Chevron Transfer Pricing (TP) case regarding an intragroup financial arrangement was heard over 21 court days in Australia. More than 20 witnesses and experts from financial and tax sectors participated in the investigations of the case.
Snapshot of the group structure
Chevron Inc, the ultimate parent of the Group with its headquarters in the US. Chevron Texaco Funding Corporation (CFC), appeared to be also a US resident and wholly owned by Chevron Australia Holdings Pty LTD (CAH). Furthermore, the Australian entity is also a member of Chevron Group.
The intercompany loan agreement
CFC issued USD commercial paper to raise funds from the open market. Given that Chevron Inc provided a credit guarantee to CFC, the interest rate of borrowing remained at low levels (approximately 1.2%). Then, CFC entered into a Credit Facility Agreement with CAH lending the AUD equivalent of USD2.5 billion. This unsecured loan bore interest at a rate of AUD LIBOR plus 4.14% (about 8.97%).
The TP aspect
Under the general TP rules, the actual conditions that operated between CFC and CAH shall be compared with those conditions expected to operate between independent parties dealing at arm’s length.
The Australian court considered that the term “independent” does not describe a standalone company. This interpretation had a significant impact on the determination of comparable arm’s length interest rates. In more detail, the appropriate question was “what would be the rate of interest charged between unrelated parties on a $2.5 billion loan made to CAH, in circumstances where the loan and interest repayments are guaranteed by a member of the Chevron group”. We can easily understand that the implicit credit support is taken as given within a group of companies.
This approach makes the identification of comparable transactions quite difficult. Also note that the borrower’s credit rating was deemed as irrelevant because the practices adopted by credit rating agencies differ from the approaches incorporated by commercial lenders.
The pure tax perspective
The investigation revealed several tax matters that result in a tax advantage at a group level. Firstly, there was no interest withholding tax on the interest payments from CAH to CFC. During cross-examination, it was indicated that CFC was not taxable in the US on the interest income. Therefore, CFC generated profits from the interest rate spread and paid dividends to its parent company (i.e. the Australian entity CAH). The dividends received by CAH were exempt from tax in Australia. CAH in turn paid dividends to its shareholder.
Finally, the Court accepted that penalties of 25% of the scheme shortfall amount could be imposed.
Summarizing and concluding
This court decision has a significant impact on the interpretation of the arm’s length principle in relation to financial arrangements. In more detail, the management of multinational companies shall:
- Review whether the characteristics of the transaction are consistent with the substance and conduct of the parties;
- Identify potential comparable companies adopting and implementing a consistent comparability analysis;
- Select and apply the most appropriate transfer pricing methodology;
- Consider if the security and implicit credit support by the group affects the controlled transaction.
From a global perspective, this case points out the current lack of an explicit TP guidance on financing transactions. Consequently, the group executives shall draft the intercompany agreements in line with arm’s length terms and conditions. Moreover, they shall undertake all necessary steps that prove the business rational of a controlled transaction.
