SMELLIE SNIFFS THE BREEZE: Shedding tears for bank tax

SMELLIE SNIFFS THE BREEZE: Don't cry for me, Structured Finance

By Pattrick Smellie

Oct 9 (BusinessWire) - Of all the crocodile tears that could ever be shed, the Steve Irwin Grand-Daddies are those shed by taxpayers who push the law to screw the Revenue, and then find out they got it wrong.

That's all that happened this week in the $961 million tax judgement against Westpac for tax avoidance in the late 1990's and early 2000's using structured finance or "repo" loans. These were popular at the time among foreign-owned banks, which could arbitrage the New Zealand tax system against offshore regimes and choose how much tax they paid in New Zealand.

Similar Bank of New Zealand transactions, worth $564 million in back taxes and interest, were ruled avoidance by Judge John Wild in the Wellington High Court in July, and the ANZ, National, ASB and Rabobank all still face their day in court on their transactions.

Yet already, with the ink barely dry on the findings by the Auckland High Court's Judge Rhys Harrison, tax professionals and banking executives are crying foul. These are presumably the same tax professionals and bankers who assumed that moving the Westpac case to Auckland would ensure a more level-headed judicial approach.

Instead, Harrison - a judge known for his particular dislike of being overturned on appeal - has reached essentially the same conclusions as Wild, and added for good measure that Westpac was lucky the IRD didn't pursue exempt income claimed within the same transactions.

"The banks think this is an absolute disgrace because they had rulings from IRD and things moved 180 degrees," said one aggrieved Aussie banker, who presumably sought anonymity because the comment is so utterly disingenuous.

Westpac and Bank of New Zealand, whose tax and interest owing totals $1.555 billion before penalties, explicitly sought to engineer arrangements that allowed them to pay as little tax as they liked in New Zealand.

That is not illegal, and the judicial findings so far don't make anyone a crook. Tax avoidance is unlawful, whereas tax evasion is a crime, and what the banks hoped they were achieving by sailing close to the legal line was lawful tax minimisation.

To those who deal in this stuff every day, it's uncontroversial, and the principle that there is no morality in tax law is sacrosanct. However, if you push the limits of the law, you are always at the risk of finding you crossed them, and it's always possible that the judicial pendulum will swing against you.

Crudely put, evidence in the Westpac case showed bank executives and top tax advisers at PricewaterhouseCoopers openly discussing public relations considerations as the only meaningful constraint on how little tax the bank might pay, thanks to repo deals.

PWC chairman John Shewan advised Westpac that declaring tax payable of around 15%, compared with the corporate tax rate of 30%, would be in the same league as its competitor banks and would be sufficient to demonstrate good corporate citizenship.

However, Westpac could probably get away with actual cash tax payments to IRD at a rate as low as 6.5%, since virtually no one other than tax geeks understood the difference between declared taxable income and actual tax paid.

No one was embarrassed about this - it's just the way big companies think. In fact, witnesses for Westpac insisted that the New Zealand CEO at the time, Harry Price, was "passionate" about paying as much tax as the bank was legally obliged to.

No doubt that's true, otherwise the other banks would never have mounted these cases against the IRD. Deutsche Bank, in fact, folded its tent on similar issues some time ago. The two judgements so far are acutely negative publicity at a time when public distrust of banks is on the rise. Remaining challengers must at least be mulling whether to back out and try to settle with IRD - if IRD will even consider that, given that it's now on a roll.

The fact remains, however, that the transactions in the BNZ and Westpac cases openly pushed the legislation to the max and beyond. Both banks relied on IRD binding rulings which related to earlier transactions, then applied the same principles to later transactions rather than seek further binding rulings.

That was a calculated risk. Tax practitioners know that binding rulings apply one transaction at a time. The fact that the IRD might change its mind later on another, similar transaction is one of the hazards of the game. If you fear that enough, you seek a binding ruling on the next transaction. If you don't, or the IRD turns you down on a subsequent application, that's a sign that you might be sailing close to the wind.

So, to claim now that these judgements make the anti-avoidance provisions of the Income Tax Act unclear looks rather self-serving, when the transactions in question were designed both to test and exploit such a lack of clarity in the first place.

However, as Deloitte's Thomas Pippos points out, the Westpac and BNZ judgements involve "quite commercial transactions that arbitrage a regime that was deliberately put in place by Parliament." Grounds for appeal may yet prove strong.

While neither Judges Harrison nor Wild have bought that argument, the Court of Appeal or Supreme Court may yet do so, because it's in this minefield of "what Parliament meant" that many of the crucial details hang.

And when you consider that most MPs are confused at the best of times on the intricacies of international tax legislation, what Parliament meant in this area is always going to be fuzzy by comparison with, say, rubbing out P gangs or tougher sentencing.

If, however, these judgements stand, and the other bank challenges are unsuccessful, this could net Finance Minister Bill English - or some future successor, once all routes of appeal are exhausted - more than $2 billion in back taxes, interest accrued, and penalty payments.

A tidy win for the taxpayer beckons in the end, and a doffed cap to tax officials who have spent big chunks of their careers on the cases that have been coming to court this year.

(BusinessWire)

© Scoop Media