Introduction
In only the fifth substantive transfer pricing (TP) decision in Australia, the Australian Commissioner of Taxation has notched up another victory, in a decision which confirms and follows the landmark Chevron decision (Singapore Telecom Australia Investments Pty Ltd v Commissioner of Taxation [2021] FCA 1597).
The decision represents a further key development in Australia's TP law. The Commissioner has now been successful in the two litigated matters pertaining to related party cross-border financing, having also won in Chevron Australia Holdings Pty Ltd v Commissioner of Taxation of the Commonwealth of Australia (2017) 251 FCR 40.
In SingTel, the TP provisions operated to partially deny interest deductions on intra-group debt issued in 2002 in connection with the acquisition of Optus by the SingTel group. The debt consisted of Loan Notes issued by the Australian acquirer to a related party in Singapore. The Commissioner had issued amended assessments for four years denying interest deductions of approximately AUD 895 million.
Justice Moshinsky found that independent parties would not have agreed to make amendments to the initial Loan Notes agreement (for example, to include an interest premium and to fix the interest rate), and that the initial interest rate (Bank Bill Swap Rate, BBSW, + 1%) was a condition that independent parties would have agreed to.
Although the ultimate outcome is the same as Chevron, the case was definitely managed differently. Chevron ran for 24 hearing days and involved 26 witnesses, whereas SingTel only took 9 hearing days and had 5 witnesses in total (one lay witness for the taxpayer and two experts for each side). This streamlined approach is likely to reflect the additional guidance provided by the Federal Court in, and since, the landmark decision in Chevron regarding the focus of the Court, and which evidence is regarded as most probative of TP issues.
The SingTel acquisition of Optus and the Loan Notes which gave rise to the transfer pricing dispute
At a very high level, the transactions under consideration in SingTel were as follows:
- On 23 October 2001, Singtel Australia Investment Ltd (SAI), a Singapore tax resident company, acquired Cable & Wireless Optus Ltd (CWO), which operated the Optus telecommunications business in Australia.
- On 28 June 2002, the SingTel group changed its holding structure for the Optus business. SAI sold the CWO shares to Singapore Telecom Australia Investments Pty Ltd (STAI) for consideration of approximately AUD 9 billion of equity and AUD 5.2 billion of Loan Notes.
- The Loan Notes originally had an interest rate of BBSW plus 1% per annum. They were subsequently amended three times:
- on 31 December 2002, to change the maturity by one day (First Amendment);
- on 31 March 2003, such that interest was only accrued and payable if and when certain performance benchmarks relating to Optus' financial performance were met, with a consequential increase to the interest rate to include a premium of 4.552% from the time the benchmarks were met (Second Amendment); and
- on 30 March 2009, changing from a floating to a fixed interest rate (Third Amendment).
These arrangements are reflected in the diagram below.
The key legal issues in the SingTel case
Applying Subdivision 815-A of the Income Tax Assessment Act 1997, the Court had to determine whether conditions operated between SAI and STAI in their commercial or financial relations which differed from those which might be expected to operate between independent enterprises.
There were four fundamental issues which the Court needed to resolve in ultimately determining the deductible rate of interest for the Loan Notes:
- Construction of Subdivision 815-A – including consideration of the principles that emerged from two earlier decisions in Chevron and Glencore Investment Pty Ltd v Commissioner of Taxation (2019) 272 FCR 30.
- Parental support – If STAI was borrowing from an independent party, might it be reasonably expected that the SingTel parent company would provide a guarantee?
- Comparability analysis – What conditions might independent parties dealing wholly independently with each other be expected to have agreed upon?
- Interest rate – Informed by the above issues, what might independent parties dealing wholly independently with each be expected to have agreed the interest rate to be?
