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A friend was a passenger in a car that was pulled over at a Breath test checkpoint. Driver was cleared. Officer went to passenger's window, requested name and address of my friend and her ID. She gave her details and passed over her Expired drivers licence. Police officer Kept her licence stating it was not her property as it was expired.

It is a little incident, however my friend has never had anything to do with the police, and on returning home became extremely upset and felt violated by police attitude and actions.

Is that correct that Expired Licences can be forfeited in this manner? Mine expired and I used it when getting a new one at AA Offices on Lambton Q. It was cut up then but I had my new one in hand.

It is correct, the Police have the authority to confiscate an expired license.
Generally, the only reason the Police would need to sight the passenger's license would be if the driver was not fully licensed, perhaps driving on a restricted license. Under these circumstances if the front seat passenger was not fully licensed, the driver would be driving outside the conditions of their license.

The driver (50 years of age) was fully licenced and gave his licence to the Police Officer who returned it to him.

So the driver being fully licenced and passing the breath test, they went to my friend the passenger and took hers. I would leave it there - disappointed in perhaps the 'not incorrect', but definitely alienating use of power.

However TODAY my friend receives a traffic offence notice POL402 filled out containing text, "Forbidden to drive until a current NZ drivers licence is obtained",

Ridiculous. If I'm pulled up - will my 11 year old sitting in the back seat of the car be sent Traffic Offence Notices stating - 'Forbidden to drive until obtaining a current NZ drivers licence'?

If the circumstances are exactly as you've relayed them to us (or, how they've been relayed to you), I've no idea why your friend would have been asked for her license. It would not be usual.
Obviously, your friend has received the notice because she produced an expired license.
I have driven through Police checkpoints many times with a passenger in my car and never has my passenger been asked for their license.
Maybe there's more to this story than you're being told?

Well, I dug for dirt. The driver is 'stroppy when drunk' and has been in trouble before.
On this occasion the driver was perfectly civil during this event. My friend on the other hand has never been in trouble, ever.

Hmmm. Maybe you need to dig a bit deeper if you really want to get to the bottom of this. It sounds like there's a small (but significant) piece of the jigsaw missing :)