Beleaguered rich-lister Eric Watson will likely remain embroiled in courts for years — and faces the possibility of a tax bill of $200m when penalties are added — after a landmark court decision yesterday saw his businesses ruled to have engaged in $51.5m in tax avoidance.
Justice Matthew Palmer said a complex 2002 transaction — involving Cayman Island companies while Watson himself was relocating from New Zealand to the UK for tax purposes — was an avoidance arrangement.
The case is one of the largest tax judgments in New Zealand history. Watson's Cullen Group was ruled liable for $51.5m in back taxes, plus interest and penalties.
During a three-week trial last year the court heard Inland Revenue considered interest costs alone amounted to $60.5m. Penalties were yet to be quantified, Palmer said.
Tax consultant Terry Baucher said Inland Revenue had the ability to impose up to 100 per cent penalties if it decided the tax position was "abusive", raising the prospect of a tax bill exceeding $200m.
Baucher said the sums involved — the "substantial" ruling was likely the country's largest tax case since banks settled with Inland Revenue for $2.2b in 1998 — meant years of appeals were inevitable.
David Cooper, who represents Cullen Group at the High Court, said his clients had not made any decision about whether to appeal. "They are considering the judgment and don't want to make any comment at this point," he said.
The consequences for Watson personally from the ruling are unclear, but they represent another setback for the increasingly embattled businessmen.
Since becoming a society page fixture in the 2000s with lavish living and relationships with lingerie models, Watson has since faced fallout from the collapse of Hanover Finance and a succession of losses in high-stakes court proceedings against fellow mogul Sir Owen Glenn.
Over the past few years he has moved to cut business ties with New Zealand, floating the Bendon underwear company, along with selling up his real estate portfolio and his stake in the New Zealand Warriors.
The ruling is a significant milestone in a protracted legal struggle. A trial last year heard Inland Revenue's interest in Watson stretched back more than a decade with proceedings having their origin in a 2004 audit of the rich-lister.
Inland Revenue legal services leader Karen Whitiskie said the decision was the "culmination of a lot of hard work by many people".
"The outcome of the High Court process is the result of hard work and dedication by the Inland Revenue team, Crown Law and Counsel. This was a long-running issue and shows the dedication of our people in unravelling what went on," she said.
Questions sent to Watson's representatives by the Herald yesterday either went unanswered or were met with no comment.
At the core of the dispute between Watson's Cullen Group and Inland Revenue were corporate manoeuvres beginning in 2002 that saw Watson transfer the ownership of the bulk of his business empire — said at trial to be worth $291m at the time — to the newly incorporated Cullen Group.
The transaction was paid with related-party vendor finance, with loans made by what Palmer described as "conduit companies" Modena Holdings and Mayfair Equities registered in the Cayman Islands.
The move — with Modena and Mayfair being not technically "associated persons" — meant only a 2 per cent levy under Approved Issuer Levy (AIL) regime was paid on the transaction rather than a 15 per cent Non-Resident Withholding Tax.
Inland Revenue contended the AIL regime was intended to facilitate foreign direct investment into New Zealand, and its use in a transaction like this was outside the contemplation of Parliament.
The case boiled down to a contention from Cullen Group that it had scrupulously followed the letter of tax laws, while Inland Revenue relied on a "general anti-avoidance provision" allowing it to assess the use of specific tax provisions with the intent for which they were brought into law to determine if arrangements were artificially contrived to avoid tax. Justice Palmer said this provision was to "prevent avoidance of the law by clever tax lawyers and accountants".
"I consider the use of the AIL regime by this sort of arrangement ... was not within Parliament's contemplation of purpose ... The success of Mr Watson and his advisers in bringing the arrangement within the terms of the specific AIL provisions does not mean Parliament contemplated that would or should occur," Justice Palmer said.
The judge found Watson was a central figure in all entities involved in the transaction — including a handful of other trusts — and taken as a whole they were "highly-related parties".
"In reality, Mr Watson was on both sides of the loan transaction," Justice Palmer said.
Cullen Group had challenged the assessment of avoidance, and also argued Inland Revenue had calculated tax owed unlawfully and had taken too long to do so therefore its claim was time-barred. Justice Palmer ruled that Cullen Group's challenge had failed on all counts.
Lawyers for Cullen Group argued the transaction wasn't intended to avoid tax, but rather that Watson needed to sever local ties in order to abandon NZ tax residency and qualify for non-domiciled status in London.
Justice Palmer also rejected this argument. "Selling [Cullen Investments] shares for this purpose did not require the complex structure set up in the arrangement, particularly the use of Modena and Mayfair."
How the case unfolded
• May 2002: Eric Watson relocates to London, ceasing New Zealand tax residency.
• November 2002: Watson transfers ownership of his $291m business empire to Cullen Group, through the use of Cayman Island entities and related-party loans. Transaction structured to fall under Approved Issuer Levy regime and pays only 2pc tax.
• April 2010: In a disputed move Inland Revenue assesses Cullen Group as having improperly used AIL regime, should have been subject to a 15 per cent tax, and says $60m in back taxes owed.
• February 2016: Inland Revenue adjudication report concludes with a view that Cullen engaged in tax avoidance.
• April 2016: Cullen commences court proceedings challenging Inland Revenue's assessment.
• August 2018: Three-week trial in the High Court.March 2019: Justice Matthew Palmer dismisses Cullen's challenge, orders payment of $51.5m, plus interest and penalties.