UPDATE 1-New Zealand buys back rail network from Toll

(Adds Toll comment, detail, background)

WELLINGTON, May 5 (Reuters) - The New Zealand government said on Monday it would buy back the country's only rail operator from Australia's Toll Holdings Ltd (TOL.AX: Quote, Profile, Research, Stock Buzz) after it could not agree future fees.

It said it would pay NZ$665 million ($520 million) for the operation, which includes inter-island passenger and freight ferries.

Finance Minister Michael Cullen said the privatisation of the rail network in the early 1990s had seen the asset run down.

"During the negotiations with Toll it transpired that buying the rail operating business including the ferries was the best way to increase investment in the industry and enable it to be more responsive to the needs of New Zealand customers," Cullen said in a statement.

The New Zealand government and Toll, Australia's biggest transport group, had been wrangling over the price Toll would pay for exclusive use of the state-owned rail network.

"The government will now avoid paying subsidies to third parties and we also avoid the ongoing disputes over the implementation of the National Rail Access Agreement that had the potential to destroy value in the business and erode the morale of the people who work in it," Cullen said.

Toll acquired control of listed rail operator Tranz Rail for NZ$230 million in 2003, but did not manage to mop up minority shareholders until late last year.

Tranz Rail was close to collapse under a mountain of debt, but a rescue package saw the New Zealand government buy back the track network and pledge NZ$200 million investment.