Taxman widens net on use of hybrid instruments

Revenue Minister Peter Dunne. Photo / Sarah Ivey.

Inland Revenue has widened the scope of action it is taking over the local subsidiaries of overseas companies' alleged use of debt and equity hybrid instruments to avoid hundreds of millions in tax.

The IRD has previously disclosed it is taking action against the mostly Australian companies' use of optional convertible notes (OCNs) to claim outsized deductions on interest paid on the instruments.

Revenue Minister Peter Dunne said last year that High Court proceedings brought by the IRD relating to companies' use of OCNs totalled about $111 million. The IRD has said this sum does not include potential penalties and interest which tax experts say may push the eventual bill to double that.

However media reports have quoted sources suggesting the widespread use of OCNs by Australian companies in the late 1990s and early 2000s could raise the amount of tax, interest and penalties being sought by IRD as high as $800 million. Yesterday an IRD spokesperson said the department was also now looking at the tax treatment of mandatory convertible notes (MCNs).

"We cannot be more specific at this time about exactly how much money is involved, as some cases are under dispute, while others are proceeding to court hearings."

Preliminary court action last year and recent financial statements have revealed that companies facing IRD action over OCNs include Telstra New Zealand, Qantas, former KiwiRail owner Toll Group and TV3 and RadioWorks owner MediaWorks.

Responding to questions from MPs on Parliament's finance and expenditure committee in November, IRD commissioner Bob Russell noted media reports suggesting $700 million was at stake in 13 cases. "I don't have a number at this point," he said.

The cases involve OCNs issued by local subsidiaries to overseas parent companies or other related parties in order to raise funds for their New Zealand activities including acquisitions.

When the IRD closed the loophole in 2006, law firm Kensington Swan noted that companies were claiming deductions by attributing value to the option component of the instruments even though exercise of the option resulted in no change of ownership in the issuing company.

The deductions were occurring where "there was no real expense".

Fairfax media has reported that filings from Telstra New Zealand Holdings put its potential liability over its use of OCNs at $31.2 million while Toll Group has made a contingent liability of almost $12 million. MediaWorks has reported its potential liability at $17.6 million.

Qantas has said it used OCNs but has not indicated the amount of any potential liability.

The Telstra case is expected to go to court in October.

NOTED

Financial instruments

* OCN (Optional Convertible Notes): Debt instrument which the lender may choose to convert to equity in the borrower.
* MCN (Mandatory Convertible Notes): Similar instrument, but automatically converts to equity on maturity.