Eric Watson’s Cullen Group has been ordered to pay Inland Revenue $112 million plus penalties and costs after the group was found to have avoided paying tax for which it was liable.
Justice Matthew Palmer of the Auckland High Court has ruled that Watson used “a web of entities” designed to avoid paying non-resident withholding tax (NRWT) of 15 percent on loans to Cullen Investments between 2002 and 2010.
Instead, Watson-controlled Cayman Island-based offshore trusts, the nominal lenders, had paid only 2 percent in tax under the Approved Issuer Levy (AIL), a tax regime aimed at encouraging foreigners to lend more to New Zealanders and at reducing the cost to New Zealanders of borrowing from foreigners.
That tax paid amounted to only $8 million but Inland Revenue had argued the group should have paid NRWT of $59.5 million, meaning it still owes $51.5 million.
Use of money interest on that amount came to $60.5 million at Aug. 27, 2018 and penalties haven’t been quantified yet.
When Watson decided to move to Britain in 2002, he and Campbell Rose, then a tax partner at Russell McVeagh and from 2012 a tax partner at Deloitte, set up a web of entities including 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 was then charged 16 percent interest on those loans by 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.”
The judgment includes a chart of the circular money-go-round that ensued, which ultimately shows Watson was at both ends of all transactions and effectively remained in control of the group of entities created to avoid tax.
Justice Palmer accepted the arguments of Inland Revenue’s barrister, Gillian Coumbe, QC, that the 2 percent AIL rate is available only to “genuine overseas third-party lenders,” that there was no genuine overseas investment from a genuine non-resident lender and there were no non-arms-length transactions involved.
“Many features of the loans and transactions are commercially unorthodox … and exhibit circularity, artificiality, contrivance and pretence that are hallmarks of tax avoidance … and are unnecessarily complex,” Palmer’s judgment says.
His decision hinges on whether Parliament had intended the AIL regime to be used in the manner Watson had.
“Viewed objectively, in a commercially and economically realistic way, is that use consistent with parliament’s purpose or contemplation? Artificial and contrived structuring of an arrangement is a ‘classic indicator’ it is not,” the judgment says.
“There is no doubt the arrangement here involved highly complex and contrived ownership structures that would not be found in arms’ length commercial relationships,” it says.
“Mr Watson retained a determining level of control over Modena and Mayfair through the terms of the loans. And he retained a very high level of control over Cullen Group,” it says.
That’s even though, in a strictly legal sense, Modena and Mayfair were not “associated persons” with the Cullen Group.
“That level of control is usually an incident of ownership of equity, rather than of debt. In reality, Mr Watson was on both sides of the loan transactions, instead of his previous position as a holder of equity.”
The fact that Modena and Mayfair were the nominal lenders was “form, but not substance …. I accept the expert evidence that no new funds were introduced into New Zealand.”
In dismissing Watson’s challenge to Inland Revenue’s assessment, Justice Palmer awarded the tax authority costs to be paid by Watson.
If the parties can’t agree on costs, Inland Revenue has 15 working days from today to file “submissions of no more than 10 pages” and Watson’s lawyers will have another 10 working days to file responding submissions “of no more than 10 pages.”
The New Zealand Herald reported in December that, in a dispute between Watson and a former business partner, millionaire expatriate Owen Glenn, Watson’s lawyers had told the Auckland High Court that Watson was unable to make a court-ordered payment to Glenn of $54 million “as he does not have the assets to do so”.
Justice Palmer noted that Watson’s counsel in the IRD case had preserved the ability to raise issues relating to the application of a four year time-bar if there is an appeal.