Customs is seeking $22 million from independent fuel retailer Gull, after discovering it has been quietly adding butane to its petrol since 2003.
Australian-owned Gull typically sells its fuel for several cents a litre below its rivals, but Customs claims it has been gaining a tax advantage - possibly 1c-2c a litre - by exploiting a low tax rate on butane, a form of liquefied petroleum gas (LPG).
A High Court decision went in Gull's favour, with Customs appealing to the Court of Appeal this week, and signalling it may take its case to the Supreme Court if required.
The issue came to light following a complaint from BP in 2010 about Gull's activities, which sought clarification as to whether it, too, could add butane to its fuel at the lower tax rate.
Customs declined BP's request, and audited the activities of a Gull subsidiary, Terminals New Zealand, at its Tauranga terminal.
Customs staff discovered that Australian-owned Gull was adding up to 5 per cent butane to its petrol.
While the mixing is legal, Customs claims Gull was failing to pay millions in excise.
The excise on petrol is about 48.5c a litre, while the excise on butane is only 10.4c.
Customs argues that Gull should be paying petrol excise on the full volume, and has therefore been underpaying by 38.1c for every litre of butane.
During almost a decade it estimated Gull had saved $9m, while Customs is claiming a further $13m in penalties. It has also complained that in previous audits of its activities Gull has never mentioned the butane mixture.
Following Customs' demand for payment, Gull sought a judicial review of the case claiming its activities did not amount to "manufacturing" and therefore it was not liable for petrol excise on the full volume.
In May, the High Court found in Gull's favour.
Details of that decision were suppressed, but the order was lifted following Customs' appeal to the Court of Appeal this week.
Dave Bodger, managing director of Gull, refused to comment because the matter was before the courts.
The Automobile Association said it would seek a review of the mandatory labelling requirements of petrol as a result of the case.
While fuel companies are required to disclose to motorists if fuel contains more than 1 per cent ethanol, no such condition is required for butane.