IRD vs the banks

June 15th, 2009 at 8:29 am by David Farrar

The Dom Post reports:

The Inland Revenue Department is asking the High Court to rewrite tax law in a $641 million tax avoidance case between it and the BNZ, the bank says. …

And:

BNZ is the first of the four main trading to challenge Inland Revenue’s claims of tax avoidance by using so-called structured financial transactions, involving foreign financial institutions between 1998 and 2002. The have been assessed to owe about $2 billion in unpaid taxes and interest. Inland Revenue claims the transactions generated tax losses through fees and hedging costs which the bank then used to offset other taxable income.

But BNZ’s lawyer Alan Galbraith, QC, said in his closing submissions to the High Court at Wellington that Inland Revenue’s case was “fundamentally misconceived” in the legal interpretation and tests, and the commercial and economic reality of the deals. Inland Revenue had also incorrectly inferred that, if Parliament had mistakenly failed to bar the use of structured financial transactions in tax legislation, the court could remedy the situation.

There is a lot at risk with these cases. I understand from informed sources close to one of the banks, that they have offered to settle the case for around $500 million. Informally it seems this was acceptable to Ministers, but that Crown Law was strongly against any settlement.

I understand that until the cases are resolved, there is considerable uncertainity over funding arrangements for the banks, and this is partly why interest rates are not dropping more.

I don’t know the strength of the Government’s case, but I imagine questions will be asked if they lose the case, after declining half a billion dollar settlement. And if the banks do lose, I suspect it will end up in the Supreme Court in a few years. And the problem is that until we get a final Supreme Court ruling, uncertainity may remain.

UPDATE: An informed source tells me that the Government is not facing much risk due to the Supreme Court decision in Trinity. They agree it will go to the Supreme Court but are very confident that the cost of doing so will be a small fraction of the eventual judgement.  Also that generally can not agree to part settlements – only to reduce or waive penalties.

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30 Responses to “IRD vs the banks”

  1. Ross Nixon (607 comments) says:

    Well we know that lawyers don’t like early settlements. Dragging cases out helps them save for the essentials of life (weekends in Paris, a new yacht etc).

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  2. alex Masterley (1,489 comments) says:

    Who-ever looses it will be off to the appeal courts.

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  3. wreck1080 (3,722 comments) says:

    there will be no shortage of 1000 dollar per hour lawyers on this, billing more than 40 hours a week.

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  4. Dougal (11 comments) says:

    When will the media learn that there are no “Trading Banks” anymore. The correct terminology is Registered Bank

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  5. Don the Kiwi (1,580 comments) says:

    Both IRD and the banks are a pain in the butt.

    But at least you can borrow money from the banks. Try doing that with the IRD.
    They screw you for your “own” money, and claim its theirs.

    Arseholes !!!

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  6. burt (7,791 comments) says:

    Don the Kiwi

    You can borrow as much money from IRD as you want when you are above the law. No interest, no penalties and you can take as long as you like to repay it (if at all). Move on!

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  7. insider (1,000 comments) says:

    “I understand that until the cases are resolved, there is considerable uncertainity over funding arrangements for the banks, and this is partly why interest rates are not dropping more.”

    I suspect that is spin from a bank given these particular structured finance deals have not been used for years when the rules were changed. There can be no uncertainty that those types of deals are no longer allowed.

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  8. aardvark (417 comments) says:

    The IRD is the single most powerful arm of the state.

    They have more draconian and far-reaching powers than the SIS or the police.

    That is because they are charged with funding the public trough and that, by decree of parliament, is far more important than protecting the nation’s security or saving its people from the actions of criminal activity.

    Because the IRD is the source of the government’s lifeblood (money), their often overzealous (to be kind) actions are frequently overlooked by the government of the day on the basis that it would be silly to bite the hand that feeds them.

    For the IRD to ask the courts to effectively rewrite the law shows the extent to which the IRD believes that *it* is above the law by which the rest of us must operate.

    If the law provides a loophole for the banks to get away with reduced tax then that’s not a good thing – but it would be a far worse thing for the IRD to start dictating to the courts just how the laws ought to be (re)written.

    If the IRD doesn’t like the law then they ought to go to the politicians, not the judges.

    Just as the IRD claim “it’s nothing personal” (cue Tui’s ad) they are “only there to enforce the legislation”, so they must concede that our judges are only there to do the same and should not be asked to do anything else.

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  9. Adolf Fiinkensein (2,787 comments) says:

    Insider, you may well be right BUT I suggest the spectre of a two billion dollar contingent liability would be likely to increase these banks’ risk profiles with international creditors.

