27 Apr 2017 Chevron case: ATO wins landmark transfer pricing case
The judgment of Chevron Australia Holdings Pty Ltd (CAHPL) v Commissioner of Taxation  FCAFC 62 was handed down on Friday 21 April 2017. In a win for the ATO, the Full Federal Court unanimously dismissed Chevron’s appeal, making it Australia’s biggest tax case with global implications for large companies and multinationals.
Chevron lost their appeal to the Full Federal Court over a tax bill totalling $340 million. This relates to a $US2.5 billion ($3.7 billion) intercompany loan agreement used to fund development of gas reserves off Western Australia.
At the heart of the case was a related party loan (Credit Facility Agreement) between the US subsidiary, Chevron Texaco Funding Corporation (CFC) and its Australian parent, Chevron Australia Holdings Pty Ltd(CAHPL). The issue was whether the terms of the loan were at arm's length, which is required under transfer pricing laws. The Court ruled that the terms of the loan were considered to have exceeded the arm’s length consideration that might reasonably have been expected in an agreement between independent parties acting at arm’s length.
- CFC borrows money in an open market in the United States at 1.2% using commercial paper.
- CFC lends borrowed funds of $2.5 billion to its Australian parent CAHPL at 9% with no security.
- CAHPL pays interest to CFC for CFC to pay its profits (essentially made up of the interest received from CAHPL) back to CAHPL as a non-assessable non-exempt (NANE) dividend under the former s 23 AJ of the ITAA 1936 (now subdiv 768-A of the ITAA 1997).
- Was the 9% interest rate reflective of the arm’s length interest rate that would have been charged between unrelated parties?
- CAHPL argued that if it had gone into the open market to borrow $2.5 billion without security, it would have paid more than 9%. Therefore the rate would be an arm’s length rate of interest.
- Accepted by the Full Court (Pagone, Allsop and Perram JJ) and Robertson J at first interest, it is not appropriate to consider what is the arm’s length rate of interest by reference to a loan where no security is provided. The Chevron group would invariably provide security in the form of a guarantee.
The appropriate question to ask is what would be the rate of interest charged between unrelated parties on a $2.5 billion loan made to CAPHL in circumstances where the loan and interest repayments are guaranteed by a member of the Chevron group.
Federal Court decisions
The Federal Court dismissed CAHPL’s appeal. The Court upheld amended assessments raised against CAHPL based on the transfer pricing rules in Div 13 of Pt III of the ITAA 1936 and, in the alternative, based on the cross-border transfer pricing rules in Div 815 of the Income Tax Assessment Act 1997. The court also dismissed a challenge to the constitutional validity of Subdivision 815-A, in particular ss 815-10 to 815-30, of the ITAA 1997.
The Court said that CAHPL provided no guarantee to CFC and did not provide to CFC any security over its other assets. CFC was entitled to terminate the Credit Facility Agreement at any time without cause. CAHPL had the right to prepay any advance made to it. CAHPL and CFC were related, each having a common parent, Chevron Corporation (CVX), and CFC being a subsidiary of CAHPL. CAHPL and CFC were not dealing with each other at arm’s length.
CAHPL did not give security or operational and financial covenants, which would have affected the interest rate. The interest rate was higher in the absence of those promises or covenants. If the property had been acquired under an agreement between independent parties dealing at arm’s length with each other, the borrower would have given such security and operational and financial covenants and the interest rate, as a consequence, would have been lower. The limited scope of the consideration given or agreed to be given by the taxpayer resulted in the consideration which the taxpayer did give, the promise to pay the interest rate, exceeding the arm’s length consideration in respect of the acquisition. It followed, on that basis, that the taxpayer had not shown that the arm’s length consideration assessed by the Commissioner was excessive.
In a unanimous decision of the Full Federal Court (Allsop CJ, Perram and Pagone JJ), the decision of Robertson J at first instance was affirmed.