Construction of Subdivision 815-A
SingTel is the third case concerning Subdivision 815-A. Justice Moshinsky helpfully summarised the previous two cases (Chevron and Glencore), and set out five key principles to be followed:
- the word "conditions" in paragraph 815-15(1)(b) "permits a broad and wide ranging inquiry";
- the test “is a flexible comparative analysis that gives weight, but not irredeemable inflexibility, to the form of the transaction actually entered into between the associated enterprises";
- the form of the transaction “may, to a degree, be altered if it is necessary to do so to permit the transaction to be analysed through the lens of mutually independent parties”;
- the comparison “will generally require that the parties in the hypothetical will generally have the characteristics and attributes of the actual enterprises in question”; and
- Justice Thawley in Glencore explained that in his view non-price terms of a transaction may be substituted, and the other judges on the Full Court bench in that case did not express a contrary view.
As might be expected, the parties' arguments were focused on the application of these broad principles to the facts and circumstances at hand, and a level of agreement regarding the principles themselves is apparent from the judgment.
Parental support
Inevitably, parental support by way of a guarantee is a crucial concept in TP disputes about financing, given the very significant impacts it can have on the creditworthiness of the borrower, and therefore the interest rate.
Types of parental support
The expert evidence led by each party considered both:
- implicit support, being the extra creditworthiness which a subsidiary obtains by virtue of being part a multinational group which might financially support it if necessary, albeit that the support is provided in a non-binding way; and
- explicit support in the form of a binding parent company guarantee, which increases the subsidiary's credit rating to that of the parent company because the parent company is liable to the lender if the subsidiary defaults on the loan.
There was contradictory expert evidence about the impact of implicit support on STAI's credit rating. The Commissioner's expert (Weiss) opined that this would improve STAI's credit rating by 6 to 8 notches, compared to only 2 to 3 notches in the opinion of STAI's expert (Chambers). The Commissioner's expert evidence was that STAI's credit rating well above the investment grade threshold, whereas STAI's expert evidence resulted in a credit rating approximately equal to the investment grade threshold.
Regarding implicit support, Justice Moshinsky preferred the evidence of Chambers because his approach more accurately reflected the criteria applied by the ratings agencies (S&P and Moody's), and also because he was "clear and persuasive" in maintaining his opinions during cross-examination.
A parent guarantee might be expected
Despite there being a significant amount of expert evidence led by both parties regarding the value of implicit support, Justice Moshinsky ultimately concluded that an explicit parent guarantee might have been expected.
His Honour's view that a parent guarantee would have been provided was reached having regard to:
- the significant loan quantum;
- the parent company was likely to have preferred to provide a guarantee rather than having its subsidiary incur the higher interest cost (the interest rate would have been much higher without a parent guarantee);
- SingTel had, in the month before the Loan Notes were issued in 2002, guaranteed a $2 billion external borrowing by its Australian financing subsidiary; and
- the documentary evidence that SingTel would undertake a cost-benefit analysis to decide whether or not to guarantee any future debt raising. Because the expert evidence showed that a guarantee would have decreased the interest rate on the loan significantly, Justice Moshinsky found that any such cost/benefit analysis undertaken by a parent in the position of SingTel was likely to result in a decision to provide a guarantee. This conclusion was also supported by the explanations of STAI's ratings expert (Dr Chambers).
These matters were considered to be more persuasive than the lay evidence led by STAI that SingTel wanted its subsidiaries to be able to stand on their "own two feet". Furthermore, the absence of a SingTel policy of the kind seen in Chevron, whereby the group would borrow at the lowest available cost of funds and with a parent guarantee generally being provided, did not impede His Honour reaching the view that a parent guarantee would be provided. In effect, SingTel's actual practice as demonstrated by the concurrent example of a parent guarantee to the Australian finance company, combined with the quantum of the transaction, was regarded as more probative on this issue than the absence of a group policy that parent company guarantees would be provided.
No guarantee fee could reasonably be expected
STAI argued that if a parent guarantee might be expected between independent parties, it should also be expected that STAI would have paid a guarantee fee to SingTel. This cost for STAI would therefore have reduced the amount of any TP benefit.
This proposition was rejected on the basis that there was an absence of evidence to support that a guarantee fee might have been charged. In addition, Justice Moshinsky noted the absence of any guarantee fee having been charged by SingTel in return for its recent guarantee of a loan by its Australian finance subsidiary.