    Messrs Key and English should be sending a loud message to IRD to stop buggering about and settle.

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  10. insider (1,000 comments) says:

    ADolf

    That liability will have been on their books and accounted for for years. It will be years before it gets paid, if ever, and is a fraction of their asset base. Given they are the most profitable banks in the western world I suspect their risk profile is slighhtly less than plenty of other banks around. I doubt it has had any great impact.

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  11. gd (2,286 comments) says:

    One thing we can be sure of it that borrowers will be paying the costs of the lawyers and the penalties if the Banks lose the case

    When Oh when will the pollies civil servants and dear old Alan fess up and admit they have no control over interest rates in NZ just like they have no control over fuel prices or any number of commodities.

    To see the select committee huffing and puffing last week would have been funny if it wasnt so pathetic

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  12. KiwiGreg (3,169 comments) says:

    @insider all the affected banks have provided (from memory in 2006-7.

    @aardvark the “courts rewriting the law” is just spin which always comes out when the relevant law used is the anti-avoidance law. The nature of tax avoidance REQUIRES compliance with the letter of all the law, but in a manner inconsistent with its “intent”. It is of course possible to debate that tax, being what it is, should clearly be imposed without the need and uncertainty of general anti-avoidance provisions.

    As insider points out, the ACTUAL law relating to these types of transactions has already been changed by the Parliament and the particular structures are no longer used.

    Banks are a vital part of the corporate tax system, my information is no doubt out of date but they used to make up more than 30% of actual corporate tax payments so IRD is pretty interested in how and how much they pay.

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  13. F E Smith (3,301 comments) says:

    Ross, the lawyers who urged rejection of the offer are all on a salary and make not one cent extra by continuing the case. The lawyers who advised the banks on making the offer are the one who will benefit, but they suggested a settlement.

    Of course, this is the same Crown Law office that said the EFA did not infringe the NZBORA. Contrary to popular belief, Crown Law do not employ the smartest lawyers in the country.

    They may have some trouble on this one.

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  14. peterwn (3,140 comments) says:

    From what I have read of the case I am all of the way with IRD on this one.

    There are two big issues here:
    1. The ordinary long suffering taxpayer must find it extremely galling that big business can virtually decide how much tax it is going to pay – the average employee has no scope for rearranging things to minimise tax.

    2. As far as the bank management is concerned being on the receiving end of IRD action is just like ‘another day at the office’ They simply ask lawyers to deal with it. In the case of individuals and small businesses, being on the receiving end of such action is a traumatic, stressful, emotionally draining and expensive business. It could mean financial ruin.

    The National government therefore owes it to its voter supporters to allow IRD to keep plugging away at this case if there is a reasonable chance of success.

    The actual issue facing the court is whether there is any commercial reason or justification for the questioned transactions apart from avoiding tax. If not the bank is caught fair and square unlawfully avoiding tax, like a possum in a car’s headlights. OK it used to be the case that if the taxpayer crossed the legal T’s and dotted the i’s, this was sufficient to escape an avoidance claim, but nowadays is there is any doubt or ambiguity in interpreting legislation the court mus interpret it (among other things) ‘in the light of its purpose’. I beg to differ with the bank’s QC but over many years when Parliament has enacted tax legislation it had never intended taxpayers to avoid tax by relying on fine points of interpretation of tax law.

    DPF seemed to imply that Crown Law woud not let the Government accept an out of court settlement. It is quite obvious to me that Crown Law provided cogent reasons why the IRD has a good chance of success with this one and to make sure IRD is not monkeyed around in the future.

    The Trinity forest scheme which also involved dubious transactions was an outstanding victory for IRD right up to Supreme court level, right from when Venning J first laid into the scheme (the organisers tried to have him removed because they feared he was going to get stuck into them with costs. That success has no doubt emboldened IRD and Crown Law in the present case.

    The Courts gave Mr Petrovitch (Bridgecorp) short shift concerning his Porche and related matters and he must be trembling in his shoes at the thought of the further treatment that the courts will be dishing out. Hats off to the judges for thaing a strong stand in such cases and not letting miscreants hide behind the finer points of the law.

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  15. aardvark (417 comments) says:

    F E Smith, what you forget is that regardless of whether the IRD’s lawyers are salaried or not, they operate in a culture that is different to any other.

    They have limitless funds and time available to them so are not constrained or influenced by the factors that may influence others.

