Case note

Each year, and each amendment, tested on its own terms

Singapore Telecom Australia Investments Pty Ltd v Commissioner of Taxation (2024) 302 FCR 192; [2024] FCAFC 29

A ten year vendor loan of $5.2 billion was amended twice, and the amendments were the problem rather than the original terms. The Full Court held that the arm's length comparison is made for each income year against the conditions existing when the relevant events occurred, not once across the life of the arrangement.

Court

Full Court of the Federal Court of Australia

Bench

Wigney, Banks-Smith and Colvin JJ, in a single judgment of the Court

Decided

8 March 2024

Outcome

Appeal dismissed with costs. All seven grounds rejected

The facts

In June 2002 an Australian company acquired the shares in the company operating the Optus telecommunications business. The vendor was a British Virgin Islands company, and both buyer and seller were wholly owned subsidiaries of a Singapore listed parent: [1], [5].

The purchase was funded by the vendor. Under a loan note issuance agreement, $5.2 billion was advanced for ten years at the one year bank bill swap rate plus one per cent, reset annually, grossed up so that the Australian borrower bore the ten per cent withholding tax on the payments out: [2], [3], [5].

The agreement also deferred payment. Interest accrued from the outset but was not payable until the lender issued a variation notice, which let the lender fix when over the ten years the borrower had to pay and how much. That mattered because the Australian business was not expected to be profitable in the early years. The Court noted the oddity: it was the borrower that needed the deferral and the lender that held the power to grant it: [3], [4]. Either side could bring the loan to an end at any time, so the borrower had no security of funding and the lender no security of return: [6].

The agreement was amended three times. The first amendment was immaterial. The second removed any accrual of interest at all. The third moved to a fixed base rate for the last three years of the term. The second and third are the amendments the case is about: [7], [77].

What was in dispute

The taxpayer's case was built on the whole of the ten year term. Its argument was that, looked at across the life of the loan, the total interest was no more than would have been paid on arm's length terms, so no benefit had been obtained.

That put a question of construction before any question of commercial judgment: is the comparison made once, over the arrangement, or separately for each income year?

What the Court decided

The appeal was dismissed with costs, unanimously, and the taxpayer lost at the threshold.

Subdivision 815-A identifies the benefit as an amount of taxable income or loss for an income year, and it is that amount a determination negates. The scheme therefore requires the Commissioner to determine not only how much might have been expected to accrue but in which year, and profit consequences spread across years do not become a single aggregate: [23], [34], [37], [39]. The Court worked the point through an example: where a non-arm's length dealing pushes three years of interest into the third year, the taxpayer cannot answer a determination for that year by saying the total is unchanged. The timing difference is itself the benefit, and unfairness in the earlier years is dealt with by a separate consequential determination: [40] to [42].

Three practical objections reinforced that reading. On the taxpayer's approach no comparison could be made until a long term arrangement ended; long term arrangements are amended along the way, so applying the provisions with hindsight to a term whose terms changed is unworkable; and the transitional provision applies the Subdivision to income years, which an aggregating approach cannot accommodate: [49], [50].

It follows that each amendment is tested against the circumstances in which it was made.

Therefore, the required comparison must have regard to the actual conditions that gave rise to the interest for which STAI claimed a deduction. Those conditions were not those that existed at the time that SAI and STAI entered into the LNIA. They were the conditions that existed at the time of the actual events that were said to justify the interest in the particular income year.

The Court at [139].

In any event, the LNIA was a financing arrangement, not some form of quasi-equity. There was no evidence that suggested that an arrangement of the kind created by the second amendment was one which a financier dealing at arm's length would have countenanced (let alone a vendor who had sold shares in SOPL on the basis of vendor financing). As to STAI's need to defer interest in the early years of the indebtedness, the LNIA already allowed for deferral and capitalisation of interest. What the second amendment did was remove any accrual of interest.

The Court at [278].

It is important to be accurate about what survived and what did not, because the case is often summarised as one where the original loan was accepted and only a later change was rejected. The Court upheld a finding that conditions differed from those expected between independent parties at the time of entry into the agreement and throughout its term: [114]. What the Commissioner never suggested was that the interest rate under the original terms was other than arm's length: [114]. Those are different statements.

The counterfactual constructed by the primary judge and upheld on appeal kept the original rate and the deferral and capitalisation feature, and added something the actual agreement never contained, being a parent guarantee provided at no cost: [116], [144]. Two amendments were stripped out of it, not one.

All seven grounds failed: on the rate, on the fixed base rate for the final three years, on the guarantee, on annual capitalisation, on whether the second amendment was irrational, on the legal effect of the determinations, and on earlier year losses. The Court also observed that even had a different rate been shown to be appropriate, it would not follow that the assessments had been shown to be excessive, because the taxpayer had never addressed the interest deductible in the relevant years: [196].

Why the decision matters

The decision is the clearest Australian authority that transfer pricing is assessed year by year. A group cannot answer an adjustment for one year by pointing to the economics of the whole arrangement, and a long dated intra-group instrument does not buy the comfort of being judged once, at the end.

The more practical proposition is that an amendment is a fresh transaction for these purposes. It is tested against the conditions existing when it was made, and the fact that the original bargain was unobjectionable does not carry across to it. Intra-group arrangements are commonly documented carefully at the outset and then varied informally as circumstances change. This case is what happens to the variations.

There is also a lesson about evidence. The second amendment failed not because a court disapproved of it in the abstract but because there was no evidence that a financier dealing at arm's length would have countenanced it, and because the deferral the borrower needed was already available under the original terms. The amendment did something different: it removed any accrual of interest. Where a variation goes beyond the commercial need it is said to answer, the explanation has to be capable of being given.

Finally, the case is a reminder of where the onus sits and of how specific it is. A taxpayer must address the deduction claimed in the particular year under assessment. Establishing that some other rate or some other view of the arrangement might have been open does not discharge it.

Where it stands

The decision stands. It has been applied or approved in later decisions of the Federal Court and the Administrative Review Tribunal, and nothing in the material read doubts or distinguishes it.

A caution about the citations often attached to it. The firm's own records, and several secondary accounts, state that special leave to appeal was refused. That could not be verified: the citator holds five citing documents, none from the High Court, and does not index the High Court transcript series. Nothing is asserted here about special leave, and the position should be checked against the High Court's own records before it is stated anywhere.

The provisions construed, Division 13 and Subdivision 815-A, have been replaced by Subdivision 815-B. The year by year reasoning depends on the structure of the benefit being defined for an income year, which is a feature of the current provisions as well, but the point should be verified against the current text before the case is relied on for it.

Three dates in the judgment attach to the third amendment and differ from one another, being when it was agreed, when it was made and when it took effect. None is used in this note.

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 reasons of the Full Court.