether vanilla or by means of convertible note) is simply netted offon a group basis, nevertheless the loan and interest would be recognisedin full for New Zealand tax purposes. They have to be, to protect theNew Zealand tax base.The role of all the relevant parties and their relationship to the Taxpayer[142] The respective roles of the parties and their relationship to FHNZ has beenpreviously described and need not be repeated. The key feature for present purposesis that all relevant parties to the transaction, with the exception of DBNZ and DAP's135 Such is authoritatively established by Commissioner of Inland Revenue v Europa Oil (NZ) Limited[1971] NZLR 641 (PC) at 556. It is also endorsed by the Commissioner in her interpretationstatement: Public Rulings Unit, Office of the Chief Tax Counsel Tax avoidance and theinterpretation of sections BG 1 and GA 1 of the Income Tax Act 2007 (IS13/01, 13 June 2013) at544.funder BNPP, were related. This includes FHNZ, DAP, Danone Finance SA andGroupe Danone SA.[143] That feature is in itself unremarkable in the context of a refinancing and equityreduction. However, two facets in particular of DAP's role warrant closer attentionand will be the subject of later discussion namely:(a) the element of circularity previously referred to; and(b) its ultimate receipt via the Forward Purchase of 1025 shares in FHNZ,a company which it had owned from the outset.[144] The Commissioner submits that the Arrangement would not have been possiblewithout DAP's participation and its relationship with the plaintiff. I accept that it isunlikely it would have been entered into in the absence of that feature. The shareswere non-voting and although they carried dividend entitlements FHNZ had no historyof declaring dividends. The Forward Purchase ensured that the ownership of FHNZwould remain unchanged,136 consistent with the fact that, as noted in FHNZ'sstatement of position, "it was not DBNZ's business to acquire equity holdings ingroups such as Danone" and DAP's intention that DBNZ simply be a conduit of theshares.[145] DBNZ's role in the transaction was pivotal. It can fairly be described as itsarchitect. For that it received a fee of $1.8 million. And I accept Professor Choudhry'sevidence that this was not conventional corporate banking business in the sense that itwas intended to generate a return on lending.[146] There was of course a DBNZ lending component ($55 million) but its March2003 transaction summary entitled "Project Falcon SCM Asia Pacific Post SignatureNote" evidences that it did not anticipate a material funding gain on the transaction.137136 A noted commercial driver for the Danone Group: see above n 20.137 The coupon receivables to DBNZ were passed through to DBNZ Treasury. DBNZ Treasuryswapped an EUR deposit using a foreign exchange (FX) swap to convert NZD receivables intoEUR receivables at Euribor minus seven basis points. In evidence, which I accept, ProfessorChoudhry said that this suggested a hedged transaction very close to Deutche Bank AG's averagecost of funds "ergo no material funding gain on the transaction".Rather this was what Professor Choudhry described as a transaction "generating areturn through fees".[147] There were also "soft" benefits to Deutsche Bank generally, given that it wascustomer advisory business which advanced relationships between it and the DanoneGroup. In an email sent by DBNZ's Mr Burridge to multiple Deutsche Bankaddressees in Australia, the United Kingdom and Europe shortly after signing, hedescribed the transaction as: represent[ing] an innovative financing structure for the client which fundstheir recent acquisitions in New Zealand and as such should enhance theDeutsche franchise with Groupe Danone.[148] A slightly unusual feature of DBNZ's role in the transaction was that it paid aguarantee fee to Groupe Danone SA. In evidence which I again accept, ProfessorChoudhry stated that banks that require a guarantee from a parent normally do not payfor the privilege of receiving it and that, if one is required, the parent will typicallycharge the subsidiary not the bank. Professor Choudhry was unable to "surmise whyon this occasion DBNZ had to pay for its guarantee". I do not, however, consider thatthis aspect of the transaction impacts in any significant way on the s BG 1 analysis.The economic and commercial effect of the documents[149] The Commissioner says that although DBNZ paid the full amount of $204million in cash for the purchase of the Note and that this payment was applied byFHNZ to replace initial acquisition funding, nevertheless the economic andcommercial effects of this arrangement were not consistent with the legal form. Shesays that if the form of a transaction is contrary to or endeavours to recharacterise itseconomic substance then the case is not one where the taxpayer can be heard to saythat they have simply chosen the most advantageous legitimate structure.138[150] She says that "in reality" FHNZ received:138 Relying for example on Westpac Banking Corp v Commissioner of Inland Revenue (2009) 23NZTC 23,834 (HC) at [603].(a) funding of $55.4 million from DBNZ on which it paid $11.09 millioninterest; and(b) $149 million "from its parent via DBNZ as a conduit" which was repaidin a "costless exercise".And she says that what was "in reality" the equity contribution gives rise to no interestor otherwise deductible cost.[151] Put this way the Commissioner's approach doubles back on her initial theoryas advanced in the statement of position, in terms of which DAP's payment under theForward Purchase was recharacterised as an injection of capital represented by equity.Although that approach was rejected by the Adjudication Unit as taxation based oneconomic equivalence, it reappears as a reflection of "economic and commercialeffect" premised on the seductive invitation to look at what was occurring "in reality".[152] In its report the Adjudication Unit endeavours to draw a distinction betweenthe proscribed and the permissible in the following terms:The approach to applying s BG 1 involves identifying the commercial realityand economic effects of the arrangement actually entered into. Identifyingthe commercial reality and economic effects of the arrangement should notbe confused within an approach that considers economic equivalence.Economic equivalence looks at identifying an arrangement that iseconomically equivalent to the arrangement entered into (such as anarrangement involving a $55 million advance to the Taxpayer from DeutscheBank and a $149 million equity injection from [DAP] identified by the[Commissioner's Service Delivery Group] in this dispute.