Sue Newberry is an Associate Professor of Accounting at the University of Sydney. Transpower is the State-Owned Enterprise (SOE) which “owns” and operates the national high voltage electricity grid. Sue has previously written on this subject in Watchdog 111, April 2006 (“Foreign Investment In Transpower. What’s Going On With Our Power Transmission System?” http://www.converge.org.nz/watchdog/11/06.htm) and Watchdog 115, August 2007 (“Who Owns The South Island Grid? Trying To Find Out Is Like Peeling The Proverbial Onion”, http://www.converge.org.nz/watchdog/15/04.htm). Ed.

Transpower’s 2003 cross-border lease over the South Island high voltage electricity grid effectively sold the $700 million grid to the Wachovia Bank of North Carolina. The sale allowed Wachovia to abuse the US tax base and for this, Wachovia paid Transpower a bribe price of approximately 5% ($34.6 million). As part of this arrangement, Transpower leased the grid back from Wachovia under a lease term of about 80 years, but with an option to repurchase the grid after about 27 years. Not surprisingly, when brought to public attention, this sale of a public asset into a tax abuse scheme prompted anger. In 2009, however, Transpower reported the restructuring and partial termination of the cross-border lease and Transpower’s Chief Executive reported that Transpower was “essentially out of the deal”.(1)

The effect of the 2003 sale and leaseback was to duplicate ownership of the grid. It meant that in New Zealand, Transpower could claim it still owns the grid because it has legal title to it, while in the United States, the Wachovia Bank could claim it owned the grid and could, therefore, claim tax deductions relating to that ownership. Now that Transpower has partially terminated the deal, I’ve been asked to clarify whether that duplicated ownership arrangement continues today. The effects of the restructuring and partial termination of the lease are not clear in Transpower’s Financial Reports. Transpower’s 2012 audited Financial Report states that the two Transpower subsidiaries directly involved in the leaseback of the grid (Halfway Bush Finance Limited and TB and T Limited) are parties “to a cross-border lease over the majority of the South Island HVAC (high voltage alternating current) assets”.”(2) If that audited statement is correct, it implies the leaseback is still in place and therefore that the duplicated ownership arrangements probably remain in place. But, when asked, Transpower’s Chairman Mark Verbiest stated that no other company can claim ownership of the grid.(3)

Transpower’s Chairman is reported in the Press as saying that the last vestige of the financial transactions is the Cayman Island-registered special purpose vehicle, New Zealand Power Cayman 2003-1 (NZPCL).   Transpower guarantees a $112 million loan that: “NZPCL has with a financial institution, while NZPCL has a slightly higher matching deposit with another financial institution. Verbiest could not name the institutions, but said it made sense for Transpower to keep the transaction in place until it expired rather than incur penalties by breaking early”(4) That loan and deposit are part of the original sale and leaseback deal which Transpower reported it had fully prepaid.

Most likely, these two amounts are intended to accumulate over the 27 years until 2030 when, under the original lease arrangement, the repurchase option could be exercised so that Transpower could buy back the grid. But if the loan and deposit are still in place because it “makes sense” and Transpower continues to report that Halfway Bush and TB and T are parties to “a cross-border lease”, taking the two together suggests the US end of the cross-border lease remains in place. And if the US end of the cross-border lease is still in place, then the US party is likely to still be claiming it owns the grid (albeit for tax purposes). Transpower’s Chairman’s statement that no other company can claim ownership of the grid seems inconsistent with Transpower’s audited financial statements. What a puzzle. In earlier articles I have described Transpower’s cross-border lease in some detail. In what follows, in an effort to make some sense of what little has been disclosed about the restructuring and partial termination of the cross-border lease, I have brought together some material that has since come into my hands and set it alongside some of the disclosures in Transpower’s annual Financial Reports.

