The Federal Court of Australia has handed down its first ruling in a transfer pricing case dealing with pricing of cross border related party loans.
The Full Federal Court of Australia (the “Court”) ruled in favour of the Commissioner of Taxation (the “Commissioner”) in the transfer pricing dispute between Chevron Australian Holdings Pty Ltd (“Chevron”) and the Commissioner.
The Chevron case has lifted up the ‘comparability’ standard significantly. To mitigate transfer pricing risks associated with cross border related party financing transactions, taxpayers should review both historic and prospective financing transactions in light of this case. For transactions which may represent a potential risk, you will need to consider how to defend your position or the impact of any potential transfer pricing adjustments.
Chevron incorporated a special purpose subsidiary in the USA (USASub).
USASub borrowed funds externally at an interest rate of approximately 1.2%.
USASub lent money to Chevron at an interest rate of approximate 9%. The loan was:
in Australian dollars
unsecured and contains no financial or operational covenants
not supported by any third party guarantee
interest only and had a term of 5 years able to be repaid at anytime without penalty
The dividends paid by USASub to Chevron are not taxable in the hands of Chevron.
The Court rejected the argument that the loan should be priced on the basis that Chevron is a standalone company.
A company that is part of a significant global group could potentially secure a lower interest rate on its borrowings when compared to a similar standalone company. This is particularly so if the parent company has a stronger credit strength than the borrower. This should be taken into account in the transfer pricing analysis.
The pricing of the loans should be based on terms which would have been agreed to between arm’s length parties
The court rejected Chevron’s argument that the interest rate should be determined based on the actual terms of the loan.
Whilst the loan was unsecured and not guaranteed by the parent, arm’s length parties would provide security and require a parental guarantee. The Court held that the loan should be priced on the basis that the loan was secured, contain loan covenants and guaranteed by the parent. Chevron group’s policy to minimise its interest costs was a relevant consideration. It is noted that the ultimate US parent did guarantee the borrowing of USASub.
The sector and conditions of the market in which the taxpayer operates are relevant
The sector in which the borrower operates and the state of the industry are relevant considerations in the pricing analysis. In Australia for instance, property developers may be finding it difficult to obtain funding from Australian banks to fund their developments. Therefore, terms of loans prevalent in the sector (including loans from local branches of overseas banks and non-bank lenders) may be relevant.
The decision will undoubtedly require more analysis to be undertaken by transfer pricing practitioners when reviewing the interest rates on international related party loans.
Chevron has the ability to appeal the decision to the High Court. So this case may not necessarily be over yet.
If you have questions in relation to this article or require any transfer pricing assistance please contact Daren Yeoh (dyeoh@Shinewing.com.au), Yang Shi (email@example.com) or your ShineWing Australia relationship partner.