Australia wins gold in the international transfer pricing games
The Commissioner’s arguments
The Commissioner made determinations under both Division 13 and Subdivision 815-A, totalling approximately A$340m, based on his view that:
- CAHPL had claimed excessive interest deductions in relation to the intercompany loan paid to CFC, as;
- The ‘property’ which CAHPL received from CFC was limited to the five-year loan facility provided by CFC and the absence of security or covenants was irrelevant in identifying the property;
- Such property would have been advanced in USD;
- ‘Consideration’ is determined by CAHPL, and such ‘consideration’ would have contained some form of security, covenant or guarantee in an arm’s length dealing entered into between independent (but not “standalone”) parties; and subsequently
- the arm's length rate of interest for the loan would have been lower than that charged by CFC.
CAHPL made submissions to the Court on a variety of factors, including the perceived unconstitutional nature of the assessment for a variety of reasons including but not limited to the retrospective nature of Subdivision 815-A.
It further argued that Division 13 requires only the pricing of the ‘actual’ property given. The ‘property received’, as contemplated by CAHPL, should take into account the fact that no security or covenants were required to be given, and thus the ‘consideration’ for the property received was to be priced on the basis it was an unsecured loan.
At first instance, CAHPL engaged the services of expert witnesses to opine on the arm’s length nature of the interest rate applicable to such a loan (i.e. on the assumption it was unsecured and no operational or financial covenants had been given), on the basis that CAHPL was an “orphan” or “standalone” entity in the arrangement, with the ultimate intention of demonstrating that the 9% rate of interest paid by CAHPL to CFC was arm’s length when priced in accordance with comparable facts and circumstances.
Lastly, CAHPL submitted that the ‘profits’ requirement of Subdivision 815-A was not satisfied as it received dividends from CFC and was no worse off at year-end on a profit basis. (And it was not to the point that those dividends were not subject to Australian tax.)
Reasoning of the Court
The Full Federal Court found:
- Subdivision 815-A did not impose an arbitrary or incontestable tax and was thus constitutional;
- The definition of ‘property’ and ‘consideration’ for the application of Division 13 was a five-year loan, not the absence of covenants and security, thereby endorsing the ATO’s amended assessments and the decision of the trial judge;
- The evidence provided by Chevron’s expert witnesses assumed the statutory question was directed at a ‘hypothetical’ company with CAHPL’s credit worthiness calculated on a standalone basis (‘hypothetical CAHPL’) which would not have been able to borrow without security; but as the ‘correct’ statutory question required a determination of what an ‘actual’ CAHPL could borrow, the expert evidence was misconceived;
- Security, guarantees and/or covenants would reasonably have been expected in a comparable independent scenario;
- Chevron’s “orphan” theory, when applied in practice, would “fundamentally undermine” Division 13’s purpose of substituting a real-world arm’s length consideration, on the basis that a Borrower-Lender relationship should be independent, but the terms of the actual arrangement should not be disregarded in its entirety;
- Chevron US’s credit standing would have resulted in CAHPL being able to obtain funds from the external market at a significantly lower rate of interest than that which it paid to CFC in the intercompany arrangement;
- Profits would have accrued to CAHPL, but did not accrue as a result of the excessive rate of interest applied by CFC to CAHPL on the loan;
- It is not relevant to examine the ‘year-end’ position of the taxpayer and the Court was satisfied that the amount of taxable income would have been greater; and ultimately
- Chevron did not discharge its onus of proof to demonstrate the assessments were excessive.
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