Viewpoint: Andrew Jackomos and Paul Ashburn
The decision of the Full Federal Court of Australia in Chevron Australia Holdings Pty Ltd (CAHPL) v Commissioner of Taxation [2017] FCAFC 62, handed down on April 21, 2017, has drawn considerable interest and may influence the OECD in its development of the Base Erosion and Profit Shifting (BEPS) guidance for the application of the arm’s length principle to intra-group financings. The court ruled that the interest paid by CAHPL to its US subsidiary Chevron Texaco Funding Corporation (CFC) exceeded the interest reasonably expected to be paid under an agreement where the parties were independent and dealing with each other at arm’s length, and upheld the assessments of the Australian Taxation Office (ATO) totalling approximately A$340m ($256m), making this the largest transfer pricing case won by the ATO. CAHPL entered into a credit facility agreement with CFC, under which CFC would make advances to CAHPL up to an aggregate amount of A$2.5bn ($1.9bn) at its sole discretion for five years, and CAHPL was not required to provide any security or commit to any financial or operational covenants. The interest rate payable on the advances by CAHPL was 9%. CFC funded itself for the advances by borrowing funds in the US financial markets at an interest rate of 1.2%.
The court noted that the usual commercial policy of the Chevron group was to borrow externally at the lowest rate possible, and that usually a parent company guarantee was provided for external borrowings by subsidiaries. The court’s approach was to identify the property, which was held to be the rights CAHPL acquired under the facility, and determine what one would reasonably expect the consideration to be to acquire the property, which would be substituted for the actual consideration paid by assuming independent parties. The court considered that the independence required is that the parties to the agreement are independent from each other, and does not require any other hypothetical relationship or the removal of characteristics of the party as the borrower that take away from identity with the taxpayer in character or situation. Conversely, Chevron argued that what needed to be identified was the price that would be paid by a standalone borrower from an independent lender for a loan structured on identical terms to the facility. Chevron’s argument was rejected, with Allsop CJ stating, “I do not see why the hypothesis… should not include a borrower in the position of CAHPL with its balance sheet in a group the parent of which is a company such as Chevron.” The court ruled that in applying the transfer pricing provisions of the Australian tax law, real world circumstances, such as the parent company guarantee, should be taken into account. Thailand’s Revenue Code does not have a specific transfer pricing regime like Australia does. However, it does have provisions that require market value pricing. Under Section 65 bis (4), where a company makes a loan without interest or with interest at a rate lower than market value, the Revenue Department has the power to deem interest to the lender at the market value on the date of the lending. On the borrowing side, there is no specific provision to disallow interest that exceeds a market rate. The Revenue Department uses Section 65 ter (13) to deny a deduction for interest paid in excess of the market rate of interest, and deny tax deductions for corporate income tax purposes for expenses not exclusively incurred for business purposes. In the past the Thai Revenue Department has argued that the interest paid above the cost of funds to the offshore related party lender is not allowable as a tax deduction. However, whether the Revenue Department, under Section 65 ter (13), can deny interest incurred on funds fully utilised in funding the business’ operations is questionable. The Revenue Department will likely use the approach adopted in the Chevron case. However, the government may need to change laws to take into account the OECD’s BEPS guidance on intra-group financing to legally deny interest deductions where the interest rate on related party debt exceeds the market rate.
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