[153] The difficulty from an analytical point of view is that if it is not possible toundertake the s BG 1 inquiry by inference to an economically equivalent arrangement(which I accept), why should it nevertheless be possible, under the pretext ofconsidering the economic and commercial effect of the transaction to, in this case,regard DAP's $149 million forward purchase from DBNZ as a contemporaneous $149million capital injection into its subsidiary at the commencement of the term? Theprohibition on identification of an economically equivalent arrangement becomes, inthat context, almost meaningless — a mere checkpoint for the Commissioner to divertaround, all the while maintaining the same recharacterisation argument. I havedifficulty with that approach.[154] Ultimately, however, the Commissioner's arguments in relation to economicand commercial effect reduce to a restatement of her overall position — that thetransaction involved $55.4 million of debt and $66.5 million of principal and interestrepayments, with the true "economic cost suffered" being $11.09 million only.[155] It is correct that on a Danone Group basis this is exactly as the transaction wasunderstood, including for accounting purposes. And it is correct, that from DBNZ'sperspective it regarded itself as introducing $55.4 million of net funding for which itsreturn of $11.09 million was largely offset by its funding costs, guarantee fees and thecost of the credit default swap it entered into.[156] However, the Commissioner's approach presupposes, in the context ofattempts first to divine parliamentary intention and then to benchmark against it, twopropositions which are contentious. They are:(a) The Arrangement is assessed in terms of its overall impact at a groupor consolidated level looking (to the exclusion of the moniesunarguably received and expended by FHNZ) at the net externalposition of entities under common control; and(b) FHNZ does not incur a cost requiring tax recognition when it issuesshares to satisfy its debt liability.[157] The first of these has already been discussed. The second I will come toshortly.Artificiality and contrivance[158] The Commissioner argues, and I accept, that the presence of artificiality andcontrivance can indicate that the Arrangement has been structured to align legal formwith specific provisions in the Act and in a way which is not in fact reflective of thecommercial and economic reality of the Arrangement. Ben Nevis recognises thisprinciple, although emphasising that the focus is on whether the taxpayer has "gainedthe benefit" of the specific provision in an artificial and contrived way and not simplywhether, compared to arm's length norms, aspects of the transaction might bedescribed as unorthodox or even artificial.139[159] She says first that there were "some features of self-funding in the closelyrelated cash flows of the Arrangement and other transactions closely connected withit".[160] This is a reference to the share buy-back transaction which was effected witha portion ($60 million) of the Note issue proceeds. That sum was paid to DAP which,as part of the same transaction, paid $149 million to DBNZ under the ForwardPurchase Agreement.[161] FHNZ argues that any circularity was a function of the commercial goals whichunderpinned the transaction and that a reconfiguration of the debt/equity position ofFHNZ could not be achieved in any other way. That is not the case. To take thesimplest alternative, FHNZ could have sought further accommodation from DanoneFinance under the Cash Management Agreement and applied the proceeds to a capitalreduction.[162] However, as Harrison J observed in Westpac, circularity in a tax avoidancecontext is a "catchphrase frequently cited but seldom enlightening".140 In that case hisHonour found that there was no circularity of the type indicative of a tax avoidancearrangement because the payments which had been made discharged a genuinecontractual liability. Such can be contrasted with the paradigm case where the circularflows of money are such that the transactions are self-cancelling or where thecircularity means that the economic outcomes claimed in support of (for example) atax deduction are not in fact sustained.[163] In my view, the element of circularity identified by the Commissioner does notmaterially advance her case. The payment by DAP to DBNZ discharged a genuine139 Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2NZLR 289 at [108].140 Westpac Banking Corp v Commissioner of Inland Revenue (2009) 23 NZTC 23,834 (HC) at [580].contractual liability. FHNZ's payment of part of DBNZ's investment to DAP had botha legitimate commercial purpose and resulted in a "real" change to FHNZ's fundingstructure. I do not see it in the category of "offensive" circularity.[164] The Commissioner is also critical of how the face value of the Note wasdetermined and how it was priced. I have already referred to Professor Choudhry'sevidence in this respect. I do not see this as evidence of "artificiality and contrivance"as such but I accept the unusually precise face value evidences that this was not anormal commercial funding arrangement and that the Note was priced as if it was anon-convertible instrument. In that sense, it was unorthodox.[165] I accept also141 that if a transaction is unusual that may be evidence ofavoidance, but that is more typically so where there is no business reason for it tooccur. So, for example, in Ben Nevis one of the reasons the arrangement was identifiedas unusual was that there was a real risk that it would not be profitable forsubscribers.142 By contrast, FHNZ says the business reasons for the Note transactionare obvious. It rebalanced debt/equity ratios in a way which retained NZ deductionsbroadly equivalent143 to those under existing "vanilla" arrangements but without thesame foreign tax exposure (French income tax). As Mr Marcello said in evidence,"vanilla financing doesn't achieve the intended purpose of the overall arrangementwhich is the non-inclusion of the recipient of the income". Significantly, theCommissioner did not challenge Mr Marcello's evidence that the difference betweenthe $149 million paid by DAP to DBNZ at the commencement of the transaction andthe face value of the shares received by DAP under the Forward Purchase would notbe recognised as income in Singapore, whereas interest payable to Danone Financeunder the Cash Management Agreement had been taxable in France.[166] So when the Commissioner submits, as she does, that FHNZ provides "nocompelling non-tax reasons" why:141 As does Professor Prebble in John Prebble Fundamentals of Income Taxation (Thomson Reuters,Wellington, 2018) at 410.142 Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2NZLR 289 at [120].143 See above n 22. The claimed deductions were approximately 20 per cent higher but on a highertotal debt, reflecting the debt/equity rebalance.(a) a convertible note was used when, by virtue of the Forward Purchase,DBNZ could not participate in any equity uplift;(b) a Forward Purchase was used when DAP already owned all the sharesin FHNZ; and(c) why therefore the arrangement is said to be "contrived and artificial".she ignores (or at least understates) "tax reasons" which featured in the calculus butare, in fact, legitimate aims that are not indicative of New Zealand tax avoidance.144[167] The Commissioner also placed some emphasis when cross-examiningMr Marcello on the $1.8 million fee paid to DBNZ, for which it said "part of the reason is a structure which delivers tax benefits in New Zealand isn't it?" This line ofquestioning was based on Professor Choudhry's evidence that the complexity of astructured finance transaction might drive a higher fee.