The case: Is each of six similar structured finance transactions entered into by the plaintiffs (the BNZ) a ‘tax avoidance arrangement’ void under s BG 1 Income Tax Act 1994? That is the primary issue in these five consolidated proceedings brought by the BNZ against the Commissioner, challenging his assessments issued after he voided each of the transactions pursuant to s BG 1. The BNZ claims the transactions are not caught by s BG 1. A second issue, arising only if s BG 1 applies, is the correctness of the way in which the Commissioner has, pursuant to s GB 1, counteracted the tax advantage obtained by the BNZ under the transactions. The Commissioner disallowed the deductions claimed by the BNZ, as its costs of the transactions. The BNZ claims the deductions should be disallowed only to the extent they are excessive or ‘overmarket’. A third, and perhaps strictly antecedent, issue is whether the guarantee arrangement fee (GAF) or guarantee procurement fee (GPF) charged in each transaction is properly deductible under s BD 2. The transactions are so-called ‘repo’ deals: the BNZ made an equity investment in an overseas entity on terms requiring the overseas counterparty to repurchase that investment when the transaction terminated. The transactions were structured to enable the BNZ to deduct its expenses of earning the income yielded by its investment, while receiving that income free of tax. In the case of the first transaction, that tax relief resulted from a credit for foreign tax paid. The BNZ’s income from the five subsequent transactions was relieved of tax by the conduit regime. That domestic tax ‘asymmetry’ – tax deductible costs earning tax exempted income – made the transactions highly profitable for the BNZ. The BNZ contends each of these transactions involved real obligations, notably those resulting from the BNZ raising $500 million on the New Zealand money market and advancing that to the counterparty upon a repo obligation. Further, the BNZ’s case is that the transactions made legitimate use both of crossborder tax arbitrage and the domestic tax ‘asymmetry’ just described. Cross-border tax arbitrage refers to the different tax treatment of the transaction in New Zealand and the foreign counterparty’s jurisdiction. New Zealand tax law treated the transactions as equity investments, the counterparties’ jurisdictions (the United States of America for the first three transactions; the United Kingdom for the later three) as secured loans. That enabled the counterparties to deduct, as interest, the distribution they made which the BNZ received free of tax in New Zealand. The BNZ submits that the evidence establishes that “tax driven structures and tax arbitrage are common and accepted elements of international finance”. The Bank says the central or critical question in the case is the appropriate approach in law to the asymmetry between deductible expenditure and tax relieved income around which these transactions or arrangements were structured. The essential bases on which the Commissioner asserts s BG 1 catches the transactions are: a) They substantially altered the incidence of tax for the BNZ. Indeed, that was their only purpose or effect. It certainly was not a merely incidental purpose or effect. The Commissioner adopted the description of one of his witnesses: … A prime purpose of the profit-maximising actions of these transactions was to use the tax base to make money. They had no commercial purpose or rationale. Absent the tax benefits they generated, the transactions were loss-making, in that the BNZ provided funding to the counterparties at substantially less than its cost of funds. The Commissioner contended “the tax tail wagged the commercial dog”. They were not within the scheme and purpose of the regimes they utilised to generate tax exempted income, the foreign tax credit (FTC) and conduit relief regimes respectively. In the case of the FTC regime utilised by the first (Gen Re 1) transaction, the transaction also did not comply with the applicable specific provisions. d) The principal deductible expenses claimed by the BNZ (the fixed rate it paid on an interest rate swap and the GAFs or GPFs) were contrived and artificial. e) The transactions were structured on a formulaic basis, which had the artificial consequence that, the higher the transaction costs, the higher the tax benefits they generated. The six transactions in issue span eight income tax years between 1998 and 2005. Three further transactions, two of them earlier in time, also featured in the evidence. While those three further transactions have a similar structure, they have the distinguishing feature of being New Zealand tax positive. The BNZ obtained binding rulings from the Commissioner on each of those three transactions, which I will call ‘the ruled transactions’. Approximately $416 million of tax hinges on the outcome of these proceedings. Challenge proceedings brought by the Westpac Banking Corporation began in Auckland on 30 June. Proceedings brought by other New Zealand trading banks have yet to come on for trial. If occasional press reports are accurate, the total amount of tax in issue is over $1.5 billion. The Court found in favor of the tax authorities. The case was later settled out of court ...

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 ...