ASB & IRD mum after settlement of GFC era tax dispute over $153 million plus interest & penalties

By Gareth Vaughan

ASB and the Inland Revenue Department (IRD) have settled a long running dispute involving $153 million plus interest and penalties, over which the two parties were due to square off in the High Court from Monday (June 15).

The case centred on the bank claiming tax deductions on global financial crisis (GFC) foreign exchange losses over its so-called "Yen Transaction", and was previously covered in interest.co.nz's subscriber email here and again here. 

An ASB spokesman told interest.co.nz yesterday the case had been resolved between the parties.

"The terms of the resolution are confidential, so we cannot comment further," the ASB spokesman said.

And all an IRD spokesman would say was; "Due to taxpayer secrecy provisions in the legislation under which we operate, we can’t comment on matters relating to the tax affairs of any individual taxpayers or organisations."

The dispute stemmed from revised assessments issued by IRD for the 2008 and 2009 years. ASB launched legal proceedings to challenge the assessments.

Effectively the taxman moved to block ASB from claiming deductions on $499.4 million of foreign exchange losses in its 2008 and 2009 income tax returns.

In a judgment stemming from an early skirmish in the case Justice Raynor Asher said the substantive question to be addressed in the proceedings was the tax deductibility of foreign exchange losses arising out of the Yen Transaction. This transaction involved ASB borrowing ¥58.21 billion (about NZ$662 million at today's exchange rate) on July 27, 2007 for use in the Yen Transaction. The key issue was the purpose and effect of the hedging arrangements that formed part of the Yen Transaction.

Whilst the IRD was arguing the Yen Transaction was part of a tax avoidance arrangement, ASB said there was no tax avoidance. However, the bank was prepared to argue that if there was tax avoidance, it shouldn't be liable for penalties because it didn't at the time take an unacceptable position. ASB was arguing it took a position that was "about likely as not to be correct" under section 141B of the 1994 Tax Administration Act. Put another way, it was a position of substantial merit on which reasonable minds could differ. For that reason, ASB had argued, there should be no penalties.

As recently as February ASB CEO Barbara Chapman told me the bank would "vigorously defend" its position. However a protracted court hearing under the full glare of the media spotlight wouldn't have been good publicity for the bank whatever the merits of its case or the ultimate outcome.

ASB has said it has made what it considers to be adequate provision for the dispute based on its assessment of the merits of the arguments and independent advice received. However, ASB has also said if the provision proves to be inadequate "those proceedings may have a material adverse effect on the financial performance of the bank for the relevant financial year."

Whilst not knowing how much the settlement will see ASB cough up, even if it's half the sum claimed by the IRD, it's a considerable amount of money even for one of the country's biggest banks. We may hear more when ASB reports its annual financial results in August. In the big four banks' 2009 settlement of their structured finance transaction disputes with IRD they ultimately agreed to cough up 80% of what IRD claimed, or $2.2 billion.

The Cayman Islands, JGBs & the GFC

As reported in our earlier stories ASB Group companies involved in the Yen Transaction included ASB Bank itself, the NZ registered Bond Investments No 1 Ltd, Bond Investments UK Ltd, which was incorporated in June 2007 under the Companies Law of the Cayman Islands and had its registered office up until March 20, 2009 at Georgetown, Grand Cayman, Cayman Islands, and ASB Finance Ltd.

In 2007 ASB used one third of the ¥58 billion, after converting it into New Zealand dollars, in its general treasury function to earn revenue via the margin between its cost of funds and the rate of interest at which it on-loaned the funds. The balance of the funds was invested in redeemable preference shares (RPS) in the Cayman Islands subsidiary, which in turn used the funds to buy Japanese Government Bonds (JGBs).

This was done in a way that allowed the risk of fluctuations in the exchange rate between the NZ dollar and yen (FX risk) to be fully hedged. 

When the NZ dollar depreciated against the yen as it did in 2008 and 2009 the resulting FX losses on the total yen funding, including the amount converted into NZ dollars and used by ASB in its treasury function, were offset by the FX gains on the investments in the RPS, whose gains were not required to be returned as taxable income in New Zealand, and, IRD said, in part of the tax deductions for the FX losses.

