Tax Avoidance: Westpac v. CIR

Nine structured finance transactions involving funds totalling $4.36 billion engineered by Westpac Bank have been struck down by the High Court as tax avoidance. As a result, Inland Revenue has clawed back tax due and use of money interest totalling $961 million.

Westpac has suffered a similar fate to a tax case lost by the Bank of New Zealand last July. But learning from the BNZ case, Westpac concentrated on two narrow issues: the deductibility of a guarantee procurement fee (GPF) paid by Westpac as part of the structured finance transactions, and; whether an interest deduction could be legitimately claimed for the cost of funds borrowed to finance the transactions.

The common template used for these transactions saw a loan structured as an equity investment in offshore special purpose vehicles. The equity investments took the form of redeemable preference shares, structured so that the dividend paid was deductible for the issuer but was received tax free by Westpac as the shareholder.

This had the economic effect of having Westpac offset substantial expenditure against its New Zealand sourced income, with the counterparty who issued the preference shares able to borrow at significantly below market rates.

As part of the deal, Westpac paid to the counterparty a GPF fee to guarantee repayment of the preference shares on redemption. Tax benefits claimed for the GPF fee alone amounted to $176 million, or nearly 30% of the tax benefits claimed by Westpac.

The High Court disallowed a deduction for the GPF fees, ruling that they had no commercial justification. There was expert evidence that the owners of special purpose vehicles used for such structured transactions routinely gave such a guarantee as a matter of course, with no fee payable.

Westpac’s claimed cost of funds led to the remaining 70% of the tax benefits claimed.

Westpac gave evidence that funding for the transactions came out of its general pool of funds managed by its treasury division and claimed that the Bank’s general funding costs should be an allowable deduction in respect of the structured finance transactions.

In disallowing a deduction for the cost of funds, the High Court ruled that while Westpac’s general pool was the immediate source of funds, there was distinct capital raising on the London capital markets in the months prior to a structured finance transaction. Each transaction was of such a size and duration that specific funds had to be raised and allocated in advance. At its peak, Westpac had 18% of its assets committed to the structured finance transactions.

The High Court ruled that the transactions were void for tax purposes as tax avoidance. Justice Harrison said parliament would not have contemplated that the tax deductibility provisions would be used to provide funding to a counterparty at a price considerably below market rates by returning a share of the domestic taxation benefit derived from claiming a deduction for a non-existent expense.

The deductions for Westpac’s cost of funds and GPF were disallowed. Justice Harrison added that Westpac might count itself fortunate that Inland Revenue did not disallow Westpac’s claim that the income on the redeemable preference shares was exempt income.

Westpac v. CIR – High Court (7.10.09)

12.09.001