Cross-Border Lease: A Pickle-Service Contract

As Transpower commented in 2005, the purpose of its cross-border lease over the South Island grid was to help Transpower’s counterparty in the United States to “manage” its tax obligations. Although the deal occurred in December 2003, Transpower did not report its $34.6 million kickback from the deal until a year later. That kickback comprised half of Transpower’s reported profits for the six months ended 31 December 2004. The reason for the delay related to a United States Senate Committee inquiry into abusive tax schemes. Some types of sale and leaseback arrangements had been used tax abusively and, consequently, been banned for tax purposes. In the wake of these bans, what was known as a Pickle-service contract became increasingly popular for tax abusive arrangements. In October 2003, a former leasing executive reported to this Senate Committee about exactly the type of deal Transpower was about to enter:

“Good morning Senators. This morning I will describe a massive scandal that has allowed major US companies to receive huge tax deductions by pretending to lease the infrastructure of foreign countries, such as dams, bridges, and subways, and then pretending to lease that infrastructure back to the country or municipality that own the infrastructure. This scheme is so pervasive that much of the old and new infrastructure throughout Europe has been leased to, and leased back from, American corporations. The sole purpose of this scheme is to generate a tax shelter for US corporations that invest in these schemes.”(5)

By this time, both the Wachovia Bank and KPMG, another prominent party in these tax shelter deals knew they were under investigation. The Senate Committee issued a report in November 2003 and subsequently, these cross-border lease deals were banned as tax abusive. Transpower’s deal was signed in December 2003, and just days later the US ban on such schemes took effect. In New Zealand, State-Owned Enterprises were permitted to engage in commercial arrangements that were not overly tax aggressive. Transpower’s interpretation of not overly tax aggressive seemed to be anything that was not (yet) specifically banned, even if it was apparent that it was about to be banned.

That the deal was primarily tax driven is apparent from the promotional material issued by those promoting such arrangements in New Zealand at the time of Transpower’s deal: the deals were designed so that the “US-based investors are able to obtain a tax benefit from participating in a US lease transaction and share some of the economic return with the foreign lessee.”(6) As testified to the US Senate Committee on Finance, the touts for such schemes say: “We are just going to pay you a fee to sign some papers that back up our deduction claim to the IRS (Internal Revenue Service)”. In Transpower’s case, the fee was the $34.6 million. But the papers Transpower signed also had the effect of transferring effective ownership of the South Island grid to the Wachovia Bank. In taking the $34 million bait, Transpower put at risk a public asset, the $700 million high voltage grid.

The promotional material about this type of lease provides an overview of how it worked. For ease of understanding, I’ve added Transpower’s name to the NZ side of this overview of the deal and Wachovia’s name to the US side(7): “A US cross-border lease of equipment (the “Equipment”) is based on the “Pickle-Service Contract (“SC”) structure. A Pickle-Service Contract lease is a sale (for US tax purposes) and lease (lease-back) transaction where the lease may be succeeded by a service contract. A cross-border leveraged lease of the Equipment would be transacted as follows:

- The New Zealand entity (the “lessee” [Transpower]) ‘transfers’ the asset to the US Lessor Trust (the ‘lessor’ [Wachovia]) via a long-term lease for a period exceeding the expected useful life of the asset as determined by an independent appraiser

- The US lessor [Wachovia] will lease the asset back to the NZ lessee [Transpower] for a term of approximately 20-25 years, but not to exceed 80% of the asset’s useful life

- At closing, the lessor [Wachovia] prepays the sale (for US tax purposes) by an amount equal to the appraised fair market value (fmv) of the asset

- The lessee [Transpower] has a fixed price purchase option (FPO) – also referred to as early buy-out option (EBO) – to buy the asset back for at least the appraised fair market value. The exercise date takes place at the end of the lease term

- Should FPO not be exercised, lessee [Transpower] is obliged to arrange a Service Contract (SC) with lessor [Wachovia]

·         ... There is no purchase option at the end of the Service Contract.

·         Lessor [Wachovia] as Service Provider (SP) and owner of the asset will have operational and maintenance responsibilities” (underlining added).

While the nature of the arrangement makes it likely that the fixed price repurchase option would be exercised, the information here reveals that if it were not exercised, Transpower would lose the grid. The diagram that came with the promotional material shows the convoluted arrangements required for this tax driven arrangement (see diagram). The arrangement is structured this way to pretend it has a commercial purpose, that is, a purpose other than tax base abuse. In the diagram, where I can, I have added names to the boxes to fit it to what little is known about the Transpower cross-border lease as it was in 2003. That structure is not necessarily still valid today - the lease has since been restructured and the effect of the restructuring is not known.

