Chevron Australia Holdings Pty Ltd v Commissioner of Taxation, [2017] FCAFC 62

The U.S. subsidiary (“CFC”) of the taxpayer (“CAHPL” – which was an Australian subsidiary in the Chevron multinational group) borrowed in the U.S. commercial paper market at a borrowing cost of about 1.2% with the benefit of a guarantee from their ultimate U.S. parent, and on-lent U.S.$2.45 billion of such funds under an unsecured Australian-dollar credit facility to CAHPL at about a 9% interest rate. CAHPL deducted such interest in computing its income for Australian purposes, and received tax-free dividends from CFC of most of CFC’s profits (based on the 7.8% spread).

The Commissioners initially denied much of CAHPL’s interest deductions for its 2004 to 2008 tax years under the sui generis domestic transfer pricing (Division 13) rule contained in the 1936 Australian Act. However, in 2012 (i.e., after the tax years in question) a new (Division 815) transfer pricing rule was enacted in the 1997 Act, but with retroactive effect to tax years starting after July 1, 2004. The Division 815 Rule essentially incorporated by reference into domestic law the Associated Enterprises Article of the relevant Treaty (here, the Australia-U.S. Convention), so that assessments could be made for departures from the Art. 9 standard. The Commissioners issued replacement assessments for the 2006 to 2008 tax years based on the Division 815 rule.

In dealing first with the Division 13 rule, Pagone J (with whom Allsop CJ agreed and whose reasons were adopted by Perram J) stated (at paras 124, 132, 133):

… The evidence found by his Honour was that the borrowing by CAHPL would not have been sustainable if obtained from an independent party. … As a standalone company, severed from the financial strength of its ultimate parent and corporate group, CAHPL could not secure a loan for an amount equivalent to $US2.5 billion at the rate obtained by its subsidiary with the backing of the ultimate parent.

The evidence...amply supported...the reasonable expectation of a borrowing by CAHPL being supported by security. …

An alternative submission made by CAHPL, however, does have some force. The alternative submission was that the hypothetical acquisition would need to assume that CAHPL had paid a fee to its parent for the provision of security on the hypothetical loan.

Turning to the Division 815 rule and, thus, Art. 9 of the Australia-U.S. Treaty, he stated (at para. 156):

His Honour was correct to assume...that what might be expected to operate between independent enterprises dealing wholly independently with each other was a loan by [sic] CAHPL with security provided by its parent at a lower interest rate.

In the (essentially) concurring reasons of Allsop CJ, he stated (at paras. 92-95):

92 The conditions operating between CAHPL and CFC if they were independent of each other would not include the direction by Chevron Treasury of the officers of both for the benefit of the group as a whole. The conditions between mutually independent CFC and CAHPL could, however, include CAHPL situated within the Chevron group and CAHPL being subject to the direction of Chevron for the benefit of the Chevron group.

93 In such circumstances, were CAHPL seeking to borrow for five years on an unsecured basis with no financial or operational covenants from an independent lender, in order to act rationally and commercially and conformably with the interests of the Chevron group to obtain external funding at the lowest possible cost consistently with any relevant operational considerations, it would do so with Chevron providing a parent company guarantee, if such were available.

94 In the light of the evidence as to Chevron’s policy concerning external funding and its willingness to provide a guarantee to achieve that end the above is the natural and commercially rational comparative analysis when one removes the controlled conditions operating between CAHPL and CFC and replaces them with the condition of mutual independence.

95 In the circumstances there would have been a borrowing cost conformable with Chevron’s AA rating, which, on the evidence, would have been significantly below 9%.