[168] I agree with Mr L McKay, however, that, on the evidence, this was a matter ofconjecture and, in any event, the fee says nothing useful above whether the taxdeductions arising under the arrangement were within Parliament's contemplation.Moreover, as Mr Marcello said:In my experience working with tax advisors, the non-inclusion benefits ofa debt financial structure is the reason for the higher fees. Not for thededuction of interest on debt. It is the non-inclusion of income to the recipientof the income stream versus the deductibility of the interest.[169] In her statement of position, the Commissioner also alleged artificiality orcontrivance on the basis that the option to settle the Convertible Note for cash wasitself "artificial (in substance) and [DBNZ] never intended to exercise that option".That allegation is not maintained (at least as an indicator of artificiality) in thesubmissions in this case. However, she does say, with reference to her suggestedinquiry into the economic and commercial effect of the documents and transactions,that the Forward Purchase changed the substance of the arrangement from optional tomandatory.144 See above n 145.[170] FHNZ does not dispute the likelihood that DBNZ would elect to settle theconvertible note by way of conversion. Nor could it. Neither in conception norexecution was the agreement designed to deliver DBNZ as a long term shareholder.The provisions of cl 3.4 of the Forward Purchase whereby, in the event, DBNZ did notgive a notice to FHNZ requiring the issue of shares on the maturity date, it wasrequired to pay DAP not only the full value of the note, but a further amount reflectingwhat would in that situation be DAP's Singaporean tax liability on the differencebetween $149 million and $204 million, acted as a strong financial disincentive againstthe cash settlement option. More importantly, the commercial relationship betweenGroupe Danone SA and Deutsche Bank AG assumed a share "pass through" andDAP's ongoing 100 per cent ownership of its subsidiary.[171] But that does not establish artificiality. There were clearly circumstancesinvolving failure of FHNZ and its guarantor, where DBNZ's position as creditor mayhave been superior to that as shareholder. It is predictable that the Forward Purchaserecognised such contingency by way of optional conversion, however remote it mayhave seemed. This was a substantial transaction. A full suite of protections wasinevitable.[172] I accept also FHNZ's argument that the optional or mandatory status of theConvertible Note is irrelevant to the core issue of the deductibility of the note couponunder the s BG 1 inquiry and that in such context the argument about whether it was,in substance, optional or mandatory takes the matter little further.The Commissioner's "no cost" argument[173] One of the central planks of the Commissioner's argument is that the sharesissued by FHNZ to DBNZ in satisfaction of the Note were issued at "no cost to thetaxpayer". The argument is summarised in the Commissioner's closing submission asfollows:[192] The plaintiff incurred no real economic cost in issuing shares onmaturity of the Note. The shares were not assets of the plaintiff and only comeinto existence on issue. Therefore, the plaintiff's property remained intact andits fiscal position unaltered. The only real or economic consequences to ashare issue result from any dilutive effect on the existing shareholders'ownership in the issuer. The plaintiff gave up nothing from issuing the shares.The expert witnesses for the Commissioner confirmed there was no real oreconomic cost incurred by the plaintiff when it issued the 1025 shares.[174] The Commissioner emphasises the point because it plays to her primary thesisthat on a Danone Group basis FHNZ received only $55 million under the Notetransaction which sum was repaid over the life of the Note.[175] Mr McKay submitted this argument was unsound for a number of reasonswhich I summarise as follows:(a) There is longstanding authority against the "no cost" proposition.(b) The Commissioner's argument is inconsistent with the approachadopted under the financial arrangements rules and in variousDeterminations relating to the discharge of debt by share issue. In noneof these situations is the borrower treated as having paid no orinadequate consideration. Nor is debt remission income assessed, aswould necessarily be the case if the Commissioner's approach werecorrect.(c) The proposition is unsupported on a counterfactual basis in that a shareissue for debt conflates as a one-step transaction what could equally betwo — payment for shares and use of the proceeds to repay the debt.In that case there would self-evidently be a cost associated with therepayment and, in FHNZ's submission, such cost should be no lessrecognised for the set-off implicit in the one-step process.(d) The "no cost" proposition cannot logically be confined to s BG 1 casesand would have far reaching negative implications if recognisedgenerally within the tax context.(e) It is not conceptually possible to have one rule for share issues to parentcompanies and another to third parties because the question is whetherit is a cost to the company issuing the shares and the recipient isirrelevant in that context.(f) In any event, there was an opportunity cost associated with the issue ofthe shares, which although they did not carry voting rights wouldinevitably have had value to the company if offered in the market —evidenced by the fact that when FHNZ was acquired by the SuntoryGroup (Suntory) it would never have contemplated the relevant parcelof shares not being included in the acquisition.[176] In response, the Commissioner submitted that Ben Nevis mandates a focus onthe economic and commercial effect of the transaction and that in reality there was noreal expenditure or economic cost associated with the impugned part of the deductions.