BNZ wins $180m tax test case

The High Court has found that the Bank of New Zealand was not engaged in tax evasion by channelling investments through the Cook Islands tax haven in the 1980s.

Failure to win could have cost the bank more than $180 million.

However, Inland Revenue is to appeal against the verdict in what was a test case relating to redeemable preference share investments.

The case was not related to the controversial Winebox deals that were the subject of a commission of inquiry in the mid-1990s.

In September 1988, BNZ subsidiary BNZ Investments made a series of redeemable preference share investments in a scheme initiated by Capital Markets Ltd, a subsidiary of merchant bank Fay Richwhite.

Preference shares entitle a shareholder to payments ahead of other shareholders when it comes to receiving dividends or in the event of a liquidation.

The money from the investments was deposited through a complex web of companies and transactions with overseas banks. Interest was returned to the BNZ as tax-exempt dividends.

Inland Revenue deemed that the scheme was set up to avoid tax and so treated the dividends as taxable. It assessed the unpaid tax at $135.7 million, plus additional tax of $44 million, and was also seeking interest since 1989.

After deregulation of financial markets in 1984, investment in redeemable preference share schemes became common, because of a tax loophole. By 1987 the BNZ had $500 million invested in schemes of that type.

In September 1988, the BNZ invested in such a scheme arranged by Capital Markets. The BNZ said it did not know the details of the scheme as Capital Markets was secretive.

The main issue of the case was whether the deal should be seen as one arrangement or two, that is, whether the BNZ should be taxed on the basis of what Capital Markets did, even though it did not know what that was.

In the High Court at Wellington, Justice McGechan concluded that the Capital Markets scheme was all about tax avoidance, but the part the bank knew about was not.

John Fogarty, QC, for the Inland Revenue Department, argued that the arrangement was all one. The redeemable preference share market was built on the exploitation of tax losses, and even if the BNZ were unaware of the details of the scheme, it would have known that.

But Justice McGechan preferred the BNZ's argument that it could not be dragged into a multistep arrangement it did not know about.

Alan Galbraith, QC, argued for the BNZ that the transactions it had carried out were routine and it had good grounds to believe CML would be involved in conventional preference share investments.

On the deal as a whole, said Justice McGechan, there was no reason for the complicated structure except to avoid tax. Indeed, tax avoidance was necessary if the whole scheme were to work.

But from the BNZ's perspective, the scheme was about preference share dividends which were legally tax exempt. The BNZ was not getting a tax advantage but an economic advantage, and the two were not the same, the judge said. He found in favour of the BNZ but reserved his position on costs.

- NZPA