Westpac has lost its $918m tax battle with Inland Revenue.
The bill is made up of core tax of $586m with another $332 million in interest arrears.
The case is the largest of six challenges by foreign-owned New Zealand banks against the IRD's contention that structured finance loans involving some of the biggest names in global corporate finance were commercial contrivances whose ultimate purpose was tax avoidance.
The Bank of New Zealand has already lost its case on similar transactions, and is appealing the decision, which sees BNZ owing $654 million in back tax and interest, before penalty charges are applied.
"We have always believed that the transactions were commercially justified and complied with the law," said Westpac NZ chief executive Frazis.
This was particularly so because Westpac obtained a ruling in 2001 from the Commissioner of Inland Revenue "in respect of a similar transaction which confirmed Westpac's view that a transaction of this type satisfied all tax laws and in particular was not tax avoidance."
"We are very disappointed with this decision," he said.
Frazis said that Westpac would take time to go through the detail of the judgment and would be considering an appeal.
The IRD introduced evidence in the Westpac case quoting PricewaterhouseCoopers chairman John Shewan advising the bank earlier this decade that it should try to declare a tax rate close to that of its competitors, and that actual tax paid should be at least 6 per cent, compared to the corporate tax rate of 30 per cent.
A Westpac loss is be a huge win for the IRD and may prompt other banks involved in similar actions - ANZ, the National Bank (prior to the ANZ merger), ASB, and Rabobank - to reconsider their legal strategy. Deutsche Bank settled with IRD on similar issues some time ago.
According to a July research note from brokers UBS, ANZ's exposure (including National Bank) is $562 million, while ASB's case involves back tax and interest of $280 million.
HOW IT WORKED:
The "structured finance" transactions targeted by the IRD used a mechanism originally set up by the Government to make New Zealand a more attractive base for international business deals.
The "conduit" rules said that if an overseas-owned company in NZ invested in another overseas entity, it would pay only 15 per cent withholding tax on the distribution of profits or dividends from the transaction.
The rules were especially advantageous to the banks, as being "thinly capitalised", with debt of up to 97 per cent on their balance sheets, they could write off huge interest costs from raising debt overseas while qualifying for a reduced tax liability on the income generated by the deals.
The return on the investment would be treated by the banks as exempt from tax because the profits were paid from the overseas company to its parent company, also overseas. Alternatively, they claimed they did not have to pay tax because of foreign-tax-credit rules.
- NZ HERALD STAFF / BUSINESSWIRE