Sue Newberry is Associate Professor of Accounting at the University of Sydney.

In his 2005 Roger Award Report, (the 2005 Roger Award was jointly won by Westpac and BNZ. Ed.) Joe Hendren commented on the activities of banks and outlined concerns about the regulatory supervision of foreign banks operating in New Zealand(1). These concerns included conflicts of interest between the home and host authorities and the potential for these banks’ activities to undermine New Zealand’s tax base. In my Financial Analysis section of the 2005 Roger Award Report, I noted that both the BNZ and Westpac had stopped engaging in the particular structured financing transactions that were the subject of Inland Revenue Department action for additional tax(2). To prevent banks engaging in the structured financing transactions that were causing concern, New Zealand’s tax law changed with the passage of the Taxation (Base Maintenance and Miscellaneous Provisions) Act 2005. The new rules for banks took effect from July 1, 2005.

In July and August 2005, soon after those new rules took effect, the former Overseas Investment Commission (OIC) issued Decision Sheets permitting Westpac to proceed with what seemed to be another large ($2 billion) structured financing transaction. I had commented briefly on this arrangement at the end of my Roger Award Report. Presumably, coming as it did shortly after the law change, this arrangement complies with the new rules. In such a very complicated area, unintended consequences and outcomes from new rules are always likely. This article updates information about that transaction in an effort to ensure that information about it is publicly available. I do not have the knowledge of this arcane area of tax law and cannot judge whether the transaction is innocuous or otherwise. For that reason, this article simply summarises the policy issues that led to the law change, notes the recognition that scope remains for further detrimental arrangements, and summarises the further information obtained about this structured financing arrangement in the hope that others may understand it and, if thought fit, investigate further.

Negative Tax Implications For NZ

Briefly, the policy issues relate to the foreign dominance of New Zealand’s banking sector, the very low levels of tax paid in New Zealand by the major banks, and the negative tax implications for New Zealand of particular arrangements entered into by those banks. The negative tax implications relate to the financing of the banks’ New Zealand operations and whether that financing is regarded as debt or equity because the tax implications differ, as well as to circumstances when financing transactions are shunted through New Zealand. In addition, some transactions under challenge were related to a double taxation treaty between the United States and New Zealand. The new rules that took effect from July 1, 2005 are complicated and even at the time it was not clear that all matters were addressed adequately. One tax law academic, for example, noted the potential for the banks to use redeemable preference shares to “circumvent the purpose” of the new rules(3).

Even the limited information available at the time of my 2005 Roger Award Report suggested a convoluted financing transaction that gives rise to doubts about the nature of this arrangement and whether it should be regarded as debt or equity. In my Report, I identified the following: "On July 19, 2005, the OIC issued approval for Westpac to sell for an undisclosed amount ‘up to 100% of certain specified securities’ in a company called Pacific Funding to Linvest LP, an organisation with its beneficial ownership in Germany. The rationale stated that ‘entities associated with Linvest LP undertake nationally and internationally, the business of financing and investment banking. The financing of Pacific Funding is a continuation of those activities’”.

On August 12, 2005, the OIC issued approval for Westpac to purchase from Linvest LP for an undisclosed amount “up to 100% of the specified securities” in Pacific Funding. The rationale stated that Westpac would “provide finance to Pacific Funding, a New Zealand incorporated unlimited liability company, which it partly owns. In order to protect its position, in certain circumstances it may wish to ensure that it has full control of Pacific Funding by exercising the option to acquire specified securities in Pacific Funding from Linvest LP”.

Pacific Funding was registered in New Zealand on November 1, 2005 with 20,294,118 shares. Companies Register documents state that 98.8% of Pacific Funding’s shares are owned by Linvest LP, which is registered in the Cayman Islands, a tax haven. The remaining 250,000 shares are owned half each by two entities, Tasman Funding No 1 and Tasman Funding No 2. The Westpac Banking Group’s 2005 Financial Report showed that Tasman Funding No 1 and Tasman Funding No 2 are owned by Westpac subsidiary, Infrastructure Australia (No 1) Limited.

Information Released, But Lots Withheld

An application under the Official Information Act resulted in the release of 53 pages of documents about the first part of this arrangement (Westpac selling securities in Pacific Funding to Linvest LP) and 42 pages of documents about the second part of this arrangement (Westpac subsequently buying back securities in Linvest LP). Both sets of documents have sections blanked out and blank pages stating that whole documents have been withheld under the Official Information Act. The reasons stated for withholding information relate to sections 9(2)(a) and/or 9(2)(b)(i) and/or 9(2)(b)(ii) and/or 9(2)(ab)(i). Section 9(2)(a) relates to the protection of the privacy of natural persons; and section (9(2)(b) covers the protection of information “where the making available of the information would:

• disclose a trade secret; or
• would be very likely unreasonably to prejudice the commercial position of the person who supplied or who is the subject of the information”.

