The High Court yesterday ordered the bank to pa' />

The Bank of New Zealand has lost what is believed to be New Zealand's biggest tax avoidance case.

The High Court yesterday ordered the bank to pay $645 million in back taxes and interest.

The decision relates to the bank's use of "structured finance" transactions.

The ruling, which the BNZ says it will appeal against, is bad news for four other banks that are also fighting the Inland Revenue Department.

The combined sum the tax department is seeking from BNZ, Westpac, ANZ National, ASB and Rabobank is about $2.4 billion.

Deutsche Bank has settled with the department.

Following a 13-week hearing in Wellington, which ended last month, Justice John Wild rejected BNZ's challenge to Inland Revenue's assessment that the bank owed it $416 million in taxes on six transactions executed between 1998 and 2005, when Parliament passed a law against their use.

"The transactions were structured to allow the BNZ to deduct its expenses of earning the income gained on the investment, while receiving that income free of tax," the IRD said.

In his decision, delivered yesterday, Justice Wild said that apart from their tax benefits, "these transactions had no commercial rationale, logic or purpose for the BNZ".

BNZ chief executive Andrew Thorburn said yesterday that the bank was clearly disappointed by the ruling.

He expected BNZ would appeal against the decision.

But if the appeal and any subsequent action in the Supreme Court failed, BNZ could "certainly" pay the $645 million, Mr Thorburn said.

"We can pay it from this year's profitability."

Last year, the bank had a net profit of $785 million.

Massey University head of banking studies David Tripe was unable to comment yesterday as he is a witness in a current case between Westpac and the IRD in the High Court at Auckland.

But he has previously told the Herald On Sunday that should the banks lose their cases, customers could suffer.

"If the banks didn't win, they would like to recoup the money through interest margins, fees and charges," he said.

"If the banks lose, we will pay."

Mr Thorburn yesterday denied that was likely, saying the market was too competitive.

And the decision would not colour the Australian-owned BNZ's view of the New Zealand market.

"The bank's been around a long time and there's always various commercial and legal issues - that's part of doing business.

"We've got an open economy, with appropriate regulation and governance, and that's come into play here. We remain very committed to New Zealand," Mr Thorburn said.

Mark Keating, an Auckland University senior lecturer in tax law who has given advice to the IRD on the structured finance transactions, said Justice Wild's decision showed that although the BNZ transactions were clever, they crossed the line.

"These transactions ... were very, very clever. They absolutely complied with the law, they were crafted by very intelligent and skilled people, but at some point they became too clever and the court said they crossed the line."

The decision did not ruin the other banks' chances of winning their cases, "but it's influential because judges don't like to disagree with each other".

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.