Australia: The transfer pricing Chevron decision - funding, parental support, currency… and the experts

Last Updated: 10 November 2015
Article by Niv Tadmore and Benjamin Lancaster

Most Read Contributor in Australia, August 2016

Key Points:
The rejection of the Commissioner's position on the relevance of credit rating agencies and the relevance of implicit support will give rise to uncertainty going forward, as it is unclear how an arm's length interest rate can be practically determined.

The Federal Court's recent decision in Chevron Australia Holdings Pty Ltd v Commissioner of Taxation (No 4) [2015] FCA 1092 is an important decision in relation to Australia's transfer pricing law and the application of the arm's length principle to financing issues (such as risk margins and choice of currency). In particular, the decision highlights the importance of having relevant and high-quality expert evidence in transfer pricing disputes.

Background to the issues

This case has been closely followed , as it was the first case to be heard by a Court in Australia which applied transfer pricing principles in a financing context (and only the third significant Australian transfer pricing case). The financing issues have attracted particular attention, as limited judicial guidance on this issue exists globally (such as the Canadian decisions in GE Capital Canada, which had accepted that passive affiliation could be taken into account in a transfer pricing analysis). 1 

It was also the first case to consider the validity of the transfer pricing rules in Subdivision 815-A of the Income Tax Assessment Act 1997 (Cth). Subdivision 815-A was enacted in 2013 with retrospective effect to the income years starting from 1 July 2004 to 30 June 2013 . These rules operated concurrently with existing transfer pricing rules in Division 13 of the Income Tax Assessment Act 1936 (Cth).

From 1 July 2013, both Division 13 and Subdivision 815-A were replaced with Subdivision 815-B of the Income Tax Assessment Act 1997 (Cth).

Background to the matter

The relevant borrower was Chevron Australia Holdings Pty Ltd (Borrower), a wholly owned subsidiary of the US-based Chevron Corporation (Parent).

CAPHL entered into a Credit Facility Agreement in June 2003, under which it borrowed from a special purpose subsidiary (Lender) which had been established to raise funds in US bond markets (with the benefit of a guarantee from the Parent). The key features of this credit facility were that:

  • the Borrower borrowed the AUD equivalent of US $2.5 billion;
  • interest would be paid at 1-month AUD LIBOR + 4.14% p.a.;
  • the loan was repayable in full after 5 years, but could be repaid earlier at the Borrower's option;
  • the loan was not subject to financial covenants; and
  • no guarantee or security was provided by the Borrower.

In summary, the Commissioner made determinations under both Division 13 and Subdivision 815-A, based on his view that:

  • the arm's length rate of interest for the loan was lower than that charged by the Lender; and
  • an arm's length loan agreement would have contained other terms which reduced the amount payable (such as that the loan would have been in USD and would have contained financial covenants).

The decision turned on the evidence before the Court. The Court made a number of findings on legal and factual issues that are likely to impact upon future transfer pricing matters, including that:

  • Article 9 of the Australia-United States double tax agreement did not operate "independently of the transfer pricing provisions in the domestic legislation" as a basis for a tax assessment;
  • the concept of "consideration" in Division 13 was not limited to the interest rate, and included valuable promises of the borrower (such as restrictive covenants and security);
  • Division 13 does not treat a taxpayer which is a subsidiary of entity as a stand-alone entity;
  • independent lenders do not rely upon published credit ratings, and instead complete their own credit analysis (as such, the practices and policies of rating agencies are not relevant);
  • although it was permissible to take the implicit support of a parent entity into account, it "had very little, if any, impact on pricing by a lender in the real world";
  • an arm's length loan may have been made in AUD for commercial reasons, despite carrying a higher interest rate than USD;
  • the transfer pricing rules can be applied irrespective of whether the amount of debt is below the safe harbour thresholds under the thin capitalisation rules; and
  • Subdivision 815-A was constitutionally valid.

The role of expert evidence

Given the nature of the issues which often arise in transfer pricing matters, the Court was heavily reliant on expert evidence to make the factual findings necessary to determine this matter.

From a practical perspective, experts are selected by the party who wishes to rely upon their evidence. However, the expert is not an advocate for that party, and their paramount duty is to assist the Court to make factual findings which are within their area of expertise.

The selected experts are then briefed with the relevant materials and asked to respond to the questions by the party's legal team. In this case, the Court found that many of the questions that had been asked did not address what the Court interpreted to be the relevant test.

The pricing experts

Justice Roberson was not persuaded by the evidence of the Borrower's two expert witnesses who were called to give evidence as to the price that would have been paid by the Borrower for an arm's length loan. Therefore, Justice Robertson found that the Borrower had not discharged its onus of proving that the assessments which the Commissioner had issued were excessive.

The Borrower's two witnesses on this point were former senior officers of major US banks. In considering their evidence, the Court accepted the evidence of each that independent lenders performed their own independent credit analysis (and did not rely on the published reports of rating agencies). Accordingly, the Court did not consider the practices of credit rating agencies to be relevant.

However, the Court did not accept the evidence of either witness as to the arm's length consideration of the loan. This was because the first witness:

  • "did not address what the consideration would have been if it had been negotiated at arm's length" (which he was not asked to do);
  • "had no relevant experience in or detailed knowledge of the" exploration and production industry;
  • disregarded credit metrics relevant to this industry;
  • assumed there could be multiple lenders (when the transaction undertaken involved only one lender); and
  • based opinions on a "form of transaction would not have occurred" (as the Court did not accept the loan could be priced as a Term Loan B).

