BNZ bill might go up to $820m

The Bank of New Zealand could face an even bigger bill after losing its $654 million case against the Inland Revenue Department, perhaps more than $820m in total.

Australian sharebrokers JP Morgan estimate that as well as the back taxes and interest, penalties of between 20 per cent and 40 per cent could also apply to the BNZ case. At the top end that is worth $166m for the IRD, on base tax of $416m, excluding interest.

On the total $654m, excluding penalties, the tax bill could be covered out of annual BNZ profits, according to BNZ chief Andrew Thorburn. BNZ made $785m last year.

JP Morgan says at $654m, BNZ parent company National Australia Bank's final dividend forecast of A73 cents a share should not be under pressure. But there are potential tax penalties and NAB also faces other tax liabilities in Australia.

So, the all-up bill for BNZ could be between $737m and $820m if it ends up losing to Inland Revenue.

JP Morgan notes there are five tax shortfall penalty levels, ranging from "lack of reasonable care" which involves 20 per cent of the shortfall to outright evasion which is 150 per cent of the shortfall. The broker suggests the BNZ case will fall into the lower penalty category. IRD declined to comment on possible penalties in the case.

Given the amount at stake, the multimillion-dollar cost of running a fleet of top lawyers at more than $600 an hour each, pales into insignificance.

It is a sure bet that the BNZ case and all the others involving the big banks and the structured finance deals will go all the way to the Supreme Court, probably taking another two years.

It is also likely that all the banks will try to keep profits as high as possible to cover the potential tax bill, rather than compete hard for customers by lowering interest rates and fees.

The tax and interest bill for all the banks is already sitting at $2.4 billion including BNZ, ANZ National, Westpac, ASB and Rabobank. The deals are thought to be relatively similar.

It is not just the amount of money at stake. There are reputations at stake for the bank executives and their boards of directors.

It is not a good look to have signed off on what Inland Revenue calls a "rort" in BNZ's case and a massive one at that.

In his ruling against BNZ this week, Justice John Wild was merciless in his language about the transactions in dispute. They had "no commercial rationale, logic or purpose". That looks like a hard line to come back from, although banking sources said they were not surprised by Justice Wild's decision.

One tax expert said the judge seemed "very persuaded" in the IRD's favour because BNZ was not making a pre-tax profit on the transactions.

If it was not a logical commercial transaction, it then must be "tax avoidance", the expert said.

The other bank transactions may be different, and may be on firmer ground if those transactions did make a pre-tax profit for the banks.

But there seems now a two-stage test did the deal meet the black letter of the law and was it an intended result of the law as Parliament intended? (The tax bill about to go through Parliament will finally close the door on such structured finance deals.)

There are still smart ways for big companies to reduce their tax bills fairly, but the BNZ case shows the method has to be commercial in the first instance otherwise it will get thumped, according to Deloitte's tax partner Greg Haddon.

Lowering tax costs gave a better return to shareholders so companies were almost obliged to try to do that, Mr Haddon said. "There are still significant opportunities out there."

Inland Revenue was already taking a harder line on tax avoidance generally, and the BNZ victory would give IRD support on that stance, he said.

The banks are also facing tougher times, with rising bad debt levels because of the recession. That means it is better for them to run the legal dispute as long as possible, rather than cough up the money when profits are already down, banking sector sources said.

It may be another two or three years for the cases to go all the way through the Court of Appeal and then to the Supreme Court.

Not the least because the banks thought the "structured financial transactions" from the late 1990s onward were all tickety-boo with IRD they had a ruling to go ahead.

It is understood that IRD carried out a regular audit on BNZ during the period in question and after many months of going through the books agreed everything was OK. Only later was there an internal argument within IRD about the structured finance deals. Those who were against them finally won out.

It seems that was because the tax from the big banks accounted for about half of all corporate tax. The structured finance deals risked a massive erosion of the New Zealand tax base.

If the banks were only paying a 20 per cent tax rate as the BNZ did, not 33 per cent, then all the other taxpayers have to make up the difference. For Joe Average there is no choice but to fork out GST and income tax to pay for schools and hospitals.

- © Fairfax NZ News