Singapore Telecom Australia Investments Pty Ltd v Commissioner of Taxation, [2021] FCA 1597, aff'd [2024] FCAFC 29

In June 2002, a Singapore-resident company (“SAI”) transferred the shares of a recently-acquired Australian telecom company (“SOPL”) to an Australian subsidiary (“STAI”) in consideration for common shares and $5.2B in unsecured notes (issued pursuant to a note facility, the "LNAI") which had a term of approximately 10 years and bore interest at a floating rate equal to the 1 year bank bill swap rate (“BBSR”) plus 1%, but multiplied by a gross-up factor of 10/9 to reflect that the interest was subject to withholding tax. After a minor amendment, the terms of the notes were amended less than a year later (under the “Second Amendment”) so as to increase the interest rate by a premium of 4.52% to reflect that the interest would not be paid if STAI did not exceed specified cash flow and profitability thresholds (which were not expected to be met for a number of years). The “Third Amendment” made in March 2009 changed the interest rate by replacing the 1 year BBSR with a fixed rate of 6.835%, so that the applicable rate thereafter became the aggregate of 6.835% and 1% multiplied by 10/9, plus the 4.552% premium, for a total rate of 13.2575% per annum.

Whether the Commissioner had appropriately reduced the interest-deduction claims of STAI turned principally on whether (under aspects of the Australian transfer pricing rules that were essentially aligned in this regard with the related-person Article of the Singapore-Australia Treaty) conditions operated between the two enterprises (STAI and SAI) in their commercial or financial relations which differed from those which might be expected to operate between independent enterprises dealing wholly independently with one another, such that the actual cost of borrowing under the notes was greater than the costs that a party in STAI’s position might be expected to have paid under such conditions.

Before dismissing STAI’s appeal, Moshinsky J found that independent parties in the positions of SAI and STAI might have been expected to have agreed in June 2002 that the interest rate applicable to the notes would be the rate actually agreed (noting in this regard that the interest gross-up was “common in international borrowings” (para. 336). This interest rate took into account that, in such circumstances, there would be a guarantee by the ultimate public-company parent (“SingTel”), given that it would not be commercially rational to bear the “much greater amount in interest” (para. 324) that would have been required without such a guarantee. Furthermore, no guarantee fee should be imputed, as there was no evidence that under the hypothetical conditions the parent would have charged such a fee (and, in fact, SingTel had not charged a guarantee fee for a $2B loan made to a subsidiary of SOPL).

Furthermore, independent parties in the positions of SAI and STAI would not have agreed to make the changes contained in the Second or Third Amendments. In particular, Moshinsky J noted (at paras. 309, 311 and 312):

[T]he Second Amendment … had the effect that the interest that had accrued under the LNIA (approximately $286 million) was treated as not having accrued … .

… I would not expect an independent party in the position of SAI to agree that the interest that had already accrued under the LNIA, which was a substantial sum, should be treated as not having accrued.

… I would not expect independent parties in the positions of SAI and STAI to agree to the terms regarding benchmarks and the Premium. The effect of these terms was that the accrual and payment of interest were contingent on certain financial benchmarks being met. Given that it was possible that these benchmarks would never be met, it is very difficult to see why an independent enterprise in the position of SAI would agree to such terms. Further, the Premium was calculated to compensate SAI for allowing what was estimated by SAI and STAI to be an interest-free period of approximately 3.5 years. If the financial benchmarks were met earlier, STAI would pay the Premium over a longer period of time. If the financial benchmarks were met later (or not at all), STAI would pay the Premium over a shorter period of time (or not at all). The terms thus exposed each party to significant commercial risk. There does not appear to be any commercial rationale for these terms.

A Singapore-resident company (“SAI”) transferred the shares of a recently-acquired Australian telecom company (“SOPL”) to an Australian subsidiary (“STAI”) in consideration for common shares and $5.2B in unsecured notes which had a term of approximately 10 years and bore interest at a floating rate equal to the 1 year bank bill swap rate (“BBSR”) plus 1%, but multiplied by a gross-up factor of 10/9 to reflect that the interest was subject to withholding tax. After a minor amendment, the terms of the notes were amended less than a year later (under the “Second Amendment”) so as to increase the interest rate by a premium of 4.52% to reflect that the interest would not be paid if STAI did not exceed specified cash flow and profitability thresholds (which were not expected to be met for a number of years). The “Third Amendment” made six years later changed the interest rate by replacing the 1 year BBSR with a fixed rate of 6.835%, so that the applicable rate thereafter became the aggregate of 6.835% and 1% multiplied by 10/9, plus the 4.552% premium, for a total rate of 13.2575% per annum.

Whether the Commissioner had appropriately reduced the interest-deduction claims of STAI turned principally on whether (under aspects of the Australian transfer pricing rules that were essentially aligned in this regard with teh related-person Article of the Singapore-Australia Treaty) conditions operated between the two enterprises (STAI and SAI) in their commercial or financial relations which differed from those which might be expected to operate between independent enterprises dealing wholly independently with one another, such that the actual cost of borrowing under the notes was greater than the costs that a party in STAI’s position might be expected to have paid under such conditions.

Before dismissing STAI’s appeal, Moshinsky J found that independent parties in the positions of SAI and STAI might have been expected to have agreed at the time of the notes’ issuance that the interest rate applicable to the notes would be the rate actually agreed (noting in this regard that the interest gross-up was “common in international borrowings” (para. 336). This interest rate took into account that in such circumstances, there would be a guarantee by the ultimate public-company parent (“SingTel”), given that it would not be commercially rational to bear the “much greater amount in interest” (para. 324) that would have been required without such a guarantee. Furthermore, no guarantee fee should be imputed as there was no evidence that under the hypothetical conditions the parent would have charged such a fee (and, in fact, SingTel had not charged a guarantee fee for a $2B loan made to a subsidiary of SOPL).

Furthermore, independent parties in the positions of SAI and STAI would not have agreed to make the changes contained in the Second or Third Amendments. In particular, agreeing to an interest rate that would provide a very high return to the lender if the cash flow and profitability conditions were met promptly and a quite low return if they were not achieved would “expose… each party to significant commercial risk” and there did “not appear to be any commercial rationale for these terms” (para. 312).