[177] At the outset I agree with Mr L McKay that a focus on "cost" is capable ofmisdirecting the required analysis. "Cost" was undoubtedly relevant in Alesco whereinterest deductions were claimed in respect of what was in fact a zero couponconvertible note145 but the underlying question in this case is not, fundamentally,whether the issue of shares had an economic cost to FHNZ but whether, as the lawstood at the time, it was consistent with Parliament's intention that FHNZ should beable to deduct interest for a debt which (absent a Doomsday scenario) was alwaysgoing to be repaid by the issue of shares which would themselves simultaneously betransferred to its parent. In principle a deduction might be consistent with Parliament'spurpose even though one or more steps in the impugned transaction might not involvewhat the Commissioner calls "an economic cost". The injunction in Ben Nevis issimply to look at the transaction in an economically and commercially real way,unconstrained by the form the parties have used. However, as the Supreme Court alsorecognised, "the economic and commercial effect of documents and transactions mayalso be significant" (my emphasis).146 It all comes back to a question of whether sucheffects assist in establishing that the relevant provision (in this case s DB 7) is (or isnot) being used consistently with Parliament's purpose.145 On the basis of deemed expenditure under Determination G22. Essentially what the taxpayerargued was that, by reference to the Determination, a notional value could be attributable to eachof the debt and option components with a deduction available for the former. See Alesco NewZealand Ltd v Commissioner of Inland Revenue [2013] NZCA 40, [2013] 2 NZLR 145 at [52] and[70]–[72].146 Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2NZLR 289 at [108].[178] As to the cases, the usual starting point is Lord Greene MR's judgment inOsborne v Steel Barrel Co Ltd in which he rejected the proposition that the issue of30,000 shares by the taxpayer did not form part of the consideration in a transactionrelated to the acquisition of trading stock.147 The Commissioner had argued that, fortaxation purposes, the value of the stock should be limited to the cash component ofthe transaction and that any uplift on that sum was therefore taxable. In that respecthis Lordship said:The argument really rests on a misconception as to what happens when acompany issues shares credited as fully paid for a consideration other thancash. The primary liability of an allottee of shares is to pay for them in cash;but, when shares are allotted credited as fully paid, this primary liability issatisfied by a consideration other than cash passing from the allottee. Acompany, therefore, when, in pursuance of such a transaction, it agrees tocredit the shares as fully paid, is giving up what it otherwise would have had— namely, the right to call on the allottee for payment of the par value in cash.A company cannot issue £1,000 nominal worth of shares for stock of themarket value of £500, since shares cannot be issued at a discount.Accordingly, when fully-paid shares are properly issued for a considerationother than cash, the consideration moving from the company must be at theleast equal in value to the par value of the shares and must be based on anhonest estimate by the directors of the value of the assets acquired.[179] The same approach was adopted in the subsequent decisions of the Court ofAppeal and House of Lords in Craddock v Zevo Finance Ltd148 and it has since beenfollowed in a number of Canadian authorities referred to by FHNZ.149 In Stanton(Inspector of Taxes) v Drayton Commercial Investment Co Ltd, Lord Frasersummarised the position as follows:150(1) A company can issue their own shares "as consideration for theacquisition of property" — as Lord Greene MR said. (2) The value ofconsideration given in the form of fully paid shares allotted by a company isnot the value of the shares allotted but, in the case of an honest andstraightforward transaction, is the price upon which the parties agreed — asLord Simonds said. The latter point was expressed even more forcibly in theHouse of Lords by Lord Wright where he said, 27 TC 267, 290: "No authoritywas cited for the claim of the Revenue in a case like this to go behind theagreed consideration and substitute a different figure."147 Osborne v Steel Barrel Co Ltd [1942] 1 All ER 634 (CA).148 Craddock v Zevo Finance Ltd [1944] 1 All ER 566 (CA) at 570 per Lord Greene MR, McKinnonLJ concurring, Luxmoore LJ dissenting. An appeal was dismissed by the House of Lords.149 See for example Tuxedo Holding Co Ltd v Minister of National Revenue [1959] Ex CR 390, KingRentals Ltd v R (1995) 50 DTC 1132 (TCC); and Teleglobe Inc v R [2002] FCA 408.150 Stanton (Inspector of Taxes) v Drayton Commercial Investment Co Ltd [1983] 1 AC 501 (HL) at511.[180] Some of these cases occur in the context of a par or nominal value regimeunlike that which now applies in New Zealand.151 But they are, in my view, no lessauthoritative for that fact. As Lord Fraser's observations in Stanton make clear, in anhonest and straightforward transaction it is what the parties agree was theconsideration for the issue of the shares which counts in legal terms. Here the partiesagreed on 14 March 2003 that the price of the shares was, for the purposes of thefinancial arrangements rules,152 $204,421,565 and I see no reason to describe thetransaction in the pejorative way necessary to exclude it from Lord Fraser's principle.[181] However, none of the cases involved application of a general anti-avoidancerule or a share issue by subsidiary to parent. As Ben Nevis makes clear, the Courts arenot limited in a s BG 1 context to "purely legal considerations".153 Although the valueof the shares might appropriately be recorded as $204 million, this does not precludea finding that interest deductions on $149 million of that amount were, when thearrangement is looked at in a "commercially and economically realistic way",inconsistent with Parliament's purpose. Nor in that context does it matter whether thetransaction is looked at as involving one step or two.[182] For these reasons, although I consider the cases to provide helpful andimportant background, I do not regard them as ultimately decisive in terms of theinquiry I must undertake.154[183] FHNZ's next and ultimately more compelling point is that the financialarrangements rules and the Determinations issued in respect of them all contemplatethat shares may be issued in discharge of legal obligations and nowhere is a distinctiondrawn between a share issue to a parent (or in this case to an intermediate party whichhad contracted to transfer them to the parent) and one to an arm's length third party.From that Mr L McKay submits a strong inference arises that Parliament did not151 Companies Act 1993, s 38.152 And in particular s EH 48(3)(a) of the Income Tax Act 1994; see above n 14.153 Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2NZLR 289 at [109].154 Including those cases relied on by the Commissioner on this point: Lowry (Inspector of Taxes) vConsolidated African Selection Trust Ltd [1940] AC 648 (HL); Ord Forrest Pty Ltd v FederalCommissioner of Taxation (1973-74) 130 CLR 124 at 131; Pilmer v Duke Group Ltd (in liq)(2001) 207 CLR 165; and Commissioner for the South African Revenue Service v Labat AfricaLtd (2013) (2) SA 33 (SCA).consider this aspect of the transaction inconsistent with its purpose. Indeed he goesfurther and says the "costless" characterisation "cannot be reconciled with thefinancial arrangements rules' treatment of debt discharge through share issuance".[184] In this context Determinations G5C and G22/22A are particularly relevant.