Frucor Suntory New Zealand Limited v CIR - Commissioner fails in avoidance argument

Does the Commissioner of Inland Revenue ever lose a tax avoidance case? For the most part it seems like the Commissioner is odds on favourite to win a s BG 1 general avoidance case.

However, a general avoidance case is not unwinnable, as recently shown in the High Court in Frucor Suntory New Zealand Limited v CIR [2018] NZHC 2860. The case involves a complex financing arrangement. This involved the New Zealand company, Frucor Holdings Limited (“Frucor”), which was a subsidiary of the Singapore based Danone Asia Pte Ltd (“DAP”) group. DAP is owned by the Danone Group, whose ultimate parent company, Group Danone SA, is based in France.

The Issue

To summarise the contentious issue, Frucor was paid some $204 million by Deutsche Bank’s NZ branch (“DBNZ”) for a convertible note – effectively a loan with the option to claim the debt repayment in the form of stock in Frucor. In advance of this, DAP paid DBNZ $149 million as part of a forward purchase agreement for the shares which might vest to DBNZ. This was partially financed by BNP Paribas, which lent DAP $89 million.

Frucor put the $204 million to good use, immediately paying $60 million to buy back 400 shares from DAP (which reduced Frucor’s share capital by $40 million, to $90 million) and repaying loans from Danone Finance SA – the group’s treasury subsidiary - with the remaining $144 million.

Frucor paid 6.5% interest, and Group Danone SA underwrote the whole agreement to the tune of $250 million – payable to DBNZ upon first demand to guarantee Frucor’s payments. DBNZ paid Group Danone SA a 0.1% guarantee fee. The forward purchase by DAP was also guaranteed up to $67 million by Group Danone SA, though no guarantee fee was payable by DBNZ.

When the convertible note reached maturity at five years, the bank chose to receive 1,025 shares, which it promptly transferred to DAP, as required by the forward purchase agreement. Overall, DBNZ received their original $204 million, and an additional $1.8 million, accounting for fees and interest.

The Commissioner’s Reconstruction

The Commissioner took issue with this arrangement. According to her reconstruction of the arrangement, DBNZ had received $149 million from DAP as part of a forward purchase agreement, as well as $66 million in interest payments from Frucor. As Frucor’s parent company prepaid $149 million, this effectively funded some of the loan to their subsidiary - as if the money had never left the related group. As a result, The Commissioner argued the payment from DAP should be recharacterised as a prepayment of equity. Further, DBNZ’s economic liability was only $55 million. Therefore, only $11 million of the $66 million from Frucor was a genuine interest payment. Justice Muir summarised the Commissioner’s theory at [150]:

  1. funding of $55.4 million from DBNZ on which it paid $11.09 million interest; and
  2. $149 million “from its parent via DBNZ as a conduit” which was repaid in a “costless exercise”.

Applying this recharacterisation, $22 million of interest payment tax deductions were no longer available to Frucor. Frucor deemed this reconstruction to be ‘incorrect and excessive’.

Other theories were posited for the true characterisation of the arrangement, but the prevailing theme was to view the arrangment ‘as a whole’, on a ‘group basis’, as an integrated transaction rather than on the merits of each transaction and taxpayer individually. One of the Crown’s expert witnesses went so far as to suggest that the ‘company is the shareholders’, a statement which was not met with agreement from Justice Muir. Instead, Justice Muir considered that the New Zealand taxpayer should be viewed as just that – a New Zealand-based taxpayer.

A Commercial Explanation

Justice Muir considered the leading Supreme Court case, Ben Nevis, which determined if an arrangement was avoidance by reference to the full scope of the rules within the overall scheme of Income Tax Act. This assessment focused on whether a transaction might be described as unorthodox, and whether it aligned with Parliament’s intention when drafting the applicable provisions. Justice Muir did not consider unorthodoxy to be a determinative indicator of avoidance - His Honour noted that you could not put the use of convertible notes in a ‘straight-jacket of orthodoxy’. The relationship between the arrangement and the tax outcomes must be one which gains a tax benefit in an artificial or contrived way, rather than simply having certain unorthodox elements. While prior avoidance cases, such as Alesco, have involved convertible note arrangements, the Judge considered this feature alone should not be not the death knell. However, at [141], His Honour accepted that unorthodoxy would beg the question, “but why, if other than to achieve the tax outcomes?”

