IRD file skewers firm at centre of tax-scheme mess

Friday 12th April 2002

Auckland firm Gosling Chapman let wealthy clients get into tax schemes they would later regret, DEBORAH HILL CONE reports

A forestry investment without a single tree. A venture capital company whose shares were worth $1 one minute and $130,000 the next. A "high-risk" investment where an investor can hardly lose his money. Sound too good to be true? For many investors it was - and now they are being pursued by Inland Revenue.

Three investment schemes - Digi-Tech, NZIL and Salisbury - all shared similar components and all were closely linked to Auckland accountancy firm Gosling Chapman, new IRD documents show.

Partner Rowan Chapman admits in a 1997 letter on the IRD file that the firm was involved in the design of the structure of the NZIL arrangement while other documents show the firm was taking millions of dollars of commission for introducing its "high-net-worth individual" clients to the schemes from 1995-97.

When the schemes later ran into trouble with the tax authorities, Gosling Chapman distanced itself from the arrangements, leaving the impression merchant banker Milloy Reid Wong was the mastermind behind them.

It also left 110 well-connected investors, including a QC, an international artist, a former New Zealand cricket player and a prominent PR man, in disputes with the IRD, which wants about $100 million in tax back.

Milloy Reid Wong principal John Reid, former UK-based merchant banker Peter Connolly and two other people who have name suppression will reappear in the Auckland District Court next week on fraud and money laundering charges relating to the Digi-Tech and NZIL schemes.

Meanwhile, Inland Revenue documents sent to investors last week show what a central role Gosling Chapman played in putting them together and signing up investors. Gosling Chapman partner Peter Russel admitted key aspects of the scheme, such as the insurance loan arrangement, were suggested by Gosling Chapman.

The insurance feature was based on the Salisbury forestry investment scheme, which had been offered to Gosling Chapman clients.

The IRD revelations throw a different light on Mr Chapman's assertion that the Serious Fraud Office investigation was sparked by his own complaint - IRD sources suggest it was its own probe that led to the SFO case.

In a statement released this week Mr Chapman said the firm disagrees with inferences about Gosling Chapman's role in NZIL scheme drawn by the IRD. He said the extent of Gosling Chapman's involvement would be canvassed in the SFO proceedings before the court so it would be wrong to comment further.

The structures of all three schemes are the same: investors, deemed to be "share traders," enter an agreement to buy shares at a future date - 10 years on. Each investor uses a loss-attributing qualifying company (LAQC) for the transaction and at the same time takes out a "loss of profits insurance policy" as a hedge against the shares not being worth what they are predicted to be worth at that purchase date.

To finance the insurance premium each LAQC investor also takes out a limited recourse loan with an overseas bank for 96% of the premium, which can then claimed in full as a tax deduction.

In the Digi-Tech scheme the shares the LAQCs agreed to purchase were in Wellington data communications company Digi-Tech Communications, while NZIL was a company that packaged up various assets linked to Mr Reid including stakes in marketing startup Escalator Advertising, trailer manufacturer Fruehauf Pacific and a company, Euston Holdings, said to have the rights to develop the "thinking battery."

Gosling Chapman's individual clients had also put $23.6 million in the Salisbury scheme, a similar arrangement which related to options (for which no money was payable) to buy timber in 10 years' time. As more became known about the forestry scheme it became clear there was "absolutely no commercial reality whatsoever to this arrangement," the IRD says. In fact there was no forest, the IRD found out.

Investors in the Salisbury scheme, who thought that they had acquired an ownership interest in a planted forest, were surprised to find there were no trees and the contract was entirely speculative, relating to the purchase and onsale of timber that can be sourced from anywhere in 10 years' time from the date of entry into the contract.

In the Digi-Tech and NZIL arrangements there is a question mark over whether the insurance policy that was a key part of the scheme actually existed.

A firm specialising in insurance matters, Peter Faire Loss Management, found "numerous errors, omissions and mistakes" in the insurance documentation, Inland Revenue said.

In one example, the insurance policy paperwork appeared to have been produced from a template and was presented on plain A4 paper.

"One would expect certain important documents such as an insurance policy to have the insurer's logo or a letterhead on the policy," the IRD noted. "The documentation appeared to be merely a mass computer-generated production for a large-scale tax-avoidance scheme."

The IRD's documentation was provided to some investors as part of the notice of proposed adjustment that relates to their deductions of the insurance premiums. They have two months to respond to the commissioner or are deemed to have accepted the adjustment.

The documents outline numerous examples of how the Digi-Tech and NZIL schemes rang alarm bells with Inland Revenue - and should have with investors.

The investors had no control over NZIL and took no interest in how NZIL was to be funded - seen as essential to most investments.

None of the regular LAQCs made any inquiries of other parties as to whether the investment in shares of NZIL was a worthwhile investment. They relied totally on information supplied by the vendor of the shares.

There was very little risk in this "high-risk" investment, with the bank and insurance company taking virtually the entire risk regarding the future value of NZIL.

No one seemed to know anything about the insurance company. Insurance experts said the profits guarantee insurance policy and underwriting agreement are contrary to normal insurance practice.

The value of shares in the companies involved increased without valuations to back them up. For example 750 NZIL shares which had an issue price of $1 each in 1992 were sold to St Lucia (a company owned by family trusts linked to Milloy Reid Wong) for $130,000 a share in December 1996. No independent valuation of St Lucia shares were undertaken.

The scheme was channelled through numerous jurisdictions, many of them tax havens with specialised secrecy laws. The countries involved included Switzerland, Hong Kong, the British Virgin Islands, Bermuda and the Netherlands.

The IRD papers show how the principals involved in the schemes were unable to answer simple questions about the companies involved in the structure.

In 1998 Hugh Milloy of Milloy Reid Wong wrote to Richard Herbert of Carley & Co, saying: "Your request for paper showing 'the original investment 12 months ago and what it is currently expected to be worth' is not something we are able to prepare."

A company called Armour Fidelity was nominated as lender for a 1997 tranche of shares, in place of the Bank of New York-Intermaritime Bank Geneva. No one involved seemed to know anything about Armour Fidelity.

The IRD's inquiries about Armour Fidelity found no sign of the company at its two Hong Kong addresses and, according to the Companies Registry in Hong Kong, Armour Fidelity had never been registered.

The IRD later found out John Currie, who was appointed as power of attorney to handle the funds from the LAQCs in Hong Kong, was also the general manager of Armour Fidelity.

The IRD expressed astonishment that the astute investors who signed up for the schemes would not have asked more questions about them.

"One would expect the shareholders of the various LAQCs, many of whom have business acumen and experience of many years in the financial world, to have made some inquiry as to the overseas parties, the trusts, the interest liability and the viability of [the schemes]. Prudent businesspeople would have made inquiries. Yet it appears no inquiries were made," the IRD writes.

Correction: The name of the UK merchant banker facing fraud and money laundering charges is Peter Michael Connolly, not Michael Connolly. In a report last week (NBR, April 5) Mr Connolly's first name was omitted. The error is regretted.

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