The U.S. subsidiary (“CFC”) of an Australian company (“CAHPL”) in the Chevron multinational group borrowed in the U.S. commercial paper market at a borrowing cost of about 1.2% with the benefit of a guarantee from their ultimate U.S. parent, and on-lent U.S.$2.45 billion of such funds under an unsecured Australian-dollar credit facility to CAHPL at about a 9% interest rate. CAHPL deducted such interest in computing its income for Australian purposes, and received tax-free dividends from CFC of most of CFC’s profits (based on the 7.8% spread). The Australian Commissioners initially denied much of CAHPL’s interest deductions under a somewhat primitive Australian domestic pricing rule, and then later issued replacement assessments for most of the tax years based on an amendment which retroactively established an ability to assess where there was transfer pricing contrary to the Associated Enterprises Article of the relevant Treaty (here, Art. 9 of the Australia-U.S. Convention).

CAHPL’s appeal was dismissed. In his concurring reasons, Allsop CJ stated (at paras. 93-5) respecting the assimilated Art. 9 rule:

[W]ere CAHPL seeking to borrow for five years on an unsecured basis with no financial or operational covenants from an independent lender, in order to act rationally and commercially and conformably with the interests of the Chevron group to obtain external funding at the lowest possible cost consistently with any relevant operational considerations, it would do so with Chevron providing a parent company guarantee, if such were available.

In the light of the evidence as to Chevron’s policy concerning external funding and its willingness to provide a guarantee to achieve that end the above is the natural and commercially rational comparative analysis when one removes the controlled conditions operating between CAHPL and CFC and replaces them with the condition of mutual independence.

In the circumstances there would have been a borrowing cost conformable with Chevron’s AA rating, which, on the evidence, would have been significantly below 9%.

Somewhat similarly, Pagone J (speaking for himself and Perram J) stated (at para. 156):

[W]hat might be expected to operate between independent enterprises dealing wholly independently with each other was a loan by CAHPL with security provided by its parent at a lower interest rate.

The U.S. subsidiary (“CFC”) of the Australian taxpayer (“CAHPL) borrowed in the commercial paper market at a borrowing cost of about 1.2% with the benefit of a guarantee from their ultimate U.S. parent, and on-lent U.S.$2.45 billion of such funds under an unsecured Australian-dollar credit facility to CAHPL at about a 9% interest rate. CAHPL deducted such interest in computing its income for Australian purposes, and received tax-free dividends from CFC of most of CFC’s profits (based on the 7.8% spread).

The Commissioners initially denied much of the interest deductions by the Australian taxpayer (“CAHPL) for interest at a 9% rate paid to its U.S. subsidiary under the sui generis domestic transfer pricing (Division 13) rule. However, a new (Division 815) transfer pricing rule was subsequently enacted, but with retroactive effect to most of the tax years at issue. The Commissioners issued replacement assessments for three of the tax years in issue based on the Division 815 rule.

In rejecting a CAHPL submission that the assessments under the retroactive legislation were constitutionally invalid, Pagone J quoted extensively from MacCormick v Federal Commissioner of Taxation (1984) 158 CLR 622 including the quotation therein of the statement by Dixon C.J. in Deputy Federal Commissioner of Taxation v. Brown that:

Although there is no judicial decision to that effect, it has, I think, been generally assumed that under the Constitution liability for tax cannot be imposed upon the subject without leaving open to him some judicial process by which he may show that in truth he was not taxable or not taxable in the sum assessed, that is to say that an administrative assessment could not be made absolutely conclusive upon him if no recourse to the judicial power were allowed.

and then stated (at paras. 143-4):

In MacCormick it was said that it must not only be possible to point to the criteria themselves, but also to show that the way in which they are applied does not involve the imposition of liability in an arbitrary or capricious manner. In Roy Morgan the majority explained that these passages, sourced from what had been said in Brown, established that compliance with the Constitution required that liability for tax not be imposed without leaving open to the taxpayer some judicial process by which the taxpayer may show that in truth the tax was exigible or not exigible in the sum assessed… :

Division 815-A does not impose an arbitrary or incontestable tax in the sense contemplated by the authorities. … That a person may not be aware at an earlier point in time what the criteria of liability may subsequently be made to apply to that earlier point in time does not make the legislation arbitrary or incontestable… .