Case note

Chevron: what the arm's length test asks of a loan inside a group

Chevron Australia Holdings Pty Ltd v Commissioner of Taxation (2017) 251 FCR 40; [2017] FCAFC 62

Australia's leading decision on how a loan between related companies is priced for tax. The Court held that the absence of security, covenants and a parent guarantee is not part of what the borrower acquired but part of what it did not pay, and that the comparison with independent parties does not require the borrower to be imagined outside its group.

Court

Full Court of the Federal Court of Australia

Bench

Allsop CJ, Perram and Pagone JJ

Decided

21 April 2017

On appeal from

Chevron Australia Holdings Pty Ltd v Commissioner of Taxation (No 4) [2015] FCA 1092

Outcome

Appeal dismissed with costs

The facts

Chevron Australia Holdings Pty Ltd was the Australian holding company of the Chevron group. It borrowed from Chevron Texaco Funding Corporation, and the direction is worth stating carefully because it is the reverse of the usual picture: the funding company was a subsidiary of the Australian company, so the Australian parent borrowed from its own American subsidiary: [99], [100].

The funding chain had two legs. The American company raised money in the United States at about 1.2 per cent, and did so with a guarantee from the ultimate American parent, which held a AA credit rating. It lent that money on to its Australian parent at about 9 per cent. The external leg of the identical chain was guaranteed; only the internal leg was not: [100], [132], [133]. The facility was capped at the Australian dollar equivalent of US$2.5 billion and ran for five years from June 2003: [23], [24], [35].

Three absences decided the case. There were no financial or operational covenants, the borrower gave no security, and the ultimate parent gave no guarantee: [34].

The tax effect followed from the interest. It was deducted in Australia, it was not taxable in the hands of the American company, and the dividends that company then paid were not assessable in Australia. Operating income that would otherwise have been assessable was, in the Court's words, transformed into non-assessable income: [19]. The debt level had been set by the group's treasury function because it was the most tax efficient structure for the group: [20].

What was in dispute

Transfer pricing asks what independent parties would have agreed for the same dealing. The difficulty in every case is knowing how much of the real world to keep when imagining that bargain, and this appeal put the question in an unusually clean form.

The property acquired had to stay constant between the real transaction and the imagined one, so everything turned on classification. Was the absence of security, covenants and a guarantee part of the property the borrower acquired, in which case it had to be carried across and only the interest rate could move? Or was it part of the consideration the borrower gave, in which case it could be replaced? The taxpayer argued the first, and argued further that the exercise was to price the loan for a borrower standing alone, outside its group: [36], [53], [115].

What the Court decided

The appeal was dismissed with costs. Perram J agreed with Pagone J without adding reasons, so those are the reasons of the majority; Allsop CJ agreed in the orders and wrote separately: [1], [98].

On the first question, an absence is not property. The definitions are wide enough to catch the rights and benefits obtained under a lending agreement, but describing the property as money is not enough, because the obligation to repay is what gives it its character as a loan: [11], [35]. What the borrower did not give was not something it received.

The ability or willingness to grant security (from the borrower or a third party) or to give a promise that may better secure or make safe the lender’s position are most readily conceived of, or characterised, as part of what the borrower is willing or able to provide to obtain the loan at an interest or discount rate that is commercially acceptable, that is as part of the consideration.

Allsop CJ at [37]. Pagone J to the same effect at [115] and [117].

That classification is not made in the abstract. Nothing requires a term of an agreement to be either property or consideration as a matter of logic; the question is answered by characterising the agreement and the facts with the ultimate task in mind: [15], [52].

On the second question the Court rejected the stand-alone hypothesis. The comparison does not require what Allsop CJ called the utter disembodiment of both parties from the circumstances of reality. The one fixed proposition is that the two parties to the imagined bargain must be independent of each other; beyond that, the degree of depersonalisation is dictated by what is appropriate to the task: [43], [44], [45].

It is worth being precise about why the taxpayer lost, because the case is often summarised as a rate that was too high. It was not. Allsop CJ accepted that a stand-alone company with this borrower's balance sheet, borrowing that sum unsecured for five years with no covenants, would in all likelihood have paid above 9 per cent: [54]. The taxpayer lost because that was the wrong comparison. On its approach a group could fix its own answer by writing in terms no independent party would have accepted and no commercial necessity required: [55], [125].

The two judgments then reach the same result by different routes. For the majority, an independent borrower in this position would have given security and covenants: [131]. For Allsop CJ, a parent in the group's position would have given a guarantee, which makes security from the borrower beside the point: [60], [62]. Either way the rate would have been significantly below 9 per cent: [95].

Why the decision matters

The decision settles that an arm's length comparison is about terms and price together, not price alone. A rate cannot be defended by pointing to the terms that produced it where those terms are themselves a product of the relationship the provisions exist to look past. That is why the case is cited far more often for its method than for its numbers.

It also establishes that classifying a feature of a transaction, as part of what was acquired or part of what was given for it, is an exercise in characterisation on the facts rather than a matter of category. A party cannot secure a favourable comparison by drafting a term onto one side of the ledger.

The case is finally a plain statement of where the burden lies. The Commissioner conceded that the officer who made the Division 13 determinations had no authority to make them, and it did not assist the taxpayer: an assessment is protected from challenge on the ground that the process behind it miscarried, and a taxpayer does not discharge the burden of proving an assessment excessive by showing that the Commissioner erred in some respect: [104], [105], [108].

Where it stands

The decision stands. On the citator material read for this note it has not been reversed, overruled, disapproved or doubted, and it has been applied repeatedly by later Full Courts, most fully in Commissioner of Taxation v Glencore Investment Pty Ltd (2020) 281 FCR 219 and Singapore Telecom Australia Investments Pty Ltd v Commissioner of Taxation (2024) 302 FCR 192. No application for special leave appears in the material read, and no statement is made here in either direction.

Two qualifications travel with it. In Glencore the Full Court corrected any impression that Chevron had adopted a test of what independent parties would have done, holding that the statute requires the lower standard of what they might reasonably be expected to have done. In Singapore Telecom the Full Court held that observations of Allsop CJ at [17] were made about Division 13, which operates differently from Subdivision 815-A.

The statutory qualification matters more. The decision construes Division 13 and Subdivision 815-A, both of which have been replaced: Subdivision 815-B governs income years commencing on or after 29 June 2013: [136]. The judgment says nothing about Subdivision 815-B and no decision in the material read applies Chevron to it. The reasoning about the arm's length hypothesis is pitched above the repealed text and is routinely cited, but a proposition that Chevron governs a Subdivision 815-B question is not established by the case itself. Every reference in the judgment to the OECD Transfer Pricing Guidelines is to the 1995 edition, fixed by a transitional provision for those years: [76], [77].

A case note by Boettcher Law. It is general information about Australian law and a summary of a published decision, and it is not legal advice on any particular arrangement. Paragraph references are to the Full Court's reasons.