Section (9)(2)(ab)(i) provides protection for “information which is subject to an obligation of confidence or which any person has been or could be compelled to provide under the authority of any enactment, where the making available of the information would be likely to prejudice the supply of similar information from the same source and it is in the public interest that such information should continue to be supplied”. In addition, a schedule from a letter was withheld under section 18(d) which provides that the “information requested is or will soon be publicly available”, and part of another letter has been withheld because “it falls outside the ambit” of the request (letter from Land Information New Zealand [LINZ] to CAFCA, 11/4/06. Since the passage of the 2005 Overseas Investment Act, the OIC, which was part of the Reserve Bank, has been replaced by the Overseas Investment Office [OIO], which is part of LINZ. The transactions which are the subject of this article straddle the old and new regimes. Ed.).

The various documents released reveal that this structured financing arrangement is between the German bank, Deutschebank AG (also known as DBAG) and Westpac Banking Corporation ( Australia). The Auckland office of Mayne Wetherell, which describes itself as finance and corporate lawyers, acted for DBAG and discloses that fact on its Website http://www.maynewetherell.com/highlights_detail.php?news_id=134. Both Mayne and Wetherell are former partners of Auckland law firm, Russell McVeagh. The Wellington office of Chapman Tripp, barristers and solicitors, acted for Westpac. The various documents also show that the OIC liaised with both sets of lawyers to determine the wording of the published OIC Decision Sheets. Mayne Wetherell sought for Westpac’s name to be withheld but the Decision Sheets do disclose Westpac’s involvement.

Mayne Wetherell’s correspondence makes clear that the legal form of this structured finance arrangement (the sale and subsequent repurchase of securities in Pacific Funding) differs from the nature of the arrangement, which seems to be a loan from DBAG to the Westpac Banking Corporation. Emphasis is added to extracts from Mayne Wetherell’s July 28, 2005 letter to the OIC to demonstrate this point:

“We do not consider that the provision of finance, in this case, between the DBAG and Westpac, should become a matter of public record merely because of the legal form in which it is implemented” (para 8). “Pacific Funding will be, until the date on which Linvest LP undertakes the Transaction, wholly owned by Westpac, an Australian corporation and an overseas person. The overseas investment is financing an Australian corporation (though through New Zealand subsidiary) [one and a half lines blanked out] Accordingly, there should be limited public interest in New Zealand in respect of the Transaction in any event” (para 10).

Really Just A Dressed Up Loan

The money transfers arising from the sale and later repurchase of the “specified securities” would be the same as the money transfers arising from borrowing and repaying a loan. The information published in the OIC’s Decision Sheet describes the legal form of the arrangement without providing the further explanation that it is really just a dressed-up loan from DBAG to Westpac and seems, therefore, to be misleading.

As is common with structured finance arrangements, this transaction occurs several layers beneath the surface of both DBAG and Westpac. Although Mayne Wetherell explains it as the provision of finance from DBAG to Westpac in Australia, the arrangement tracks through at least three other countries besides Germany and Australia: the United States, the Cayman Islands, and New Zealand. As disclosed in a schedule with Mayne Wetherell’s letter of July 4, 2005 to the OIC, DBAG’s ownership of Linvest traces down through five other entities before reaching Linvest LP:

It runs from Deutschebank AG; through

Taunus Corporation;

DB US Financial Markets Holding Corporation;

DB Holdings ( New York), Inc;

Deutsche Leasing ( New York) Corp;

Linder LP; and then finally to

Linvest LP.

Both Linvest LP and Linder LP are registered in the Cayman Islands. Presumably, Deutsche Leasing ( New York) Corp; DB Holdings ( New York) Corp; and DB US Financial Markets Holding Corporation are all US based companies. Therefore, from the Deutschebank end of this arrangement, it seems to track from Germany through the United States and the Cayman Islands then when passed on to Pacific Funding it tracks into New Zealand. The Westpac end of this arrangement seems to start with Pacific Funding, and then tracks on to Australia where the ultimate owner of Pacific Funding is Westpac Banking Corporation, Australia:

From Pacific Funding, it tracks through

Tasman Funding No 1 and Tasman Funding No 2;

Infrastructure Australia No 1 Limited;

Sixty Martin Place (Holdings Pty Limited; and finally to

Westpac Banking Corporation.

