BNZ tax case shows sticking to the letter of the law isn't enough

This article first appeared in the New Zealand Herald on 18 July 2009.

The High Court's $654 million ruling against BNZ is a reminder to companies that  technical compliance with the letter of the law is not an iron-clad defence when it comes to defending tax avoidance actions by Inland Revenue.

Following a 13-week hearing in Wellington, Justice John Wild found against BNZ which had challenged a $416 million amended assessment from the IRD relating to the bank's use of structured finance transactions to generate tax benefits.

New Zealand's four major banks and Rabobank are also challenging IRD on amended assessments. All up the IRD says the five banks owe it more than $2.4 billion including interest.

Westpac faces the largest potential bill of $903 million in the structured finance transaction tax cases being fought in New Zealand, analysts say.

ANZ has $562 million in dispute and Commonwealth Bank of Australia, which owns ASB, has $280 million in dispute, according to a report by UBS analysts. Deutsche Bank has settled with the department.

The IRD's case against Westpac began on June 30 in the High Court at Auckland.

Industry observers said each case was different, in particular with respect to the issue of whether banks had binding rulings from Inland Revenue.

Australian bank analysts said the banks were treating the disputed amounts as contingent liability in their accounts and their capital should be able to withstand provisions for the cases if they go against them.

BNZ and the other banks used the "conduit regime" set up by Parliament in order to make New Zealand a more attractive base for international business deals.

However the IRD contended that in six deals between 1998 and 2005, BNZ used the regime principally to avoid tax.

In his judgment, Justice Wild noted that the IRD conceded the bank was in "compliance with the applicable specific provisions" around the use of the regime.

But while the "scheme and purpose" of the conduit relief regime was to allow a New Zealand subsidiary to pass foreign-sourced income to its offshore owner free of tax except for 15 per cent non-resident withholding tax, "That has not happened here and it cannot happen because there is nothing for the BNZ to pass on".

"These transactions generated no income or gains to pass on. They generated only tax benefits for the BNZ," said Justice Wild.

In his judgment, Wild said that Victoria University Professor of Economics Lew Evans calculated that the six BNZ transactions enhanced the value of the BNZ Group to its owner National Australia Bank by $238.6 million as at June 30, 2005. At the same date the transactions had a total cost to New Zealand society of $335.6 million.

"The transactions, viewed in a commercially and economically realistic way, do not use the conduit regime in a manner consistent with Parliament's purpose in enacting it."

Chapman Tripp tax partner Casey Plunket says Justice Wild's judgment was like saying "here are the rules, but if you don't play according to the spirit of the rules then you're still committing an infringement".

"Even if you technically comply, the referee - being the Commissioner of Inland Revenue - can still ping you."

The principle that a taxpayer can be deemed to have been avoiding tax even though they have complied with the letter of the law is set out in Section BG1 of the Income Tax Act.

While BG1 has been drawn on in previous cases including the Trinity tax case, Plunket said the BNZ case, and others involving the other major banks which may cost them up to $2.4 billion in back taxes and interest, marked a more activist use of the provision by the IRD.

The Trinity tax avoidance scheme, which was finally settled in the Supreme Court late last year, could have seen 300 investors avoid more than $3billion in all, but that was over the 50-year lifetime of the scheme, and to date repayments and penalties imposed by the IRD are likely to be less than the sum sought from the BNZ alone.

While there was little commercial activity underpinning the Trinity scheme, the bank cases were different, Plunket said.

"There's no doubt that a genuine investment has been made by the banks. They've borrowed this money in New Zealand and they've invested that money with another financial institution offshore."

However that view appears to be at odds with Justice Wild's ruling that: "Putting aside the tax benefits they generated, these transactions had no commercial rationale, logic or purpose for the BNZ."

But Plunket said Justice Wild was allowing BG1 "to be used much more broadly and in an activist way by the commissioner to fix what the commissioner perceives to be unintended consequences of the legislation".

"I don't think BG1 was ever meant to be used as a vehicle for fixing unintended consequences, that's really a matter of getting the legislation right and if it isn't right, fixing it."

Plunket questioned whether the commissioner should be able to "change the law kind of retrospectively by applying BG1" suggesting it would create uncertainty.

"It will definitely stop people doing things that are tax effective.

"Some of those things might well be tax avoidance in anyone's definition and others might be things that are quite sensible and should happen."

Plunket said Chapman Tripp didn't have any direct interest in the BNZ case but it might have an interest in some of the subsequent cases.

BNZ chief executive Andrew Thorburn said yesterday that his bank could afford to pay "out of this year's profitability".

The bank remained very strong, he said.

BNZ made a $785 million bottom line profit in the year to September 2008 but this included a one-time gain. The underlying profit was $657 million.

Westpac reported a $484 million annual profit in New Zealand in 2008 after impairment charges. The profit before charges was $883 million.

The Reserve Bank of New Zealand, the regulator of banks, declined to comment on the BNZ decision.

Five New Zealand banks are disputing 22 transactions in a raft of court proceedings, of which the BNZ was the first.

One of their defences is that some of the transactions had binding rulings from IRD, which allowed interest and fees to be deductible and dividends to be exempt from tax.

Auckland University senior law lecturer Mark Keating, who has previously advised the IRD on the banks' structured finance transactions, said virtually all tax avoidance cases involved taxpayers who were technically compliant with the law.

"Technical compliance with the law is never enough."

Thursday's  decision a few months after the Supreme Court's Trinity ruling continued the Commissioner of Inland Revenue's winning run.

"The commissioner's interpretation of what is tax avoidance is `don't get too clever and if you do you may find you've crossed the line into tax avoidance'," Keating said.

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