The Borrower's second pricing witness' evidence was not accepted because:

  • the Court found that the question he had been asked did not address the statutory question, which required consideration of a loan negotiated at arm's length;
  • he based his opinion on the Borrower having a lower credit rating (being "approximately equal to a B rating by" Standard and Poor's) than the Borrower had asserted (BB or BB+);
  • he accepted there could not have been a single lender (also basing his analysis on there being multiple lenders);
  • he agreed the loan would not have been made in the absence of restrictive covenants (but did not consider how such covenants would have affected the interest rate); and
  • he had asserted that his bank would have had a minimum fee of 300 basis points (which was not accepted, after he was confronted in cross-examination with documents showing his bank extended a lower rate to other borrowers).

As the evidence of the Borrower's pricing experts was rejected, the Borrower did not have any evidence which would establish the arm's length consideration for the loan. As such, the Borrower was unable to satisfy the onus of proving that the assessment was excessive.

The other experts

These were not the only expert reports which the Court rejected. In considering the reports of the 20 experts called in the matter, most of the evidence was rejected as the Court found that it did not address a relevant question.

Credit ratings

Much of the evidence held to be irrelevant was led in relation to the credit rating which the Borrower would have been given by a rating agency, which was argued by the Commissioner to be relevant. Once the Court found that the practices of rating agencies were not relevant, it followed that the evidence given about credit ratings was not relevant. One of the immediate and practical implications of this case flows from this finding in that it creates uncertainty as to how the pricing exercise should be performed in practice.

In any event, much of the evidence on credit ratings was found to be unpersuasive for other reasons. As examples, the Commissioner relied on the evidence of:

  • a witness who attempted to use a statistical model to determine the Borrower's credit rating (rather than applying the policies and practices of rating agencies);
  • a witness who was directed to an abstract question of whether a subsidiary's rating could be equalised with its parent, and whose answer was based on a methodology would could not have reliably answered this question;
  • a witness who had not been directly involved in issuing credit ratings for some time prior to the relevant loan being made; and
  • a witness who had not been a rating analyst.

One witness called by the Commissioner on this question was confronted in cross-examination with an article which he had written in relation to the impact of implicit parental support (which had concluded that there was no market evidence of a lender would provide a lower interest rate for this reason). The article was consistent with the evidence given by the Borrower's witnesses, and was taken into account by the Court in reaching the same conclusion.

Currency

The Commissioner also sought to rely upon the evidence of an expert accountant as to the "ideal" currency of the loan. However, the Court accepted that the choice of currency is a commercial matter and was outside the scope of the accountant's expertise. Though not addressed in the decision, commercial decisions around currency are not black and white. As such, evidence as to the "ideal" currency of a loan is unlikely to address the relevant question for transfer pricing purposes.

Having rejected this evidence, the Court was not persuaded that an arm's length loan would have been made in USD, rather than AUD.

Using expert witnesses

There are a number of key points to take away from this decision for parties relying on expert evidence:

  • the evidence must be relevant - this an obvious point, and depends on the Court's view as to what may or may not be relevant. Unless the evidence addresses a question of fact which is relevant to the Court's task, the evidence cannot be taken into account by the Court;
  • carefully formulate the questions - the evidence of an expert will not be relevant unless they are directed to the right question. In particular, care should be taken to avoid reformulating a statutory test or requirement;
  • consider setting the questions collaboratively - issues regarding the relevance of questions are more easily addressed where the parties have agreed as to the relevant questions to be put to the experts (depending on the matter, the Court may also have a role to play in facilitating this process);
  • the expert must have relevant expertise - opinions on issues which are outside an expert's area of expertise will not be given weight by the Court.   Consider whether there are features of the case at hand which require specialised experience relevant to that transaction or industry;
  • due diligence on your own experts - witnesses in this case were confronted with evidence from their own organisations or prior research which did not sit comfortably with their analysis. Where this occurs, there is the potential for significant damage to the witnesses' credibility (which can be managed better if the expert has an early opportunity to address the allegedly contradictory evidence); and
  • consider having experts address your opponent's case theory - only leading expert evidence which is consistent with your case theory may leave you exposed if your opponent's case theory is accepted. Consideration should be given to having the expert consider whether your opponent's case theory would lead to a different conclusion.

Given the central role which expert evidence plays in most transfer pricing cases, these issues take on an increased importance. The potential issues with expert evidence should be addressed early, with a view to preventing disputes as to the utility and relevance of an expert's evidence.

Conclusion

The Commissioner was successful in terms of the outcome of this case. The Commissioner was successful as the Court found that the Borrower had not led evidence which addressed the Court's interpretation of the proper statutory question.

Importantly, however, the Court rejected the Commissioner's key contentions that would have affected the arm's length interest rate. In particular, the Court rejected the Commissioner's submissions that:

  • an arm's length loan would have been made in USD (rather than AUD); and
  • that the arm's length interest rate would have been reduced because the Borrower would receive a higher credit rating due to the implicit support of its Parent.

The rejection of the Commissioner's position on currency highlights the commercial nature of this decision. The question of whether arm's length parties would borrow in different currencies is broader that asking what would the ideal currency for a loan be.

The rejection of the Commissioner's position on the relevance of credit rating agencies and the relevance of implicit support will give rise to uncertainty going forward, as it is unclear how an arm's length interest rate can be practically determined (without resorting to expert evidence). Taxpayers using an approach based on rating agency guidance will need to consider their positions.

The implications of this decision will be thoroughly considered in at least three contexts:

  • applying the arm's length principle to establish and analyse transfer pricing positions;
  • negotiating advance pricing agreements with the Commissioner; and
  • transfer pricing dispute.

Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states and territories.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Mondaq Advice Centre (MACs)
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.