Wellington, July 16 NZPA - National Australia Bank (NAB) switched a structured finance transaction from the UK to New Zealand when NAB's UK tax position became uncertain.
This is one of the conclusions of a High Court judgment against NAB's subsidiary Bank of New Zealand, which could cost it $654 million in unpaid tax and interest and more in penalties.
BNZ said it was likely to appeal today's judgment.
Five New Zealand banks are disputing 22 transactions in a raft of court proceedings, of which this is the first. In total, they have been assessed to owe as much as $2 billion in unpaid taxes and interest.
One of their defences is that some of the transactions had binding rulings from Inland Revenue (IRD), which allowed interest and fees to be deductible and dividends to be exempt from tax.
The judgment from Justice John Wild said a binding ruling expressly applied only to the transaction ruled on.
IRD argued that the "tax tail wagged the commercial dog" in the transactions BNZ entered into with foreign counter parties.
Justice Wild said the genesis of the transaction structure appeared to be a proposal in June 1995 put by Clydesdale Bank, a UK subsidiary of NAB's, to the group credit bureau of NAB for a preference share transaction between Clydesdale and a subsidiary of the AIG Group.
NAB's taxation division indicated that the bank's UK tax position had become uncertain and suggested substituting the BNZ.
An advantage of BNZ was the ability to get a binding ruling from IRD, which was not available from the equivalent UK authority.
The "opportunity" was referred to the BNZ by NAB in Melbourne.
Justice Wild found that the transactions were not in keeping with the intention of the conduit relief regime, which is designed to encourage multi-nationals to use New Zealand as an investment base by relieving, from New Zealand income tax, income earned overseas by a New Zealand subsidiary.
The transactions did not encourage NAB to "invest" through BNZ, he said.
The transactions operated at a cost to the New Zealand economy and the New Zealand tax base. They had a total cost to New Zealand society of $335.6m.
"This is the antithesis of the legislative intention in introducing the conduit regime," he said.
Justice Wild said the transactions had the purpose, or effect, of substantially altering the incidence of tax for BNZ.
They had no commercial purpose or rationale.
"Shorn of the tax benefits they were anticipated to generate, they involved the BNZ providing funds to the counterparties at a substantial loss.
"Their only purpose was to use the bank's tax capacity to generate exempt income."
Lending at a substantial loss was a "classic indicator" of tax avoidance.
The transactions were templated, which could also indicate tax avoidance.
They generated claimed deductible expenses in a contrived and artificial way.
Justice Wild said the BNZ's challenge to the commissioner's assessments failed. Costs were reserved.
"Clearly we are disappointed by the outcome," BNZ chief executive Andrew Thorburn said.
"We will review the judgment which spans 179 pages, and make a decision within 20 working days on whether we will appeal.
"At this time it is our expectation that we will do so."
The Commissioner for Inland Revenue, Robert Russell, welcomed the ruling.
Mr Russell said the BNZ made an equity investment in an overseas entity on terms requiring the overseas entity to buy back that investment when the transaction finished.
The transaction was structured to allow the BNZ to deduct its expenses of earning the income gained on the investment, while receiving that income free of tax.
The six transactions by BNZ spanned eight income tax years between 1998 and 2005.
BNZ said the judgment would have no impact on its ability to meet any debt or equity obligations.
Compare Credit Cards - Independent interest rate and fees comparisons for New Zealand banks.