Pacific Funding, Tasman Funding No 1 and Tasman Funding No 2 are registered in New Zealand and the other entities are Australian. As specified in Mayne Wetherell’s advice to the OIC: “the directors of Pacific Funding will be New Zealand resident, senior employees of WBC” [Westpac Banking Corporation]. The financing arrangement between DBAG and Westpac is presented as the sale and subsequent repurchase of “certain specified securities” in Pacific Funding, an unlimited company that seems to have been created for the purpose of this arrangement. Pacific Funding’s 20,294,118 shares are divided into three classes, A, B, and C. Different rights and obligations attach to each class of shares. The rights and obligations attached to shares will affect determinations as to whether the shares should be classified as debt or equity irrespective of what they are called but it seems that the determination for tax purposes differs from the determination for accounting purposes(4). The sections of the released documents that refer to these classes of shares are partially blanked out so it is impossible to know exactly what rights and obligations are attached to each class. From the information available:

• The A shares consist of 250,000 voting shares. Westpac subsidiaries Tasman Funding No 1 and Tasman Funding No 2 hold 125,000 A shares each.
• The B shares consist of 44,118 voting shares, and these are held by Linvest LP. These shares give Linvest LP the power to pass a special resolution at a meeting of shareholders, to appoint and remove directors, and to liquidate Pacific Funding.
• The C shares consist of 20,000,000 non-voting shares. These are held by Linvest LP. According to Mayne Wetherell’s explanation, these C shares are redeemable at Pacific Funding’s option.

Debt Or Equity (Shares)?

For accounting purposes at least, the rights attached to the A and B shares suggest they are more likely to be classified as equity, while the lesser rights attached to the C shares make it more likely they will be classified as debt even though they are legally described as shares. This view is borne out in Westpac’s Annual Report for the year ended September 30, 2006. This Report states that Westpac owns 85% of Pacific Funding (Note 42). This percentage seems to arise from classifying only the A and B shares as equity (the 250,000 A shares owned by the two Westpac subsidiaries comprises 85% of the total of the A and the B shares, i.e. 294,118 shares). That suggests for accounting purposes, Westpac classifies the C shares as debt. In contrast, the Companies Register details treat all of the shares according to their legal description. These Register details state that Linvest LP owns 98.8% of Pacific Funding’s shares. That calculation seems to include all 20,294,118 shares. Linvest LP’s 20 million C shares plus its 44, 914 B shares (20,044,914) comprises 98.8% of that total while the 250,000 A shares held by Westpac subsidiaries comprise 1.2% of the total issued shares. Despite the legal description of Pacific Funding’s class C shares in the companies’ documentation, even Westpac’s financial reports regard them as debt.

In summary of all this information, this financing transaction between DBAG and Westpac contains several hallmarks of the type of structured finance transactions that caused concerns leading to changes in the law. It occurred after July 1, 2005 when the law took effect, and presumably complies with the new rules. Even at the time of the law change, however, it was known that loopholes remain and one of those loopholes relates to the use of redeemable preference shares which tend to straddle the divide between debt and equity. Pacific Funding’s 20 million C shares are redeemable shares but blanked out sections of the documents released make impossible precise assessment of the nature of those securities. However, from the information that is available, it appears that the rights attached to Linvest LP’s B shares would allow Linvest LP to protect its interests at all times. Linvest LP certainly seems to occupy a preferred position that is as good as or better than, the status it would achieve if the C class redeemable shares did carry preference rights. While Companies Register details record these shares as shares, Westpac’s 2006 Annual Report suggests Westpac regards them as debt. Further, Mayne Wetherell’s comments to the OIC are clear that the arrangement is DBAG providing finance to Westpac Australia, with that finance shunted through New Zealand via Pacific Funding. The arrangement does, therefore, seem to be one that warrants closer scrutiny.

(1) Joe Hendren, “Roger Award Report, 2005” http://www.converge.org.nz/watchdog/11/03.htm. See Joe’s comments about regulatory supervision.

(2) Sue Newberry, “Financial Analysis: BNZ and Westpac” http://www.converge.org.nz/watchdog/11/04.htm

(3) Andrew Maples, (2005) “A Thin Capitalisation Regime For Foreign-Owned Banks Operating In New Zealand” Asia-Pacific Journal of Taxation, Volume 9, No 1, pp. 50-65

(4) Andrew Maples (2005) makes this point – see previous reference.