It was crucial to Frucor’s argument that they could distinguish cases like Alesco and Ben Nevis by exhibiting genuine commercial reasons for the arrangement. His Honour observed that ‘if a transaction is unusual that may be evidence of avoidance, but that is more typically so where there is no business reason for it to occur.’ Frucor explained that the arrangement had created a desired debt/equity rebalance within the Danone Group. While there were other arrangements that would have created the same debt/equity outcome, these options would have resulted in assessable interest in foreign jurisdictions. Repayment of the loan by Frucor to a parent company would have been treated as assessable interest income for the parent. Justice Muir accepted Frucor’s submissions that avoidance of foreign tax is not “tax avoidance” for the purposes of s BG 1. Therefore, Frucor was able to show a commercial reason for the transaction, albeit one which only aligned with the 2004 Income Tax Act. By contrast, the new BEPS provisions in the 2007 Income Tax Act would have affected Justice Muir’s assessment - as acknowledged at [204].

The Commissioner submitted that the issuance of shares was at no cost to Frucor, and therefore it could not reasonably be used to discharge debt. However, Frucor noted that Parliament could not have intended that a ‘no cost’ issue of shares would change the taxation outcome. For instance, if a parent sells property held on revenue account to a 100% subsidiary in return for shares in the subsidiary, then there would be no cost base to the subsidiary. The same can be said if the property was depreciable, or trading stock, but in all three instances a deduction for the cost of the property must be reasonably allowed, even if there was no cost to the company when issuing shares.

At [195], Justice Muir determined that Parliament must have intended for the taxpayer to:

  1. Take a deduction for interest economically incurred;
  2. Deduct financial arrangements expenditure deemed to be incurred over the life of a financial arrangement;
  3. Account for tax on a separate entity basis, if the member of a multi‐ national group; and
  4. Issue shares to satisfy a liability owed to a third party, including its parent.

Further, His Honour found that the grouped economic approach for with the Commissioner argued was inconsistent with the New Zealand international tax regime. Most notably because of the selective nature of the Commissioner’s reconstruction, which ignored the loan to DAP from the third-party bank, BNP Paribas. Justice Muir also observed that ‘payment of cash by a parent to a subsidiary, for which the consideration is the issue of additional shares, represents a routine commercial transaction. The unorthodox aspects of the transaction are of ‘marginal assistance’, as noted in Alesco, rather than being determinative of avoidance. Further, the transaction had genuine economic drivers, including offshore tax minimisation.


Justice Muir also briefly considered the appropriateness of the shortfall penalties, which were imposed against Frucor for taking an ‘abusive tax position’. Logically, Justice Muir’s findings quashed these penalties, however His Honour considered their appropriateness in the alternative. This obiter section of the judgment may impact the Court of Appeal’s treatment of the shortfall penalties, should they choose to reverse the decision upon appeal. Justice Muir explained that an abusive tax position is an unacceptable tax position with a dominant purpose of avoiding tax. This results in a punitive 100% shortfall penalty.

To establish that a tax position is ‘unacceptable’, it must fail to be ‘about as likely as not to be correct’. Justice Muir was quick to note that this standard, in keeping with well-established precedent, does not require that the taxpayer have a 50% chance of success. A lower chance is acceptable, so long as the taxpayer’s interpretation has substantial merit. His Honour was careful to note that the test is not whether the position is ‘correct’, only whether it has substantial merit. If a court would seriously consider a taxpayer’s position, this is indicative of a fairly advanced position with substantial merit. Justice Muir’s efforts to clearly set forth the test for an unacceptable tax position, albeit in obiter dictum, will likely be very useful in guiding taxpayer’s and their advisors.


While this may be an example of a case which would now be unwinnable in light of the new BEPs provisions (which may yet guide the Court of Appeal as to Parliament’s true intention when drafting sBG 1) it offers other insights.

This case shared features with Alesco, so much so that the Commissioner’s team may have considered it a home run before the pitch was thrown. However, the Judge in Frucor warned against any “instinctive” assumption of avoidance at [194]:

Courts have an understandable resistance to structured transactions which may be seen to cost the New Zealand tax base but intuitive subjective assessments based on any such thought processes must themselves be firmly resisted.

Wise words.

© G D Clews, 2018


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