[185] Determination G5C relates to mandatory convertible notes. Several of theexamples provided in it acknowledge a base price adjustment (a final "wash-up"calculation) upon termination of the arrangement and conversion of debt to shares.None contemplate any issue of debt remission income arising to the borrower onaccount of inadequacy of consideration on the share issue.[186] Determinations G22 and G22A (which relate to optional convertible notes) areto similar effect and FHNZ makes the valid point that if the Commissioner's "costless"approach was correct a difference in approach could be expected depending onwhether the note holder exercised the cash or conversion option. If the cash option,then a cost would be incurred in the form of the cash paid but, if the conversion option,there would be no cost and debt remission income would accrue. There is nothing inDeterminations G22 or 22A, however, to suggest that remission income would arisein this event. In the broadly analogous circumstances of Alesco, the Commissionermade no such allegation. Nor did she challenge the effectiveness of the Alescosubsidiary satisfying the debt owed to its parent by way of share issue. The Court ofAppeal accordingly made no suggestion that the liability could not be discharged inthis way.[187] As Mr McKay submits, if the issue of shares to satisfy a Note is to be regardedas economically costless then the issuing entity will have derived taxable debtremission income for the entire amount of the face value of the Note and this is highlyunlikely to have been within Parliament's contemplation. Nor does Alesco suggestsome special rule for Note transactions.[188] Mr McKay also provided examples of three other regimes which he saidimplicitly recognised that Parliament cannot have intended that the absence of cost (inthe sense contended for by the Commissioner) on the issue of shares by a subsidiaryto its parent changed taxation outcomes — namely:(a) the revenue account property rules (which permit a deduction for thecost of revenue account property subject to tax on disposal);(b) the depreciation rules (which permit depreciation deductions measuredagainst the cost of the asset); and(c) the trading stock rules (which determine an end of year deduction forthe cost of trading stock acquired and not disposed of).[189] He postulated the example of a parent selling property to its 100 per centsubsidiary at market value with the price satisfied by the issue of shares for asubscription amount equal to the value of the property (and with the mutual obligationsoffset). He then invited an assumption that the property was on revenue account, orwas depreciable, or was trading stock. On the Commissioner's approach the propertywould have no cost base to the subsidiary which he submitted was "schematically andpurposively untenable".[190] I agree that it is difficult to envisage what gloss the Commissioner couldintroduce to her no-cost proposition to preclude that outcome. Either the issuance ofshares is regarded by Parliament as sufficiently commercially and economically realto discharge debt liabilities or it is not. And all the pointers to parliamentarycontemplation are that such commercial and economic reality is well recognised.Parliament's assumed intention is in that sense consistent with the common lawposition previously discussed.[191] The financial arrangements rules provide an example. Assume an optionalconvertible note with a coupon rate of 6.5 per cent, issued by a New Zealand subsidiaryto its 100 per cent offshore parent, in exchange for up-front funding. It may besatisfied by the issue of shares or repayment of cash. If by shares, the Commissioner'sexperts would say the debt had been satisfied at no economic cost to the subsidiary.Should that result in non-deductibility of the coupon payments? I can find nosuggestion in the financial arrangements rules that it would. Of course NRWT maybe payable and, depending on the agreed value of the shares, there may be other"accrual" consequences. But the relevant issue is whether the economic cost of theshare issue could affect the deduction for interest paid under the note. On my readingof the rules, it would not.[192] Neither Determination G5C or G22 suggests that a parent-subsidiaryrelationship could affect the treatment of coupon interest payments.155 DeterminationG22A does suggest that this relationship has a bearing on the financial arrangementsas a whole. But it makes no mention of the effect of that relationship on thedeductibility of interest. Rather, Determination G22A treats the consideration flowingbetween the parties as entirely attributable to the debt component of the note.156 Thisprovides an even stronger basis to suggest the interest payments would be deductible— as would be interest paid under a vanilla loan structure.[193] I accept also Mr McKay's submission that, apart from constituting goodconsideration, the shares must be taken as having had real value. His observation inrelation to the subsequent sale to Suntory is compelling in that context. And even withthe restriction on voting rights it is inevitable that a price would have been achievablefor them if offered in the market. In that sense the transactions also involved anopportunity cost to FHNZ. And there was always some commercial risk, howeverwell managed, in issuing shares to an unrelated third party.Was therefore s BG 1 appropriately invoked?[194] I admit to finding application of the s BG 1 test difficult, as many judges beforeme have likewise done. Benchmarking against parliamentary intention, for all theappropriateness of the exercise, can be an elusive quest. Courts have anunderstandable resistance to structured transactions which may be seen to cost the155 Determination G22 consistently excludes coupon interest payments from the excepted financialarrangement component of an optional convertible note – see cls 6(1) and (2), and 5(a). But therelationship between holder and issuer does not change this approach under the determination.Under Determination G5C, coupon interest payments are pro-rated to income years and this toois unchanged by the relationship between note holder and share issuer (see cl 4(4)).156 See cl 6(3) which states that for parties in a wholly-owned group, or with the same beneficialownership or control, the equity component of an optional convertible note is treated as zero.New Zealand tax base but intuitive subjective assessments based on any such thoughtprocesses must themselves be firmly resisted.[195] In my view, Parliament can be assumed, at a minimum, to have intended thatthe taxpayer could:(a) Take a deduction for interest economically incurred;(b) Deduct financial arrangements expenditure deemed to be incurred overthe life of a financial arrangement;(c) Account for tax on a separate entity basis, if the member of a multi-national group; and(d) Issue shares to satisfy a liability owed to a third party, including itsparent.