The High Court has dismissed a challenge to the Commissioner’s assessment in a multi-million dollar tax avoidance case involving Mr Eric Watson’s New Zealand company, Cullen Group Ltd (Cullen Group). In moving to the United Kingdom in 2002, Mr Watson restructured a significant shareholding into debt owed by Cullen Group to two Cayman Island conduit companies, all of which he still controlled to a high degree. This allowed Cullen Group to pay an Approved Issuer Levy (AIL) totalling $8m, rather than Non-Resident Withholding Tax (NRWT) of $59.5m. The High Court found this was a tax avoidance arrangement because it was not within Parliament’s contemplation and purpose in enacting the AIL regime. Cullen Group was liable for the $51.5m difference plus use of money interest and penalties.

The background

When moving from New Zealand to the United Kingdom in 2002, Mr Watson restructured his business affairs so his shares in Cullen Investments Ltd (CIL) were replaced by loans owed by Cullen Group to conduit companies in the Cayman Islands, Modena Holdings Ltd (Modena) and Mayfair Equity Ltd (Mayfair). The day after the 2002 transaction, as required under the loan agreements, Cullen Group applied for status as an “approved issuer” for the purposes of the AIL regime and applied to register its loans from Modena and Mayfair as registered securities. The Commissioner confirmed these applications.

Modena and Mayfair were not legally “associated persons” with Cullen Group so the arrangement fell within the provisions of the AIL tax regime. From March 2003 to November 2008, Cullen Group paid AIL at 2% of the $397m of interest it paid, or credited in account, to Modena and Mayfair, amounting to just over $8m.

Cullen Group made income tax returns but, except for dividend income of $12.6m received from CIL in 2005, did not return any income. It claimed its interest expenses from the loans from Modena and Mayfair as deductions and tax losses, some $108m of which was transferred to other Cullen Group companies by way of subvention payments and loss offsets from 2003 to 2009.

In 2010, the Commissioner assessed Cullen Group as liable for NRWT on the $397m of interest at 15%, amounting to around $59.5m. The Commissioner offset that by the $8m of AIL, at 2%, it had paid from 31 March 2003 to 30 November 2008. The resulting tax liability was around $51.5m. As at 27 August 2018, use of money interest on the $51.5m came to $60.5m.

Cullen Group challenged the Commissioner’s assessment. It maintained the arrangement restructured Mr Watson’s affairs in order to achieve certainty about his change of tax residence from New Zealand to the United Kingdom and to plan for application of the United Kingdom’s laws governing remittance of foreign-sourced income.

High Court’s decision

The High Court dismissed Cullen Group’s challenge and held that it was liable for the $51.5m of tax plus use of money interest and penalties. The Court found as follows:

  1. Viewed in the light of the arrangement as a whole, the use of the AIL regime by the Cullen Group was not within Parliament’s contemplation or purpose.
  2. Parliament enacted the AIL regime with the objective of encouraging investment in New Zealand by reducing the cost of New Zealand residents borrowing from non-residents (Vinelight Nominees Ltd v C of IR (2013) 26 NZTC ¶21-055, [2013] NZCA 655 1cited). That was pursued by exempting from NRWT the interest paid by some New Zealand borrowers to non-residents, a cost which was typically borne by the borrowers due to international market pressures.
  3. The arrangement in this case replaced shares in a New Zealand company (CIL) with loans to another New Zealand company (Cullen Group), which were assigned to overseas entities (Modena and Mayfair) in form but not substance.
  4. Mr Watson retained a high degree of control over the relevant entities and was on both sides of the loans. No new funds were introduced into New Zealand and speculation about counterfactuals did not change that.
  5. Viewed objectively, the Cullen Group failed to demonstrate that altering the incidence of $51.5m of tax was a purpose or effect of the arrangement that was merely incidental. The amount of tax avoided and the integral nature of payment of AIL as a term of the relevant loans indicated tax avoidance was an end pursued in its own right.
  6. Section GB 1 of the Income Tax Act 2004 empowered the Commissioner to make certain adjustments for the purpose of counteracting any tax advantage obtained by a person from or under a tax avoidance arrangement under s BG 1. However, the power did not have to be exercised if the purpose of counteracting such a tax advantage could be achieved through a lawful assessment. There was no doubt that in this case, counteracting the tax advantage was the Commissioner’s purpose. It was clear that the Commissioner’s assessment of Cullen Group as liable to pay NRWT on the reported income, instead of AIL, did counteract the tax advantage and the Commissioner was entitled to do that. The arrangement was void by operation of s BG 1(1) and the Commissioner was entitled to make her assessment on that basis without exercising her discretion under s GB 1.
  7. The Commissioner’s assessment of 22 March 2010 was more than four years after the AIL paid by Cullen Group up to and including the return period ending 30 November 2004. The Cullen Group filed the form required to accompany AIL but did not file an NRWT form.
  8. In Vinelight, in relation to Resident Witholding Tax (RWT), the Court of Appeal questioned whether the time bar applied to NRWT because the section allowing the Commissioner to assess for RWT expressly incorporated s 108 of the Tax Administration Act 1994 whereas the section allowing the Commissioner to assess for NRWT did not. In any case, the Court of Appeal held “a taxpayer which invokes the time bar against the Commissioner’s RWT assessment must point to a return filed in the form prescribed for RWT”.
  9. The Court of Appeal’s decision in Vinelight required a finding that the Commissioner was able to issue assessments for NRWT and, because Cullen Group filed AIL returns, rather than NRWT returns, it could not rely on a time bar.

Cullen Group Ltd v C of IR [2019] NZHC 404, 12 March 2019.