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BNZ Final Judgment

On 15 July 2009 Wild J issued his final decision in the long running BNZ structured finance litigation. The decision is BNZ Investments Ltd v C of IR (unrep, HC Wellington, CIV 2004-485-1059; CIV 2005-485-1045; CIV 2006-485-1028; CIV 2006-485-2084; CIV 2008-485-1056, 15 July 2009).

This is the second High Court decision concerning the application of the general anti avoidance provision since the Supreme Court decision in Ben Nevis Forestry Ventures Limited v CIR [2008] NZSC 115 (Ben Nevis).

At a very general level the litigation involved six cross border transactions all of which had the following broad characteristics. A subsidiary of the BNZ would acquire from a counter-party (characteristically with a stronger credit rating than that of BNZ) an equity interest in an overseas entity (“the issuer”) on the basis that the counter-party (or an associated party) would repurchase that interest (at the same price, subject to adjustments) at a specified time in the future (usually 5 years). The counter-party’s parent company guaranteed performance. BNZ’s subsidiary’s initial return was in the form of distributions from the issuer.

The return to the BNZ group and the overall balance of advantage between BNZ and the counter-party was a function of the agreed distribution to be made by the issuer to the BNZ subsidiary, and interest rate swap arrangement, a guarantee procurement fee (usually at 2.95% of the purchase price) paid by the BNZ subsidiary for procuring the performance guarantee from the counter-party’s parent company (“GPF”) and the bank’s borrowing costs.

Is there a logic glitch in the judgment?
The point of this posting is to explore whether there is a logic glitch in the judgment. In this regard some background is needed. Justice Wild correctly follows the Ben Nevis Supreme Court judgement and looks to see if the arrangement or parts of it generate tax benefits outside of the contemplation of Parliament. This is the correct approach methodologically because the majority judgment of the Supreme Court said at paragraph [109] that:

“The ultimate question [concerning the application of the general anti avoidance provision] is whether the impugned arrangement, viewed in a commercially and economically realistic way, makes use of the specific provision in a manner that is consistent with Parliament’s purpose.”

Accordingly Justice Wild considered the various provisions and regimes that the arrangement engaged with. In particular he looked at the conduit regime. That is a regime relieves a New Zealand resident company of liability to income tax under the controlled foreign company rules or the dividend withholding payment rules in certain circumstances. The judge’s analysis on this issue is contained at paragraphs [217] to [242]. The judge concludes that the arrangements were not within Parliament’s purpose with respect to the conduit rules: paragraphs [243], [488] to [497]. Other regimes are looked at too and reviewed but in order not to overly complicate matters I will ignore them. Additionally the point here is not to deal with whether the analysis of scheme and purpose of the Act is correct or not. This article focuses only on the adjustment under s GB 1 of the Income Tax Act 1994 (ITA) [GA 1 of the 2007 Act].

Having concluded that the arrangements are tax avoidance arrangements the judge moves on to consider whether the adjustments that the Commissioner has made are wrong. He does this at paragraphs [527] to [542].

The adjustments that the Commissioner had made were to disallow a number of expense items: interest and the guarantee procurement fee, net interest swap costs and the risk participation fee. The judge accepts in the judgment that these adjustments are correct.

Under s GB 1 of the ITA the Commissioner is empowered to counter act the tax advantage. Tax advantage is not defined in the Act except in a very limited sense that is not relevant here.

In Ben Nevis the majority of the supreme court found that the Trinity Scheme generated tax advantages that were outside the contemplation of Parliament because in essence the contingencies surrounding the liability to pay the promissory note concerning the licence premium were too great for it to be said that there was actually a cost as required by the depreciation provision to enable depreciation deductions to be claimed: see Ben Nevis paragraphs [117] to [130]. Similarly with respect to the insurance premiums they were not seen as falling within what Parliament had contemplated when enacting s DL 1(3) of the ITA because they were not truly paid or incurred in any real economic sense.

The adjustment that the Commissioner had made was to disallow those expenses. That adjustment was supported by the Supreme Court. There is an obvious link between the areas in which the Trinity arrangement generated tax benefits outside of the contemplation of Parliament and the resultant tax advantage that was counteracted under s GB 1 of the ITA [s GA 1 of the 2007 Act].

There is a logical connection between how the tax benefit has been generated outside Parliament’s contemplation and the concept of tax advantage. Given that tax advantage is not meaningfully defined in the Act it seems principled and logical to see the concept of a tax advantage in terms of the generation of a tax benefit outside of Parliaments contemplation. Having so generated a tax benefit the Act empowers the Commissioner to remove that benefit. There is thus a cohesion and linkage back to the purpose of the general anti avoidance provision which is to address tax avoidance which is basically generating tax benefits outside of Parliament’s contemplation: see Ben Nevis [paragraph [103] and [107].

In Ben Nevis there was a Charity that was used in part of the arrangement. The Charity was not used in a way that was outside of Parliament’s contemplation. It is suggested that it would not have been a lawful adjustment for the Commissioner to tax the Charities receipts under s GB 1 of the ITA because the Charity was not being used outside of Parliament’s contemplation.

Returning to BNZ the judge found that the conduit regime was not used as intended by Parliament. Hence in simple terms, items of receipt were not taxed when Parliament contemplated that they would be. The question raised is whether by disallowing the expenses under s GB 1 as opposed to taxing the receipts there is a logic glitch in the reasoning in the BNZ case. Should the correct adjustment be the taxation of conduit relieved income?

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