Chevron lost their appeal to the Full Federal Court over a tax bill totalling $340 million. This relates to a $US2.5 billion ($3.7 billion) intercompany loan agreement used to fund development of gas reserves off Western Australia.
At the heart of the case was a related party loan (Credit Facility Agreement) between the US subsidiary, Chevron Texaco Funding Corporation (CFC) and its Australian parent, Chevron Australia Holdings Pty Ltd(CAHPL). The issue was whether the terms of the loan were at arm’s length, which is required under transfer pricing laws. The Court ruled that the terms of the loan were considered to have exceeded the arm’s length consideration that might reasonably have been expected in an agreement between independent parties acting at arm’s length.
CFC borrows money in an open market in the United States at 1.2% using commercial paper.
CFC lends borrowed funds of $2.5 billion to its Australian parent CAHPL at 9% with no security.
CAHPL pays interest to CFC for CFC to pay its profits (essentially made up of the interest received from CAHPL) back to CAHPL as a non-assessable non-exempt (NANE) dividend under the former s 23 AJ of the ITAA 1936 (now subdiv 768-A of the ITAA 1997).
Was the 9% interest rate reflective of the arm’s length interest rate that would have been charged between unrelated parties?
CAHPL argued that if it had gone into the open market to borrow $2.5 billion without security, it would have paid more than 9%. Therefore the rate would be an arm’s length rate of interest.
Accepted by the Full Court (Pagone, Allsop and Perram JJ) and Robertson J at first interest, it is not appropriate to consider what is the arm’s length rate of interest by reference to a loan where no security is provided. The Chevron group would invariably provide security in the form of a guarantee.
The appropriate question to ask is what would be the rate of interest charged between unrelated parties on a $2.5 billion loan made to CAPHL in circumstances where the loan and interest repayments are guaranteed by a member of the Chevron group.