Debt capital markets: comparability
The issue of comparability arose in the context of the evidence led about the debt capital markets (DCM). In determining what might reasonably be expected to have occurred if the parties were independent of one another, both parties' experts looked to the DCM for examples of transactions between independent parties which would provide a sufficient basis for comparison.
The parties took different approaches to what might reasonably have been expected if the borrowing was between independent parties, as summarised in the table below.
The fundamental differences between the experts were:
- Mr Johnson's approach was a broader inquiry. He considered the relevant matters being agreed between the parties at each time that the Loan Notes had been amended; and
- Mr Chigas' approach was narrower, seeking to price the Loan Notes as though they were a transaction in the debt capital markets, making adjustments where necessary to seek to address the lack of independence between STAI and SAI. However, His Honour considered that there were too many differences between the structure of the Loan Notes and a bond issued in the DCM, and the failure to consider how the Loan Notes had been changed by the Second Amendment was significant.
The difference in approach can be seen by comparing each expert's list of conditions which might not have been expected between independent enterprises. Mr Johnson identified seven such conditions, whereas Mr Chigas identified three.
Ultimately, His Honour preferred the evidence of Mr Johnson on the basis that it was more consistent with the statutory test in Subdivision 815-A. His calculations on the basis that no amendments were made to the original Loan Notes agreement were adopted as being consistent with the Court's reasons.
Interest rate
Based on all of the evidence, His Honour concluded that the interest rate which the parties had actually agreed under the original Loan Notes (BBSW plus 1%) did not differ from what might have been expected between independent enterprises.
This conclusion was reached largely based on lay evidence, not solely expert evidence. The contemporaneous documents from the time at which the Loan Notes had been put in place showed that the original interest rate had been calculated by personnel within the SingTel group to reflect an arm's length interest rate, having been determined by reference to SingTel's bonds. This was consistent with His Honour's conclusion that a parent guarantee might be expected, as discussed above.
His Honour then concluded that independent parties would not have agreed to the Second and Third Amendments. Specifically independent parties would not have agreed to the Second Amendment because:
- it resulted in STAI foregoing approximately AUD 286 million of accrued interest, which it might not be expected to have foregone if it was acting independently;
- it imposed benchmarks and a premium interest rate which exposed each party to significant commercial risk; and
- independent parties would not have agreed to the Third Amendment, particularly because floating interest rates were dropping during the Global Financial Crisis and moving to a fixed component of 6.835% therefore did not make commercial sense.
Outcome: the Commissioner's argument accepted
Justice Moshinsky accepted the Commissioner's secondary argument that no amendments would have been made to the original Loan Note agreement. Calculations giving effect to this outcome were prepared by the Commissioner's expert witness (Johnson), and are included in the judgment.
For the income years in dispute, being those ending 31 March 2010 to 2013, STAI had claimed interest deductions on a cash paid basis of approximately AUD 2.75 billion, whereas the Court found that only AUD 984 million was deductible during those years. The difference is approximately AUD 1.77 billion of deductions, before the application of any tax losses, withholding tax adjustments and/or corresponding adjustments.
STAI has 28 days from the date on which final orders are made by the Court to determine whether it files an appeal to the Full Federal Court. Given the quantum in dispute, and the application of a nebulous test to determine what might reasonably have been expected to have occurred between the parties had they been independent, it would not be surprising if an appeal was commenced by STAI.
How the SingTel decision will affect transfer pricing
Further tightening the debt net
The decision reflects an application of the principles emanating from Chevron rather than any significant development in the law. Again, the Commissioner was successful in establishing that parental support should be hypothesised, significantly reducing the interest rate for Australian deductibility.
Taxpayers with current or imminent disputes with the Commissioner regarding their financing arrangements and Subdivision 815-A should pay very close attention to the decision. It is categorical in relation to the expectation that a parent company guarantee might be expected in these circumstances. Taxpayers will need strong evidence for these to be any possibility of justify a borrowing cost which is higher than that of their parent company.
Notably, the Commissioner might be successful in hypothesising a parental guarantee even without some of the evidence in his favour in SingTel. Because the hypothesis involves a subsidiary in a multinational group like SingTel, rather than focusing on the SingTel group specifically, the Commissioner might only need to lead evidence that multinational groups generally might be expected to guarantee their subsidiaries' loans. There was evidence here that SingTel specifically might be expected to have provided a guarantee, but disproving this point in relation to the borrowing in question might not be sufficient for taxpayers to succeed.