[196] It is also in my view tolerably clear that the grouped "economic" approachadopted by the Commissioner's expert witnesses is inconsistent with at least threespecific aspects of New Zealand's international tax regime and more broadly theindividual entity framework which underpins them. It is also selective because itignores the fact that $89 million of the forward purchase amount was funded outsidethe Danone Group by BNPP.157 Were the group approach to be accepted, it would bedifficult to suggest that only internal transfers within the group should be assessed fortax purposes.[197] In assessing whether the subject transaction crossed the line betweenpermissible arrangement and tax avoidance arrangement I accept (adopting thelegislative framework at the time) that:157 By way of example and of potential relevance to any reconstruction that an appellate court mightbe required to consider, prorating the $66 million of interest deductions by reference to the DanoneGroup's external lending position would suggest at least $46.5 million of interest may bedeductible on a reconstructed basis.(a) Parliament contemplated the use of OCN's and that the coupons onthem, if calculated at an arm's length rate, will ordinarily be deductible;(b) It was agnostic about the use of convertible note structures betweenparent and subsidiary.[198] I accept as relevant also that other debt structures, incapable of realisticchallenge under s BG 1, would have produced the same or similar tax benefits in NewZealand and that the particular appeal of DBNZ's structure was that it provided fornon-assessibility of income in Singapore, albeit that the Arrangement delivered otherbenefits such as better balancing FHNZ's debt to equity position and creating a naturalcurrency hedge. It was in that sense a transaction which assumed a status quo in termsof New Zealand deductibility but with significant added commercial advantages.[199] What cannot be gainsaid is that the taxpayer received $204 million in cash fromDBNZ. It was real money and it was expended. It attracted interest at 6.5 per centwhich was incurred. Over the life of the Note, FHNZ's payments corresponded to thatinterest liability.[200] The Commissioner adopts the grouped economic approach of her experts butthe economic purity of their model drives a conclusion — that the Arrangementinvolved principal payment deductibility even in the context of cash settlement ornovation — which raises significant questions about the utility of the model inpredicating whether the transaction "crossed the line". And it is significant thatParliament should choose to define the limited circumstances in which a groupedapproach applies and that this transaction is not among them. New Zealand's statusas a net importer of capital would mean serious erosion of its revenue base if cross-border money flows between group members were routinely assessed on the basispredicated by the Commissioner's experts. Demonstrably that was not Parliament'sintention.[201] Likewise the "no cost" proposition, which underpinned the Commissioner'sexpert evidence and her submissions, does not in my view establish avoidance.Payment of cash by a parent to a subsidiary, for which the consideration is the issue ofadditional shares, represents a routine commercial transaction. The consideration isreal and has never been doubted as such. The financial arrangement rules,determinations and other aspects of the legislative and regulatory framework point toParliament recognising the issue of shares by subsidiary to parent as economicallyreal, irrespective of what the Commissioner calls "economic cost" to the subsidiary.This is the landscape on which the s BG 1 inquiry is necessarily imposed. Against thelegislative background that existed at the time, there is, on account only of the methodof repayment, simply nothing in my view to suggest non-deductibility of couponpayments on a MCN (or OCN on which the option was exercised) issued to an offshoreparent by a New Zealand subsidiary. And if that is the case then it seems to me to bea long bow to suggest that the same method of repayment invokes a tax avoidanceanalysis in this case. If anything the interposition of DBNZ and the risk, howeversmall, that it failed to on-transfer the shares elevates the case to a higher level ofassumed conformity with parliamentary purpose.[202] Nor am I persuaded that the "unorthodox" features of the Note identified byProfessor Choudhry tip the analysis in the Commissioner's favour. I adopt theapproach of the Court of Appeal in Alesco that these considerations are of "marginalassistance".158 Parliament must be taken as recognising that related entities may usefunding models which, within a different context, may exhibit other features. It cannotbe assumed to stifle market activity to the extent I consider Professor Choudhry'sevidence contemplates.[203] This was a transaction which I consider had real and (from a New Zealandtaxpayer perspective) legitimate economic drivers, primary among them offshore taxminimisation. It was self-evidently more "commercial" than the zero-couponarrangements in Alesco. Interest was incurred by FHNZ both legally and, at a single-entity level, economically. And it was actually paid. The deduction did not dependon the taxpayer reverse engineering a deduction by application of the financialarrangement rules. Nor did the transaction involve back-to-back arrangements, eachakin to the other, in the manner now typically assumed to infringe s BG 1.158 Alesco New Zealand Ltd v Commissioner of Inland Revenue [2013] NZCA 40, [2013] 2 NZLR145 at [57].[204] I conclude therefore that the section was not appropriately invoked by theCommissioner. In reaching that conclusion I note for completeness Mr L McKay'sconcession that as from 1 July 2018 the transaction is unlikely to satisfy the "blackletter" of the 2007 Act, in light of new provisions introduced to counteract base erosionand profit shifting (BEPS).In the alternative: was this merely incidental tax avoidance?[205] I briefly address this issue on the assumption I am incorrect in my primaryfindings. FHNZ argues the "purpose or effect" of tax avoidance was "merelyincidental". It relied on the following definition in the Act:159tax avoidance arrangement means an arrangement, whether entered into bythe person affected by the arrangement or by another person, that directly orindirectly—(a) has tax avoidance as its purpose or effect; or(b) has tax avoidance as 1 of its purposes or effects, whether or not anyother purpose or effect is referable to ordinary business or familydealings, if the purpose or effect is not merely incidental(Emphasis added).[206] In Westpac, Harrison J explained what was meant by "not merelyincidental":160[W]hen used in conjunction with the word "incidental", I think the phrase "notmerely" is designed to emphasise that a tax avoidance purpose, if found, willoffend s BG 1 unless it naturally attaches or is subordinate or subsidiary to aconcurrent legitimate purpose or effect, whether of a commercial or familynature. Identification of a business purpose will not immunise a transactionfrom scrutiny where tax avoidance can be viewed as "a significant or actuatingpurpose which ha[s] been pursued as a goal in itself": see Tayles per McMullinJ at NZTC 61,318; NZLR 736. Conversely, a transaction will not offendwhere tax avoidance naturally attaches to that other acceptable purpose oreffect.