Chevron Case – Impact on Taxpayers
On the 23rd October 2015 the Federal Court released the decision on the latest transfer pricing case in Australia, Chevron Australia Holdings Pty Ltd v Commissioner of Taxation [2015] FCA 1092. The Commissioner of Taxation was successful, with Robertson J. holding that Chevron Australia Holdings Pty Ltd (CAHPL) failed on its challenges to the amended assessments under Division 13 of the Income Tax Assessment Act 1936 (ITAA 1936) and, in the alternative, under Division 815-A of the Income Tax Assessment Act 1936 (ITAA 1997).
The Chevron case is a big win for the Commissioner and will definitely give confidence to the Australian Tax Office to pursue more transfer pricing cases, although it is expected that with a potential $322 million tax bill, Chevron will appeal.
As expected, the decision includes several points that will impact the way in which taxpayers set prices and analyse intercompany loans transactions. The key points from the judgement that will have an impact on taxpayers are as follows:
- Burden of the proof for Taxpayers: Robertson J held that CAHPL has not discharged its burden of proof by demonstrating that the consideration (interest paid) was an arm’s length consideration (or less than an arm’s length consideration) and therefore concluded that the transfer pricing adjustments issued by the ATO under Division 13 and Subdivision 815-A were not excessive. CAHPL was not able to demonstrate through the evidence provided, including expert reports and comparable searches that the interest rate paid was at arm’s length. Robertson J analysed each of the comparable transactions provided by CAHPL and gave reasons as to why they could not be accepted (all based on comparability factors)
- Reconstruction of terms and conditions: Division 13 does not allow the Commissioner to replace the terms of the actual agreement with "arm's length" terms, other than the ‘consideration’. The ‘consideration’ can go beyond price (or the interest rate) and extend to other promises such as security or covenants, or the absence of such promises, under the agreement, however it cannot be understood as an authority to reconstruct an agreement in its entirety.
- Implicit credit support: Determining the consideration that would be given in the hypothetical arm's length agreement required identifying a hypothetical transaction (e.g. internal or external comparable transactions). When identifying the hypothetical borrower and lender, the hypothetical borrower is not required to be viewed as wholly stand-alone. The hypothetical borrower has to be only independent of the lender. Robertson J disregarded the value of implicit support as in his view, in the absence of a legally binding parental guarantee, implicit credit support had very little, if any impact on pricing by a lender in the real world
- Currency of the intercompany loan: Robertson J accepted the commercial reasons provided by CAHPL in relation to the borrowings being made in AUD i.e. borrowings in AUD would avoid or limit foreign currency gains and losses. According to Robertson J, this condition is not different from what independent parties dealing wholly independently from one another would have agreed in a similar arrangement.
- Credit Rating: Robertson J discounted all of the evidence of ratings experts on the basis that banking industry experts said institutional lenders did not use credit ratings to make lending decisions on loans of the kind at issue.
- Commercial and financial reasons: The decision also devoted several paragraphs to the commercial reasons for CAHPL to enter into the international related party transaction under dispute. Based on the evidence (including emails and testimonials), Robertson J concluded that CAHPL entered into the borrowings for the dominant purpose of obtaining a “scheme benefit”, and on that basis concluded that a 25% penalty should be imposed.
Conclusion
The decision brings to the attention the importance for taxpayers to have a commercial purpose for entering into international related party dealings and to be able to provide enough evidence of this commercial purpose (e.g. emails, minutes and notes of discussions). Likewise, it also emphasizes the importance of providing good comparable transactions to support the arm’s length nature of the prices agreed between related parties when entering into intercompany loans; sometimes is better to have a few good quality comparable transactions rather than lots of ‘comparable transactions’ with comparability issues (i.e. quality is better than quantity).This is particularly important given than the taxpayer had the burden of the proof.
This case was based on Australia’s former transfer pricing rules, however it is expected to have a significant impact on the application of the arm’s length principle in Australia going forward especially around the key technical concepts considered in this case (including implicit credit support, ‘reconstruction’ of terms and conditions, the credit rating of the borrower). Given Australia’s active role in the BEPS process, the decision is also likely to have a global impact as the OECD is developing detailed transfer pricing guidance on financial transactions.