Relevance for Subdivision 815-B
SingTel concerns Subdivision 815-A, the second iteration of Australia's TP legislation. It has now been superseded by Subdivision 815-B for income years commencing on or after 29 June 2013. The amended assessments in dispute in SingTel concerned the year commencing 1 April 2012, approximately one year prior to the commencement date of Subdivision 815-B. The earlier TP legislation, Division 13 of the Income Tax Assessment Act 1936, was also relied upon by the Commissioner as an alternative basis supporting the assessments, but this was not focused on in the proceedings.
Many of the same principles continue to apply. The Subdivision 815-B the test for identifying a TP benefit still operates by reference to "the conditions that might be expected to operate between independent entities dealing wholly independently with one another in comparable circumstances".
Having said this, the Commissioner has noted the textual differences between Subdivisions 815-A and 815-B in his Decision Impact Statement regarding Glencore (DIS). The DIS makes particular reference to two differences:
- the use of the phrase "comparable circumstances" and the non-exhaustive list of potentially relevant factors in this regard; and
- the use of a basic rule and exceptions framework.
Future TP litigation in Australia is likely to concern Subdivision 815-B, and those cases might emerge over the next couple of years.
More dual TP / Part IVA disputes
In SingTel, the Commissioner did not assert that the general anti-avoidance rule in Part IVA of the Income Tax Assessment Act 1936 applied, and it is not suggested that he should have done so. There have not yet been any such parallel cases run by the ATO even though some TP cases have had, or been implied by the Commissioner to have had, hallmarks that might be at odds with the general anti-avoidance rule and vice-versa.
This may change going forward. Senior ATO personnel have recently been commenting that more large scale TP audits may well consider applying both TP and Part IVA in the alternative.
Taxpayers in these scenarios will need to pay significant attention to ensure that both positions are managed carefully. Both issues are factually intensive so would be likely to be the subject of very detailed information gathering (including written requests, statutory notices and functional interviews), and both technical positions involve hypotheses which are based on different statutory tests.
Streamlined TP dispute management with the ATO
The additional guidance obtained from a Court decision can sometimes result in an opportunity for more streamlined dispute management, as well as assisting the ATO to conduct audits and litigation more efficiently. The numbers of witnesses appearing in Chevron (26) and then Singtel (only 5) bears this out.
The nature of the SingTel decision raises an interesting question about the extent to which taxpayers should be entitled to Independent Review (IR) of a Statement of Audit Position issued by the ATO on TP issues during an audit. There has previously been an understandable reluctance from the ATO (and some taxpayers) to have TP matters proceed to IR in circumstances where the issues are essentially questions about economics and pricing.
However, although there is clearly a pricing component, SingTel shows that a significant amount of analysis is required to determine the non-price conditions which might have been expected to operate between independent parties. This is a question of fact, informed by lay and expert evidence. For example, there may frequently be circumstances in which IR would be an appropriate forum to consider whether parent company support would have been expected to be provided. The narrowing of dispute issues that might be achieved would benefit both parties.
Ongoing monitoring of structures is required
More broadly, the decision is a reminder that taxpayers need to be diligent in ensuring that fundamental aspects of their corporate structures continue to operate as intended from a tax perspective, including taking into account changes in legislation and facts over time.
Legislative change in this realm has been relatively frequent, and in recent years the Australian tax treatment of cross-border financing may have been impacted by the introduction of the Multilateral Instrument modifying various Australian tax treaties, as well as the anti-hybrids legislation. Set and forget can lead to regret.
In SingTel, the Loan Notes were implemented in 2002, but needed to comply with Subdivision 815-A which was introduced in 2012 with effect from income years commencing on or after 1 July 2004. The example is somewhat unusual because Subdivision 815-A was retrospective, but many taxpayers may have financing arrangements which may have been subject to all three versions of the Australian TP legislation over time. Reviewing positions, having regard to each of the separate and distinct applicable sets of TP provisions is highly recommended.