    They see nothing wrong with spending millions of taxpayer dollars to prosecute what they believe is a transgression of the tax law — because they probably measure their own performance by the number of successful prosecutions, not the ‘best outcome for the nation”.

    In this way they are very similar to ACC who will spend a million on legal action in order to save a thousand dollar pay-out.

    Having seen first hand how the IRD culture can work, I would say that it’s now a grudge-match on the part of the IRD.

    They don’t like to lose.

    I recall that when I appeared in court against the IRD, the judge tore a strip of the IRD’s lawyer. I thought I’d won, but as I left the courtroom a woman in a small contingent of IRD staff near the door stopped me and said “we’ll get you”.

    That’s how the IRD works in far too many cases.

    It’s got more to do with demonstrating their might and power against those who would challenge them (especially if that challenge is successful) than anything to do with enforcing the law.

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  16. KiwiGreg (3,169 comments) says:

    @peterwn there is no real comparison between the Trinity scheme and the banks’ funding schemes in my view. I would suggest that Trinity only went to court at all because the promoters were lawyers. Otherwise is looked like a lay down mezzaire for the IRD to me.

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  17. F E Smith (3,301 comments) says:

    Aardvark, you are absolutely right. In fact, if you replace the words ‘IRD’ in your last comment with ‘the Crown’ then you have pretty much summarised the difficulty defence lawyers face. Bain showed what a well resourced defence team can do when it has a more level playing field than usual to work with.

    In this case Crown Law is more than happy to continue precisely because they have no accountability to anybody other than the already house trained justice minister and the pack of fascists in the justice ministry.

    My point was, of course, that in this instance the privately instructed lawyers wanted to settle and the crown is wanting to continue. I am waiting for the accusations that the Crown is rorting the system to begin…

    But your comment shows accurately the thinking of the IRD. in general, that attitude is also shown by ACC and CYFS. Lawyers generally dislike dealing with any of those three agencies.

    Surely the Crown should have accepted the offer and then closed the loophole, if it genuinely is one. legislatively? That would have been much cheaper for the government, at least.

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  18. wreck1080 (3,722 comments) says:

    So, peterwn, if I move my cash from my high interest savings account, into my PIE account just for purposes of saving tax, then that is tax avoidance.

    People rearrange financial stuff every day to minimise or ‘avoid’ tax . Not sure how the ird decides what to prosecute.

    Sounds like a lottery to me (much like immigration).

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  19. alex Masterley (1,489 comments) says:

    FES,
    I concur absolutely with your comments about dealing with those crown agencies.
    I go out of my way to avoid them or any lawyer in government service.
    I would have thought the new AG might have cast his beady eye over the proceeding and offered his 2 cents worth to cabinet.

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  20. KiwiGreg (3,169 comments) says:

    DPF – IRD can agree to settle once a matter is in court much like any other litigant. They can also settle without a court case but there are some statutory tests they need to meet.

    My guess is the settle/don’t settle issue is far more about the legal precedent a decided case will have than the actual cash as that is what will be real important to IRD as an enforcement agency.

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  21. peterwn (3,140 comments) says:

    wreck 1080 – Selecting investments, etc for tax minimisation is OK – one is not entering into ‘schemes’ to avoid tax. In the PIE case the tax advantage is available to all who take it up with Parliament’s blessing – it is not tax avoidance.

    There are probably some grey areas. A family trust is OK as long as it is set up in an acceptable manner and proply cared for. A farmer got ‘done’ by IRD some years back because he had a common account for everything and things only got split up when the accountant did end of year accounts – IRD declared the arrangements a sham and hence void. Trinity and BNZ IMO went right beyond the pale.

    KiwiGreg – the Trinity scheme IMO has everything to do with the BNZ scheme. They both involved artificial arrangements which served no other purpose than to avoid paying tax – this is why BNZ are going to lose out big time IMO – the piggies will go to the works OK. Venning J took a hard line with Trinity and was upheld by the Appeal and Supreme Courts. The BNZ lawyer is pretty well reduced to waffling. The judge in the BNZ case will be taking very careful note of the SC Trinity judgment.

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  22. MM (5 comments) says:

    Peterwn, I think you’ll find that an agreement with your bank to invest in a PIE would satisfy the definition of “arrangement” in the Act. You don’t need a “scheme”. Similarly, in BNZ’s case the Income Tax Act says that companies can deduct their interest costs regardless of what the interest relates to – it’s called the “global deductibility rule” because Parliament has made a policy decision that it doesn’t matter what the debt which the interest is uncurred on is used for.
    I am not saying that the banks will necessarily win, but your analysis is very simplistic. When you say the BNZ lawyer is “waffling” I think you’re far from the mark. The reports of the submissions suggest that its the IRD who is using ridiculous emotive language like “tax rort” and “magical tax machine” (I kid you not. “magical tax machine” was a term used in a Court in this courty by a leading silkl. How’s that for legal analysis?!).