[207] In Ben Nevis, although reliance had not been placed on the "merely incidental"exception, the majority observed it would "rarely be the case that the use of a specific159 Income Tax Act 2004, s OB 1, definition of "tax avoidance arrangement".160 Westpac Banking Corp v Commissioner of Inland Revenue (2009) 24 NZTC 23,834 (HC) at [206].provision in a manner which is outside parliamentary contemplation could result inthe tax avoidance purpose or effect of the arrangement being merely incidental."161[208] FHNZ argued:(a) The arrangement was motivated by legitimate commercial objectives:refinancing the New Zealand subsidiary and introducing local currencydebt with a fixed rate of interest at a higher level.(b) These objectives required deductions at (or over) the level achieved bythe convertible note.(c) The deductions achieved would have arisen whether the fundinginvolved bank debt, related-party debt, a combination of the two, ahybrid instrument, or a vanilla loan repayable at the end of the fundingterm.(d) As the deductions were a "constant" throughout, the use of theconvertible note and DAP's role in the transaction can be explained bythe Singaporean tax advantages of the arrangement.(e) The New Zealand tax consequences were therefore merely incidentalto the Singaporean tax advantages.[209] Counsel submitted that a passage in the Commissioner's InterpretationStatement on tax avoidance is "clearly correct" where she says:162Under the merely incidental test, a non-tax avoidance purpose for the adoptionof the particular specific structure may be relevant. Again, tax for this purposeis New Zealand tax, so avoidance of foreign tax would count as a non-taxavoidance purpose. If the New Zealand tax avoidance purpose or effect ismerely incidental to a non-tax avoidance purpose, the arrangement is not a taxavoidance arrangement. As was explained, a tax avoidance purpose will bemerely incidental if it follows as a natural incident from an arrangementstructured a certain way for a non-tax avoidance purpose. If it can be shown161 Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2NZLR 289 at [114].162 Public Rulings Unit, Office of the Chief Tax Counsel Tax avoidance and the interpretation ofsections BG 1 and GA 1 of the Income Tax Act 2007 (IS13/01, 13 June 2013) at [545].that a structure was put in place in the specific way it was to gain a taxadvantage from another country, then it is possible that the New Zealand taxavoidance purpose follows as a natural concomitant. If the New Zealand taxavoidance purpose is pursued as a goal in itself in any respect, however, thetax avoidance purpose will not be merely incidental.(Emphasis added).[210] The Commissioner submits FHNZ's non-tax avoidance purposes could havebeen achieved in a simpler way. She argues unnecessary complexity in the transactionindicates the tax avoidance purpose was not merely incidental. The Commissioneralso submitted that the Singaporean tax "benefit" was exaggerated by FHNZ — theabsence of tax in one jurisdiction or another was "a given" and the transaction wasprimarily concerned with New Zealand deductibility. The features of artificiality andcontrivance raised by the Commissioner in her submissions on the substance of thearrangement show, Mr Smith submitted, the purpose or effect was not merelyincidental. The Commissioner said further the size of the tax benefit obtained meansFHNZ was being paid to borrow. Taking advantage of the tax base to this extent couldnot have been merely incidental but must have been an independent driver of thearrangement.[211] In some ways these competing arguments simply reflect the substantivearguments on the primary issue. As such they underscore the difficulty in saving anArrangement under the "merely incidental" limb in circumstances where, exhypothesi, it has already been found to use a specific tax provision in a way which isoutside parliamentary contemplation. I have some sympathy with FHNZ's argumentthat domestic deductions were a "constant" and therefore a "concomitant" of theSingaporean tax advantages. But that is unsurprising given the conclusion I reach onthe principal issue. Assuming a different conclusion, I am, perforce, also assuming atleast one of the purposes or effects of the transaction was domestic tax avoidance. Tothen say that New Zealand deductibility was simply a "concomitant" of Singaporeannon-assessibility would, as the Supreme Court suggested in Ben Nevis, appear to be adifficult argument. Ultimately however, I am not required to decide it.Reconstruction — s GB 1[212] In the course of the hearing the parties advised that, in the event I decided thatthe Arrangement was not a "tax avoidance arrangement" for the purposes of s BG 1,there would be no utility in my endeavouring to address how the Arrangement shouldbe reconstructed on the assumption my conclusion was in error. I do not thereforetake that aspect of the mutual submissions further.In the alternative: would liability for penalties arise?[213] The Commissioner considers FHNZ took an "abusive tax position" andassessed the taxpayer for shortfall penalties of $1,786,555 and $1,924,779 for the 2006and 2007 income tax years respectively. My finding on the issue of tax avoidance hasthe effect of quashing these penalties. But had I reached the stage of assessing whethershortfall penalties were rightly imposed, I would have found they were not. Myreasons follow.[214] FHNZ is liable for a shortfall penalty if it took an "unacceptable taxposition".163 Taking an unacceptable tax position results in a 20 per cent penalty.164But if, viewed objectively, taking that unacceptable tax position was "with a dominantpurpose of avoiding tax, whether directly or indirectly", the taxpayer will have takenan abusive tax position.165 That results in a 100 per cent penalty.166 As is the casehere, previous good taxpayer behaviour can then reduce those penalties by half.167[215] An unacceptable tax position is one that, viewed objectively, "fails to meet thestandard of being about as likely as not to be correct."168 That must be determined asat the time FHNZ took its tax positions169 and the court must have regard to:170163 Tax Administration Act 1994, s 141B(2); the quantum of shortfall in this case satisfies para (a) and(b) of this section.164 Section 141B(4).165 Section 141D(7).166 Section 141D(3).167 Section 141FB.168 Section 141B(1).169 Section 141B(5).170 Section 141B(7).(a) the actual or potential application to the tax position of all the tax lawsthat are relevant (including specific or general anti-avoidanceprovisions); and(b) decisions of a court or a Taxation Review Authority on theinterpretation of tax laws that are relevant (unless the decision wasissued up to 1 month before the taxpayer takes the taxpayer's taxposition).