Clifford Gouldson Lawyers

What is "arm's length"? Inside Australia's biggest tax case

Print Version

11/05/2017

Summary

  • Chevron forced to pay $200 million in taxes because of a loan found not to be at "arm's length"
  • The ATO and Courts will not assume a wholly owned subsidiary is unrelated to its parent company
  • Arrangements between related entities should be on genuine commercial terms if they want to be considered at "arm's length"
Recently the Australian Tax Office (ATO) won a tax case against Chevron Australia Holdings Pty Ltd (Chevron) a multinational oil company, in a case that has been dubbed as Australia’s biggest tax case in history with an order for Chevron to pay roughly $200 million in taxes.

The Facts:
  • The ChevronTexaco Funding Corporation (CFC) was formed in America as the primary funding company in its corporate structure;
  • In 2003, Chevron and CFC entered into a loan agreement for the construction of Chevron’s North West Shelf gas project in Western Australia;
  • CFC borrowed approximately $2.5 billion from the commercial market in the US at an interest rate of approximately 1.2% per annum;
  • CFC then lent this money to its Australian related company at a 9% interest rate between 2004 and 2008.
  • CFC, and ultimately the whole Chevron group, profited from this loan to an amount of $1.7 billion dollars, which was not taxed in either Australia or the US; and
  • Chevon claimed interest deductions as a result of this loan agreement under the transfer pricing rules as if it was a standalone company separate from CFC.

The Issue:

The primary proceedings in 2015 saw the Federal Court hand down a judgment that was mostly in favour of the ATO, however this Judgment did not accurately address the loan agreement’s dubious arm’s length terms surrounding transfer pricing.

On appeal this year, the core issue of the proceeding surrounded the terms of the interrelated party loan, which allowed Chevron to make inflated interest deductions that dramatically decreased the tax payable.

The ATO successfully argued that the terms of this loan were not made at arm’s length, which is required under the international transfer pricing rules.

The Commissioner for the ATO retrospectively denied a significant proportion of the claimed interest deductions by Chevron and issued amended tax assessments for each of the years between 2004 to 2008. The ATO made the decision to amend Chevron’s assessments on the basis that the interest paid by Chevron was greater than it would have been under an arm’s length dealing between independent parties.

What is transfer pricing?

Transfer pricing is only applicable if you engage in international transactions with a related-party – such as the loan agreement between Chevron and CFC. If the transactions between the related parties do not comply with the ATO’s arm’s length principle under the transfer pricing rule, the Australian company’s tax position could be dramatically affected.
The transfer pricing rules are an attempt made by the ATO under their anti-avoidance tax initiative aimed at multinational organisations that attempt to “shift their profits to low-tax jurisdictions by setting unrealistic prices for their actual commercial or financial dealings with their related parties”.

The Outcome

The commissioner was successful in terms of the outcome of this appeal. Chevron is to pay the ATO in the approximate amount of $311 million for the inflation of their interest deduction due to their loan arrangement with CFC.

The ATO has commented that the Federal Court’s decision has direct implication for several
cases that it is currently pursuing in relation to related-party loans and transfer pricing.
The ATO and Chevron have yet to apply for special leave to appeal to the High Court of Australia.

Key lesson:

This case only reaffirms the narrow view that the ATO and the Court takes when reviewing
transactions that are conducted on an arm’s length basis. When forming interrelated party loans, it should not be merely assumed that a subsidiary is wholly independent from the parent company.

Organisations, when dealing at arm’s length, must consider the appropriate market prices and the common ownership between the parent company and subsidiary in determining the most appropriate tax structure.

If you require any tax structuring advice to assure your compliance under the Tax Rules, please get in touch with one of our Tax, Structures and Planning team today on (07) 4688 2188.

1. Chevron Australia Holdings Pty Ltd v Commissioner of Taxation (No 4) [2015] FCA 1092.
2. Australian Taxation Office, Income tax: application of the transfer pricing provisions to business restructuring by multinational enterprises, TR 2011/1, 9 February 2011.
3. Income Tax Assessment Act 1997 (Cth) s 815-130.
4. https://www.ato.gov.au/Business/International-tax-for-business/In-detail/Transfer-pricing/Internationaltransfer-pricing---introduction-to-concepts-and-riskassessment/?page=2#The_arm_s_length_principle_and_comparability
5. Australian Taxation Office, Income tax: application of Division 13 of Part III (international profit shifting) - some basic concepts underlying the operation of Division 13 and some circumstances in which section 136AD will be applied, TR 94/14, 14 December 2011.

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