The very fine dotted line that runs in a rectangle around Transpower encloses those entities that would be included in Transpower’s Financial Reports. Notice the intentional placement of some parts of the deal outside Transpower. The fallout from the 2001 collapse of US energy corporation Enron* brought to public attention the intentional structuring and concealment of arrangements outside a company’s balance sheet. Such activity was not confined to Enron – it was very common and remains so today. NZ Power Cayman 2003 - Limited is just one of the entities that, at the time, were structured to fall outside Transpower’s balance sheet. *See Jeremy Agar’s review of the documentary “Enron: The Smartest Guys In The Room”, in Watchdog 111, April 2006, http://www.converge.org.nz/watchdog/11/10.htm.  Ed.

Bad Smell

If this deal made Transpower smell bad, its counterparties already smelled even worse. The Wachovia Bank and the financier of the deal, AIG, were notorious and had been under investigation in the US for their financial activities.(8) So too was KPMG to which the Senate Committee devoted much of its report on abusive tax shelters, along with those known to work with KPMG, including the Wachovia Bank.(9) Transpower Chairman Mark Verbiest’s comment that Transpower has no ownership interest in NZ Power Cayman 2003 - Limited did not indicate who does own it. (10) In 2007, Transpower reported to Parliament’s Commerce Select Committee that NZ Power Cayman 2003 – Limited was owned and controlled by KPMG Partners in the Cayman Islands.

At the very least, this sale and lease-back deal was supposed to last for 27 years until the option to repurchase the grid could be exercised. It is interesting to note that in the early days of the deal, Transpower reported that it had given “a limited guarantee dated 22 December 2003 in respect of the South Island AC assets” and that it considered “the likelihood of losses to be remote.(11)”Just three years later, the likelihood of Transpower incurring losses because of its guarantee was no longer so remote, and the folly of such dubious long term deals became apparent. During the global financial crisis (GFC) of 2008, both the Wachovia Bank and AIG found themselves in severe financial difficulties, and Transpower’s guarantee became a worry. As Transpower disclosed in its Half Year Report to 31 December 2008:

“In respect of the 2003 lease transaction, the recent downturn in financial markets has impacted the credit ratings of various financial institutions that are counterparties to the financial arrangements. As a result, the Group, in its role as guarantor, has undertaken a restructure of certain parts of the transaction. The restructure was completed shortly after 31 December 2008. The Group’s remaining exposures are as follows:

a/ If a financial institution’s credit rating deteriorates to a point where the Group is required to replace that institution with a more highly rated institution, the Group would be exposed to the cost required to replace that institution.

b/ If a financial institution defaults on its obligations to a counterparty to the transaction and funds deposited with the financial institution cannot be recovered fully, the Group would be exposed to the level of the funds deposited.

The likelihood of the occurrence of a) or b) is considered remote”.(12)

Perhaps fortunately for Transpower, during the GFC Wachovia was taken over by Wells Fargo, and, adding insult to injury for US taxpayers, AIG was bailed out by the US government with billions of dollars of taxpayer money. In 2009, Transpower responded to Parliament’s Commerce Select Committee which had asked about the risks associated with the remaining arrangement and how Transpower was addressing those risks. According to Transpower: “If an opportunity arises we will look to terminate the arrangements associated with the 2003 lease, which are still in place (although the substantial transaction is terminated. In the meantime, the residual risks, following the reorganisation and partial termination of the 2003 lease are not significant and similar to the counterparty risks associated with our other banking and financial arrangements”.(13)

In Transpower’s 2010 Annual Report, Transpower’s Chief Executive reported that, “following prolonged negotiations, we terminated most elements of the 2003 lease. As a result, the major risks associated with the cross-border leases have been removed. None of the arrangements, past or remaining, impacts on our ability to maintain, operate or develop the National Grid”. As part of this restructuring of the cross-border lease, Transpower brought NZ Power Cayman 2003 – Limited within its Financial Reports. Today, Transpower says it guarantees the loan to NZ Power Cayman 2003 – Limited and further says that Transpower would be responsible for any shortfall between the value of the assets and the liability held by NZ Power Cayman 2003 – Limited.(14)

So, What Is Left Of The Cross-Border Lease?

