The BNZ tax avoidance case highlights transfer pricing pitfalls
Whilst all the focus on The BNZ High Court tax case that was handed down in July was around tax avoidance, one of the key outcomes of the case highlights the need to be vigilant in pricing transactions involving overseas parties.
The BNZ case involved tax, interest and penalties in excess of $650 million and precedes several other bank cases currently being pursued in the courts by the IRD. The total amount of tax at stake is believed to be greater than $2.4 billion relating to what are so called “repo” deals or structured finance transactions.
The transfer pricing aspects of the case particularly assisted Justice Wild to conclude that the transactions were tax avoidance.
Transfer pricing is the internationally accepted terminology for the requirement that related party cross border transactions be carried out at arms length pricing. It is rated as the number one tax issue facing multinational businesses, both from company and revenue Authority perspectives. And it’s easy to see why. Whilst the tax at stake in the BNZ case is significant, it pales into insignificance to the dollars at stake in current overseas transfer pricing disputes, which in most cases becomes a direct cost to the bottom line of business profitability.
While strictly speaking the New Zealand transfer pricing legislation was not actually applied in the BNZ case, the cornerstone principle of arm’s length dealings enhanced the Judge’s view that tax avoidance was present:
“… none of the transactions, taken either as a whole or in terms of the components, is reasonable or defensible from a commercial or economic point of view.
…
In my view, the six transactions were not determined as part of an arms length market driven process.”
The Judge was not impressed that two experts’ evidence, one in support of the BNZ, the other representing the IRD, found that the fixed swap rates used in some of the transactions were outside market rates.
An analysis of the pricing of a guarantee procurement fee charged was undertaken to establish whether the transaction was at arm’s length. The Judge concluded that the transactions generated the claimed expenses in a contrived or artificial way, finding that the 2.95% p.a. guarantee procurement fee was itself a contrivance. A guarantee from the parent of the counterparty would have been forthcoming for no fee, or for a fee of no more than 0.65% p.a. This represented an excess payment in the order of 350% above market prices.
The Judge also considered BNZ also contrived to set the fixed rate on the interest rate
swap at the highest rate it thought defensible, and in the case of some of the transactions this was significantly outside market parameters. The returns on the transactions to the BNZ and counterparties alike were substantially in excess of what could have been expected from a risk free (except for tax risk for the BNZ) investment via a structured finance transaction, negotiated at arm’s length.
The finding begs the question that if the transactions had been set based on arms length principles, whilst still enjoying the structured finance benefits of the cross-border transactions, whether the Courts would have found tax avoidance. Instead, the lack of sustainable cross border pricing lead to a tainting of the entire transactions, and the determination of tax avoidance.
Taxpayers should therefore take heed of the messages delivered in this case, which strike at the heart of all cross border transactions. Transfer pricing is a significant issue, and one which revenue authorities are throwing increased scrutiny into, particular with the economic downturn leading to a battle between different countries for their share of the tax take of any particular business.
At a minimum, businesses need to look at their cross border transactions and assess the risk they pose to the business, not just in commercial terms, but from attack by multiple revenue authorities. The last thing any business needs whilst it endeavours to ride the wave of financial uncertainty is to be exposed and unprepared for when the tax man comes knocking, as they inevitably do.
For further information, contact:
Paul Gallagher
Grant Thornton
T (04) 474-8500
E pgallagher@gtwn.co.nz