TPguidelines

Westpac Banking Corporation has challenged amended assessments issued by the Commissioner of Inland Revenue to its taxation liability for the years 1999 to 2005. The assessments impugn the bank’s taxation treatment of nine structured finance transactions entered into with overseas counterparties in that period. The funds invested in each transaction ranged between NZD390m and NZD1.5b. By August 2002 Westpac’s total investment in the transactions was NZD4.36b, representing 18% of its assets.

The Commissioner says that the purpose or effect of the transactions or parts of them was tax avoidance. He has reassessed Westpac to liability of $586m. With the addition of use of money interest of $375m, the total amount of tax at issue is $961m (including voluntary payments of $443m made by the bank under protest).

In brief summary, the transactions were structured in this way: Westpac, acting through subsidiaries, purchased preference shares issued by specially formed subsidiaries (in one case a partnership was used) within a counterparty group of companies in the United States and the United Kingdom. Another subsidiary within the group assumed an obligation to repurchase the shares in five years or less. Westpac paid that subsidiary a fee, known as the guarantee procurement fee or GPF, to procure the parent company’s guarantee of the subsidiary’s obligations.

The counterparty jurisdictions treated the transactions for taxation purposes according to their economic substance as loans. Dividends payable on the shares were thus deductible interest for the issuer. By contrast, New Zealand revenue law treated the dividends according to their legal form as income returned to Westpac on equity investments which was exempt from taxation liability.

This cross-border differential created the first element of taxation asymmetry inherent in the transactions.

The Commissioner makes these allegations: The GPF was an artifice, designed to create a taxation benefit for the parties to share. The mechanism was the dividend rate which was fixed to incorporate both asymmetries and to provide the counterparty with the funds to pay that dividend. By this means the bank was able to offset substantial expenditure against its New Zealand sourced income. And the counterparty received or borrowed large sums at significantly less than market rates. Without this artificial benefit, the financing would never have taken place.

The commercial viability of these transactions, the Commissioner says, depended wholly on the achievability of the deductions which were their goal, and on the existence of certain interdependent prerequisites that drove the structure and detail of the arrangements. In particular, he identifies a New Zealand financial institution with a significant tax capacity; a suitable overseas counterparty with a tolerance for tax driven deals; statutory mechanisms within the New Zealand system which Westpac could use to ensure that the income stream was exempt or relieved from tax and to obtain deductions for tax purposes for the costs; and a statutory mechanism within an overseas tax jurisdiction allowing the counterparty to obtain deductions for the distribution stream.

Westpac carries the statutory burden of proving what is effectively a negative. It contests the Commissioner’s assessments. The bank says that it advanced real money to real parties and assumed a real and substantial credit risk; that the business purpose of each transaction was to provide funding to the counterparty group; that the transactions, if viewed with commercial and economic realism, made use of specific taxation provisions in a manner consistent with Parliament’s purpose; and that, contrary to the Commissioner’s contention, the transactions were pre-tax positive. The bank denies any element of artificiality, contrivance or lack of business purpose in its use of the specific deduction provisions. It denies also that it shared the benefit of its deductibility entitlement with the counterparty through the dividend rate calculation. And it says that it acted entirely within its legal rights in choosing a structure that used permissible tax advantages.

The Judgement

In the result, Westpac’s challenge to the Commissioner’s reassessments must fail. The bank has failed to discharge its onus of proving that the Commissioner erred, either in law or in fact. It may count itself fortunate that he did not, on his hypothetical reconstruction, disallow the bank’s claim for its exempt income.

Summary
In summary, I have found as follows:
(1) Westpac’s claim for deductions for the GPF were unlawful, and the Commissioner is entitled to disallow them in entirety;
(2) In any event, Koch and the other three transactions were tax avoidance arrangements entered into for a purpose of avoiding tax;
(3) The Commissioner has correctly adjusted the deductions claimed by Westpac in order to counteract its tax advantage gained under an avoided arrangement.

It follows that I dismiss Westpac’s applications on Koch, CSFB, Rabo 1 and Rabo 2 for an order cancelling or varying the Commissioner’s amended assessment.

The case was later settled out of court

Westpac Banking Corporation v Commissioner of Inland Revenue 20 February 2009