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IRD should have doubled claim against Watson's Cullen Group - Professor

Tuesday 21st May 2019

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Inland Revenue Commissioner Naomi Ferguson should have asked the courts for twice as much as it was awarded earlier this month against Eric Watson’s Cullen Group, according to a University of Auckland law professor.

The High Court ordered Cullen to pay non-resident withholding tax of $51.5 million plus interest of $60.5 million and as yet unquantified penalties.

Cullen is appealing that decision.

Watson-controlled Cayman Island-based trusts had paid only 2 percent in tax under the Approved Issuer Levy, a tax regime aimed at encouraging foreigners to lend more to New Zealanders.

But rather than identifying the unpaid tax as tax on interest, IRD should have treated Cullen’s tax avoidance scheme as designed to avoid income tax, says Professor Michael Littlewood.

“The commissioner is to be congratulated on her victory and one hesitates to criticise a litigation strategy that has proved successful,” Littlewood says in a paper on the case.

“The aim of this brief article, however, is to suggest that the aim of the scheme was actually to reduce the taxpayer’s liability to tax not by $51.5 million but by about $103 million,” Littlewood says.

While it’s too late for the Cullen case, “the issue is worth addressing because it has arisen in other cases in the past," he says.

"It will almost certainly arise again in the future and there is every reason to suppose that significant public revenues are consequently at risk.”

In the words of Justice Matthew Palmer of the Auckland High Court, Watson used “a web of entities” to avoid paying tax after moving to Britain in 2002. They were set up by his advisor, Campbell Rose, then a tax partner at Russell McVeagh and from 2012 a tax partner at Deloitte.

The entities included the Cayman Islands-registered Modena and Mayfair Trusts, River Group, Tower Trust, Elizabeth Equities and The Valley Trust.

Using these entities, Watson’s equity in Cullen Investments was converted into debt of $291 million loaned to Cullen Group which then paid 16 percent interest on those loans to the Modena and Mayfair Trusts.

Justice Palmer noted that Cullen Investments had told third-party financiers in 2002 that “the change is an internal reorganisation and has no practical effect on the control of Cullen and its group of companies.”

While IRD had argued that these arrangements had avoided non-resident withholding tax - NRWT - on the loans, “the commissioner’s analysis seems wrong or, at best, misleading, for the key to understanding the case is that the taypayer’s aim was not to escape NRWT, charged at 15 percent, but to escape income tax, charged on companies at 28 percent,” Littlewood argues.

IRD says it can’t comment because the matter is still before the courts and because it has to follow tax secrecy rules.

However, Tori Sullivan, NZ Law and Tax Controversy Leader at accounting firm EY, says “there are many ways of skinning a cat” and that IRD was probably wanting to avoid time bars and that it couldn’t have gone back as far if it had pursued unpaid income tax.

Littlewood’s view of the case is understandable from an academic perspective. “I can see what his point is, but there’s a whole lot of other factors you have to take into account,” Sullivan says.

“The problem is it could cause problems from a time bar perspective” if the IRD had gone after unpaid income tax. “Income tax would have been time-barred and you couldn’t have gone back as far.”

Littlewood acknowledges that "perhaps there was some procedural obstacle, such as the time bar" that explains why IRD didn't pursue unpaid income tax.

But if IRD has lost so much money “because of procedural problems, it seems likely that the explanation is either the legislation is deficient or that the commissioner’s resources are inadequate," he says.

"Either the law should be amended or the commissioner’s budget should be increased.” 

Littlewood says New Zealand’s tax professionals are “likely to find objectionable” much of his arguments and to argue that the law should be interpreted to produce “a less harsh result.”

He quotes Lord Wilfred Greene in a 1942 tax case: “It scarcely lies in the mouth of the taypayer who plays with fire to complain of burnt fingers." 

“Nothing has changed since,” LIttlewood says


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