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  23. Phil (125 comments) says:

    peterwn/wreck,

    Actually, PIES’s are tax avoidance… And there’s nothing wrong with that at all.

    The illegal stuff is defined as ‘Tax Evasion’ which is a different kettle of fish all together.

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  24. MM (5 comments) says:

    Tax avoidance is illegal too, hence the whole case and article that this thread is about.

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  25. peterwn (3,140 comments) says:

    MM – I never said that a PIE investment or any other in ivestment needed a scheme. By a scheme I mean a set of transactions designed to fulfil some purpose. If it is a genuine commercial transaction, but happens to reduce the incidence of tax, then fair enough. However in both Trinity and apparently in BNZ thare various transactions that save tax alright, but apart from this have no commercial purpose. It is such transactions that both Parliament and IRD want to see clobbered. That is why IMO the bank’s QC is wrong, but he is merely trying to damage control on behalf of his client.

    Years ago the judges tended to ‘gut’ anti avoidance provisions such as a very old section 108 then a Section 99 etc etc. Judicial attitudes have changed significantly over the years from the Law Lords down. In the past Parliaments intentions and ‘purpose’ meant little – now they mean everything.

    It was not that long ago that if a lawyer in court or the judge referred to Hansard or Select Committee reports without the Speaker’s approval, that was a contempt of Parliament. Several years the Speaker ruled that there was no objection to courts referring to such material and NZ Parliament quickly followed suit. Such references are now commonplace.

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  26. MM (5 comments) says:

    So I have my money on deposit and instead I put it in a PIE. What’s the commercial purpose? To make an investment with the best possible tax treatment? Yes, surely?

    That’s what the banks were doing – making an investment with the best possible tax treatment. The IRD drafted legislation that said you can deduct your interest costs REGARDLESS OF WHETHER YOU EARN EXEMPT DIVIDENDS. So the banks entered into these investments (which is what banks do). Sorry, but I don’t see how that’s different to investing in a PIE. Someone at IRD underestimated the financial cost of these transactions. Their fuck up, not the banks’. Not to mention the positive binding rulings the IRD gave on the transactions that were identical, except paid tax in NZ.

    Parliament’s purpose is what exactly? The Parliament that came up with the anti avoidance provision? The interest deductibility rules? The conduit rules? Should we go back and ask each MP what they think of the transactions?

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  27. wreck1080 (3,722 comments) says:

    Peterwn, I’m still confused about this tax avoidance stuff.

    I saw a tax lawyer a few years ago, and he recommended a method to get around the 80/20 attribution rule. This basically involved me paying a friend a large amount of cash, and him paying me the same amount back.

    It sounded dodgy to me, so I didn’t go through with it. But, according to the expensive lawyer (part of a large law firm) it was a completely legal way to lessen my tax payable. But, under your definition it would not be legal as there was no real commercial purpose other than to avoid tax.

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  28. peterwn (3,140 comments) says:

    wreck1080 – I would agree that it sounds dodgy and may well have relied on being under IRD’s radar. Now there is this (allegedly) smart commercial lawyer who used to be a partner in one of the big firms and left to form his own firm with another guy. He concocted the Trinity scheme and at IRD’s and Venning J’s hands it turned to custard big time leaving many investors wailing and gnashing their teeth, I think some will have to declare bankrupcy. That lawyer just did not see it coming. If hat is not enough he has to fork out about $1M costs following an unsuccessful legal spat with Westpac on another matter. The judge was so unimpressed he awarded Westpac indemnity costs (ie nearly ‘full’ costs) than a portion usually awarded, and the Appeal Court upheld this.

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  29. Tauhei Notts (1,601 comments) says:

    I think the case that involved, I think, an orthopaedic surgeon practising in a company structure, could signify a change in the judiciary’s attitude to tax avoidance. The case I am referring to seemed to overule case W33 from the Taxation Review Authority. I always thought that Case W33 was silly. And more so as it only arose from that sullen Cullen’s envy tax.
    A flat tax rate; it would be so much easier.

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  30. wreck1080 (3,722 comments) says:

    What happened to the days when a tax loophole was a tax loophole?

    Flat tax would be brilliant. As would removing tax on savings.

    Lift GST to compensate and then I will be happy.

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