ASB maintains when it entered into the Yen Transaction it knew if the NZ dollar appreciated against the yen it would get a foreign exchange gain, which would be subject to NZ tax "in the ordinary way." And if the NZ dollar depreciated against the yen, ASB would experience a foreign exchange loss giving rise to a NZ income tax deduction.

The bank said in late 2007 and 2008 the NZ dollar depreciated rapidly and significantly against the yen going from ¥96.46 at July 27, 2007 to ¥51.97 at December 1, 2008. The main reason for this was the GFC.

"It was not possible for ASB or other reasonable financial institutions to predict the GFC, or its impact on foreign exchange rates, and ASB did not foresee these events," the bank has said.

In about November 2008 ASB said it decided to terminate the Yen Transaction by migrating Bond Investments UK Ltd, which had been resident for taxation purposes in the United Kingdom, to NZ. This move took effect from December 1, 2008. ASB subsequently filed income tax returns for the 2008 and 2009 years.

Then, via a notice of proposed adjustment on March 2, 2012, IRD told ASB it was disallowing foreign exchange losses on yen funding claimed as a deduction by ASB in relation to the Yen Transaction. These totaled $115.7 million for 2008 and $383.7 million for 2009. On top of this IRD outlined shortfall penalties for ASB of $3 million for 2008 and $14 million for 2009.

In November 2012 ASB issued a statement of position rejecting the IRD claim that the Yen Transaction was a tax avoidance arrangement. This was rejected by IRD's adjudication unit in May 2013. ASB then sought from the courts a declaration the IRD assessments were incorrect, a determination the assessments be reduced or modified, and a direction the Commissioner of Inland Revenue Naomi Ferguson alter the assessments in a way that conformed with the Court's determination, plus costs.

'Not possible to predict what NZ dollar would do against the yen'

ASB maintained when it entered into the Yen Transaction in July 2007 it wasn't possible to predict with any confidence "whether, when or by what amount" the NZ dollar might depreciate or appreciate against the yen in any relevant period. However, IRD said it was possible to obtain a forward rate, which provided "the best risk neutral, rational expectation, no-arbitrage expectation of the future spot rate."

"At the time of entering into the Yen Transaction the NZ dollar/Japanese yen forward rate was lower than the NZ dollar/Japanese yen spot rate and therefore reflected the market's expectation of a depreciation in the NZ dollar/Japanese yen cross rate at that exact point in time," IRD said.

IRD also claimed the migration of Bond Investments UK Ltd from the UK to NZ was "contemplated in the development of the transaction." Additionally IRD said in 2008 and 2009 a combined total of $347 million worth of unrealised gains on redeemable preference shares in Bond Investments UK Ltd, held by Bond Investments No 1 Ltd, were not returned. This had the effect that the "tax benefit for foreign exchange losses equalled the net foreign exchange loss."

However, ASB denied a forward rate would have provided the best risk neutral, rational expectation, no-arbitrage expectation of the future spot rate. ASB also described forward rates as "a poor and biased predictor of future spot rates." The bank did, however, admit in developing the Yen Transaction it contemplated the possibility of migrating Bond Investments UK Ltd to NZ. But it denied the migration was intended, reiterating the decision to do so was taken "in or around" November 2008.

'Transferred risk to the NZ tax base'

ASB also acknowledged the tax consequences of the "rapid and material" depreciation of the NZ dollar against the yen was a matter taken into account in its decision to shift Bond Investments UK Ltd to NZ, but otherwise denied this was "for tax purposes." Instead the primary reason was because the depreciation of the NZ dollar against the yen led to an "unacceptable commercial position for ASB."

IRD said Ferguson viewed the Yen Transaction as a tax avoidance arrangement that transferred a risk that was commercially unacceptable to ASB on to the New Zealand tax base.

This article was first published in our email for paying subscribers early on Thursday morning. See here for more details and how to subscribe.