While Transpower may report now that it is “essentially out” of the cross-border lease, as is apparent from the promotional material about such leases, the primary purpose was always tax driven. When such a purpose predominates, it seems likely that any partial termination will, as far as possible, protect any tax base attack and allow its continuation. Transpower documents relating to the 2007 unwinding of a different tax-driven deal (a borrowing and on-lending arrangement with AIG) reveal that although the arrangement seemed to disappear from Transpower’s Financial Reports at the time of the unwinding, that disappearance may have resulted from accounting that helped to bury it, rather than the arrangement’s complete unwinding. A Transpower Board paper explained that some parts of the deal had “not been unwound for tax reasons”.(15)

As was apparent from that document, what disappeared for financial reporting purposes did not disappear for tax purposes. Consider applying the same logic to the reported partial termination of the South Island grid deal. Put that logic together with the disclosures in Transpower’s 2012 audited financial statements that Halfway Bush and TB and T are still parties to “a cross-border lease” and the continued arrangements with NZ Power Cayman 2003-1. If the US-based tax arrangements are still in place, then it seems likely that the US counterparty to the cross-border lease (today, the Wachovia Bank’s successor, Wells Fargo) would still be able to claim today that it owns the grid so it can obtain its tax deductions.

The idea behind financial reporting especially with Government entities is that it provides for accountability. Financial reporting is supposed to provide a means of communication but it has long been known that published Financial Reports are difficult to read. One way to improve the readability of Financial Reports would be to provide clearer and fuller explanations – doing so might support accountability objectives. Papers released under the Official Information Act revealed that when Transpower and other SOEs were contemplating dubious deals such as this cross-border lease, they were instructed to manage any “communication risks” arising.  That communication risk management seems to have translated into even more difficult Financial Reports. It seems Orwellian to refer to the publication of cryptic Financial Reports as being accountable.

Such information risk management practices, especially when combined with the half truths and dissembling responses to questions that emerged from Transpower in 2005, reduced my trust in Transpower’s communication management efforts. From my re-examination of this sale and lease-back over the South Island grid, I remain concerned that Transpower’s financial reporting practices fail to make clear the current state of affairs with this deal, and I remain concerned about the inconsistencies between Transpower’s published audited Financial Reports and Transpower representatives’ public statements. Transpower’s Chairman says no other company can claim ownership of the South Island grid. Transpower’s audited financial statements leave open the possibility that the US side of the deal remains in place which would, in turn, suggest the US counterparty is still able to claim in the US that it owns the grid, and therefore that the duplicated ownership arrangements remain in place.

1. Paul Gorman, “Transpower buys its way out of controversial deal with US firm”, (Press, 15/10/09, A4).
2. Transpower, 2012 Annual Report, Note 26.
3. Michael Berry, “Fears over grid are history”, (Press, 19/10/12).
4. Michael Berry, “Fears over grid are history”, (Press, ibid.).
5. United States Senate Committee on Finance, “Tax shelters: who’s buying, who’s selling, and what’s the Government doing about it – Testimony of Mr Janet: a witness pseudonym regarding abusive cross-border leasing and leasing with US municipalities”, 23/10/03.
6. Undated promotional document from New Zealand titled “US Cross-Border Lease Background”.
7. This quoted material is taken from an undated promotional document titled “US Cross-Border Lease Background”.
8. Today, AIG is a major sponsor of New Zealand rugby http://partner.allblacks.com/partnership/
9. Permanent Subcommittee On Investigation, 2003, “US Tax Shelter Industry: the role of accountants, lawyers and finance professionals Four KPMG studies: FLIPS, OPIS, BLIPS, and SC2”
10. Michael Berry, “Fears over grid are history”, (Press, 19/10/12).
11. Transpower Annual Report 2005, Note 19, Contingent Liabilities.
12. Transpower Half Year Report to 31 December 2008, Note 1.1 Contingencies (i) Guarantees
13. Post-Hearing Questions for Year ended 30 June 2009: Transpower
14. Transpower, 2012 Annual Report, Note 25.
15. Transpower Board paper, “Quarterly Directors’ Report and Semi-Annual Directors’ Certificate pursuant to the Trust Deed between the Transpower Group of Companies and the New Zealand Guardian Trust Company Limited as Trustee”, 19/9/07, released under Official Information Act 1981.