[216] The "about as likely as not" standard does not require the taxpayer to show it"had a 50 per cent prospect of success" but rather that there was substantial merit inthe taxpayer's argument.171 Mr M McKay pointed to a select committee report on theTaxpayer Compliance, Penalties and Dispute Resolution Bill 1995, where thecommittee observed:172Officials advised us that "about as likely as not to be correct" means that aposition does not have to be the correct position, or even have a 50 percentchance of success, but must be a position which would be seriously consideredby a court.[217] Mr M McKay argued the Commissioner's three theories about the arrangement— in his words comprising "multiple, and contradictory, positions" — illustratedFHNZ's contention was about as likely as not to be correct. The Commissionerrejected this characterisation saying that nothing could be read into her raising"alternative arguments" on the facts.[218] I accept Mr McKay's submission that there were elements of inconsistency inthe three different approaches. For example, assessing FHNZ for NRWT simplycannot be squared with theories challenging the deductions. This is favourable to thetaxpayer insofar as it suggests difficulty in articulating a coherent theory whichjustifies description of the arrangement as tax avoidance. However it is not decisive.Whether the standard "about as likely as not to be correct" has been met involves anobjective assessment. It must be made at the time the taxpayer's position was takenand cannot be answered solely by reference to later vacillations in the Commissioner'stheory of the case.171 Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2NZLR 289 at [184].172 Taxpayer Compliance, Penalties and Dispute Resolution Bill 1995 (119–2) (select committeereport) at v.[219] The relevant tax positions were taken on 24 July 2006 and 21 December 2007.The most authoritative statement on the relationship between avoidance provisionsand other aspects of the Act (specifically, the accrual rules) at that time was thedecision of the Privy Council in Commissioner of Inland Revenue v Auckland HarbourBoard.173 Lord Hoffmann, giving judgment of the Board, described the anti-avoidancerules as a "long stop".174 His Lordship observed:[11] Their Lordships will return in due course to consider whether a baseprice adjustment on the basis of a transfer for a nil consideration is inconsistentwith some fundamental principle of the accrual regime. But they should firstdraw attention to the fact that the Commissioner's argument involves puttings 64J(1) to a very unusual use. The section appears to Their Lordships tocontemplate that the circumstances which justify its application will bespecific to a particular transaction, arising out of the relationship between theparties and other relevant circumstances. In this respect it is similar to otheranti-avoidance provisions such as s 99. Their Lordships do not of coursesuggest that the two sections necessarily cover the same ground, but what theyhave in common is that they are, generally speaking, aimed at transactionswhich in commercial terms fall within the charge to tax but have been,intentionally or otherwise, structured in such a way that on a purely juristicanalysis they do not. This is what is meant by defeating the intention andapplication of the statute. Some of the work such provisions used to do hasnowadays been taken over by the more realistic approach to the constructionof taxing Acts exemplified by (W T) Ramsay Ltd v Inland RevenueCommissioners [1982] AC 300, although Their Lordships should not be takenas casting any doubt upon the usefulness of such tax avoidance provisions asa long stop for The Revenue.[12] In the present case, there is no tension between the commercial andjuristic character of the transaction. It is, in legal, commercial or any otherterms, a transfer of financial arrangements for no consideration. Such atransaction either attracts a deduction or it does not. The Commissioneraccepts that it does, but claims the right under s 64J(1) to be able to amend thelaw to ensure that it does not. Their Lordships do not think that the sectionwas intended to confer such a power. It would amount to the imposition of taxby administrative discretion instead of by law.[220] The Commissioner argued that in the 2007 income tax year, the Court ofAppeal in Accent Management had confirmed deductibility provisions "should onlybe invoked in relation to the incurring of real economic consequences of the type173 Commissioner of Inland Revenue v Auckland Harbour Board [2001] 3 NZLR 289 (PC).174 At [11].contemplated by the legislature when the rules were enacted."175 Similar observationswere drawn from earlier judgments.176[221] But the inquiry is not with whether the taxpayer has correctly invoked thedeductibility provisions. It is whether there is substantial merit in its arguments —that is whether they would be seriously considered by a court. FHNZ paid interest toDBNZ and claimed a deduction for it. Focusing on the "commercial and juristiccharacter of the transaction",177 there was a strong argument in the taxpayer's favour.For the reasons previously outlined, I also consider FHNZ was always credibly in aposition to challenge the relevance of the economic analysis on which theCommissioner relied. I therefore consider that FHNZ did not take an unacceptable taxposition. It is unnecessary in that context to consider whether the arrangement wasabusive.[222] In the result, if I am wrong in my principal conclusions I would have set asidethe shortfall penalties.Result[223] In accordance with the relief sought in the statement of claim I:(a) Declare that Commissioner's Assessments for the 2006 and 2007income years are incorrect.(b) Make orders pursuant to s 138P of the Tax Administration Act 1994cancelling the Assessments.178175 Accent Management Ltd v Commissioner of Inland Revenue [2007] NZCA 230, (2007) 23 NZTC21,323 (CA) at [126].176 The English case of Inland Revenue Commissioners v Willoughby [1997] 1 WLR 1071 (HL) at1079 per Lord Nolan; Peterson v Commissioner of Inland Revenue [2005] UKPC 5, [2006] 3NZLR 433 at [45]; and Challenge Corp Ltd v Commissioner of Inland Revenue [1986] 2 NZLR513 (CA).177 Commissioner of Inland Revenue v Auckland Harbour Board [2001] 3 NZLR 289 (PC) at [12].178 Adopting the definition of "Assessments" in paragraph 77 of the statement of claim.Costs[224] Costs have not been addressed in submission. If FHNZ seeks to have thesefixed at this stage then, in the absence of agreement as to quantum, memoranda(maximum five pages plus any supporting schedules) may be filed. Counsel are toconfer to limit any areas of difference. Any submission, in opposition is to be filedwithin 14 days of the plaintiff's submission and any submission in reply within sevendays thereof.__________________________Muir J