Australian TP Case Law Update

Chevron - High Court Appeal

The complexity of transfer pricing is again in focus with the taxpayer appealing to the High Court against the decision in Chevron Australia Holdings Pty Ltd v CoT [2017]. In that case the full Federal Court upheld the Commissioner’s assessments adjusting a 9% interest rate on an inbound, unsecured $2.5 billion international related party loan facility to a rate slightly above the Chevron group’s 1.2% global cost of funding.

The Commissioner's Position

The ATO position:

1. Re-characterised the taxpayer’s Australian dollar (AUD) facility into USD (noting interest rates in the United States are generally lower).

2. Claimed arm’s length parties would never provide a $2.5 billion loan totally unsecured, without a parent company guarantee and in the absence of financial or operational covenants.

3. Argued that, even without the above, the 9% rate was higher than market.

Chevron's Case

The taxpayer argued the actual loan to Chevron Australia Holdings Pty Ltd (CAHPL) was wholly unsecured and denominated in AUD. The arm’s length principle determines the interest rate that would have applied had a similar loan been in place between independent parties. It is beyond the scope of the arm’s length principal for the Commissioner to impute a guarantee from the parent in another jurisdiction and that isn’t a party to the matter in dispute. For similar reasons the taxpayer argued provision of security over the assets of CAHPL’s subsidiaries couldn’t be imputed.

Federal Court Decisions

The matter was first heard by a single judge of the Federal Court (CAHPL v CoT (No 4) [2015]) and later on appeal to the full Federal Court. The Commissioner was successful both times, reaffirming amended assessments of $340 million.

Matters in Dispute

Items 1 to 3 above can be divided as follows. In the first two items the Commissioner argues that the loan should be re-characterised, both from AUD to USD then secondly from unsecured to secured. The second issue is a pure transfer issue. Assuming the loans were in AUD and wholly unsecured, the Commissioner believes the interest rate should have been no higher than 5.38%. The onus is on the taxpayer to prove that the amended assessments are excessive - then show their alternative position is correct. In both Court proceedings the taxpayer failed to prove the amended assessments were excessive, thus the judgements paid little attention to the question of what alternative rate might apply.

Full Federal Court in Detail

It is pertinent to consider how the three judges of the full Federal Court structured their decision. Each judgement must record the arguments presented and methodically apply the law to each. Every coop has its pecking order and it was left to Justice Pagone to perform that task, substantially upholding the decision in the first instance. An exception was loan security, with the earlier decision assuming an independent party in CAHPL’s position would have arranged security for the loan over the LNG assets of its subsidiaries. Pagone J also imputed security, but in the form of guarantee from AA rated parent Chevron Corporation. This position was supported by Chevron group policy of providing such guarantees to secure external borrowing. The judgement by Perram J is notable for brevity, being a single 20-word sentence agreeing with Pagone J. With $340 million at stake, an appeal to the High Court was likely. With that in mind the judgement by Chief Justice Allsop adds weight to the key issues likely to be appealed. Allsop CJ starts by saying he had the opportunity to read and substantially agrees with the judgement by Pagone J (with Perram J not rating a mention). He then proceeds with a classic analysis on whether legislation should be interpreted narrowly or broadly. He argues that whilst legislative interpretation always starts and ends with the words of the statute, context is indispensable as it prevents linear thinking and deriving results to unrealistic and impractical ends. Narrow Interpretation The taxpayer’s case relied upon a narrow reading of the law, being to take the loan as it was actually granted (in AUD, unsecured and without covenants) and determining the price that would have been charged had such a loan been made between independent parties. Also narrow is the argument that only facts that apply to CAHPL as a stand-alone entity may apply (the “orphan” approach), as opposed to considering CAHPL being part of a multinational group. A Broader Perspective Allsop CJ rejected the taxpayer position, broadening application of the transfer pricing provisions on the following three bases. In considering the independence requirement within Division 13, Allsop CJ asked the ontological question, “Independent from whom?” Whilst the taxpayer argued CAHPL should be considered independent form the rest of the Chrevon group, Allsop CJ argued that the to the loan against which the CAHPL loan is to be benchmarked needed to be between parties that were independent from each other. That form of independence doesn’t imply CAHPL as being “detached” from the rest of the Chrevon group. If not detached, then the Commissioner was entitled to impute security in the form of a parent company guarantee. Secondly, Allsop CJ stated the hypothesis under the arm’s length principle “must be made to work”. That is, because wholly unsecured $2.5 billion loans don’t exist between independent parties, it is unrealistic to hypothesize an arm’s length interest rate under such uncommercial conditions. Adding sensible commercial conditions, like an assumed parent company guarantee, moved the loan into the spectrum of what can sensibly be benchmarked. Making such adjustments is permissible on the basis the legislation is otherwise unworkable. Finally, the new Division 815 transfer pricing provisions (effective for the 2006 and later years) specify the OECD Transfer Pricing Guidelines as a reference on the arm’s length principal. Key extracts from the OECD guidelines are so on point that Allsop CJ quoted directly: “However, there are two particular circumstances in which it may, exceptionally, be both appropriate and legitimate for a tax administration to consider disregarding the structure adopted by a taxpayer in entering into a controlled transaction. … The second circumstance arises where … the arrangements made in the transaction, viewed in their totality, differ from those which would have been adopted by independent enterprises behaving in a commercially rational manner and the actual structure practically impedes the tax administration from determining an appropriate transfer price.” [Emphasis added.] With the transfer pricing provisions in most countries based on the OECD guidelines, such prominent quoting of the OECD Guidelines by the Chief Justice broadens the Chevron case to global significance. Can that paragraph be used by the Commissioner to impute a guarantee from a foreign parent on the loan to CAHPL? If so, what limits might the High Court draw around the exercise of such a power (noting the word “exceptionally” emphasized above)? Or are the circumstances surrounding the unsecured $2.5 billion loan so different to loans between independent parties that the loan terms warrant re-characterisaction prior to benchmarking as contemplated in the OECD Guidelines? Either way the High Court appeal should make exceptional reading.

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