Smith is observing via audio visual link, wearing his toupee.
The judges are currently discussing whether the appeal is "moot" given Smith has been allowed to keep the hairpiece.
Lawyer for the Attorney-General on behalf of Corrections, Una Jagose QC, said such a declaration had its own "independent meaning".
She said Smith was now in possession of an item that had a "specialised legal feature protected by the Bill of Rights Act".
Corrections said Smith did not have a right to the hairpiece under the act.
"In prisons alone there are rules about property, there are rules about what you wear, there are rules about beards and moustaches," Jagose said.
If the declaration stands, prisoners would begin refusing to follow these rules with the excuse of freedom of expression, she said.
This could include prisoners claiming they had a right not to wear their prison uniform because they "look better in a different colour".
Jagose said the ruling provided "fertile ground for challenge for administrative decision makers".
The right to freedom of expression was "simply not engaged here".
Section 14 of the Bill of Rights Act states "everyone has the right to freedom of expression, including the freedom to seek, receive, and impart information and opinions of any kind in any form".
Jagose said the section was "wide and untravelled" and that "the scope is as wide as human thought and imagination".
She said there must be "some expressive content" for the matter to fall under section 14, "otherwise, in my submission, section 14 produces too broad a concept to be protected at law in the way the Bill of Rights Act protects those rights and freedoms".
"He wasn't conveying any meaning by wanting to wear a hair piece . . . he wanted to wear it for his self esteem.
"It's not expressive at all, it's in Mr Smith's mind."
She said a young man wearing his hair long in protest against the Vietnam War was recognised as exercising his right to freedom of expression, but this was not the same thing.
Smith's lawyer, Tony Ellis, argued that hairstyles were a way for people to express themselves, pointing to the hairstyles youths wore in the 1960s.
Justice Kos said that was different "because it's challenging".
"It challenged the norms," he said.
Ellis said hair and different hairstyles was "how you're reflecting yourself to others, how you're expressing yourself".
Kos asked whether the suit he was wearing today expressed something about himself.
Ellis told him the suit expressed how the court perceives its members and lawyers.
Kos also questioned whether it would have been a breach of the act if Ellis turned up in jeans and an anorak and the judges refused to hear from him.
The judges have reserved their decision.
The background
At the time of his escape in November 2014, Smith was on a temporary release while serving a life sentence for the 1995 murder of the father of a 12-year-old Wellington boy he had been molesting.
Representing himself in court in March, Smith said the days after he was returned to custody were among the lowest in his life because New Zealand newspapers ran pictures of him appearing bald on their front pages.
"I felt belittled, degraded and humiliated," he said.
He told the court he began going bald in his early 20s and hairpieces gave him the confidence to present himself in public.
Smith argued prison authorities had not given him a valid reason for why he could not wear a hairpiece and used exaggerated concerns about security to justify their decision.
