The Facts of Chevron

The central issue in the Chevron case was whether the interest rate on a loan from Chevron Texaco Funding Corporate (CFC), a wholly owned United States (US)-based subsidiary, to Chevron Australia Holdings Pty Ltd (CAHPL), the Australian parent com-pany, exceeded the arm’s length interest rate (the price that might reasonably have been expected in an agreement between independ-ent parties acting at arm’s length). The interest was paid under an agreement between the parties dated June 6, 2003, called a ‘Credit Facility Agreement’. The purpose of this agreement was to affect an internal refinancing of an Australian currency debt of Chevron Australia and to fund the purchase of Texaco Australia Pty Ltd by CAHPL. CFC was established in the US to lend funds in the amount of US$ 2.5 billion to CAHPL with interest rate payable at AUD-LIBOR plus 4.14 percent after raising that money from the commercial paper market at approximately 1.2 percent. No secu-rity was provided by CAHPL and the advance to CAHPL was not guaranteed by the US parent company. For each income year in question, CAHPL claimed a tax deduction in Australia for the inter-est it paid to CFC. There was no withholding tax imposed on the interest payments as Australian tax law provided an exemption to the type of arrangement in place.

CFC then paid dividends to CAHPL out of its profits, which were non-assessable non-exempt income under the Australian income tax regime. Non-assessable non-exempt income is income which is expressly excluded from being subject to tax under Australia’s taxation laws and, as such, is completely tax free. In this case, the dividends were exempt because non-portfolio dividends paid to a company are not assessable when received by an Australian resident company. Further, evidence provided to the court, which it accepted, was that no tax was payable in the US on the profits earned by CFC.

While not revealed in the case, this was no doubt due to the US

‘check the box’ rules which allowed CFC to be a disregarded entity and treated as part of CAHPL with the internal transactions sub-sequently ignored. The arrangement effectively provided a ‘round

multinational entity finance schemes | 143 robin’ of money with Chevron relying on tax arbitrage to reduce its tax liability and maximize its profits.

Australia has what are known as thin capitalization rules, which contain a separate entity level debt to equity ratio rule and are designed to limit the amount of debt which can be used to generate an interest deduction. However, these were ineffective against such an arrangement. This is because, despite a default objective debt to equity ratio of 1.5 to 1, there is an overriding provision which allows a deduction to be the arm’s length debt amount, which is what was claimed in this case. Instead, relying on what are known as trans-fer pricing provisions, contained in Australia’s domestic legislation,

Chevron Australia borrows money from Chevron Corp

US at a high rate

The federal court upheld the decision in favour of the ATO The federal court ruled this

type of arrangement may not actually be “arms-length’.

After costs, Chevron Crop

US makes a massive profit from its Australian

subsidiary Estimated

interest cost

$1.84b

This money isn’t taxed in the US or Australia

Chevron Corp US borrows money

at a low rate Estimated interest cost

$110m Chevron 4

5

2

6

3 1

Estimated profit

$1.73b

Figure 6.1 How the off-shore structure worked Source: Mather (2017).

144 | kerrie sadiq

Chevron Corporation US

Chevron Australia Holdings (Chevron) Australia

Chevron Texaco Funding Corporation (CFC)

US Dividend

Guarantee

Funds raised at interest rates of 1.2 %

to 2.05%

Dividends paid of approx. AUD $ 1.1 bn

Interest paid to CFC Credit facility agreement of up to US $2.5 bn.

Interest rate of approx. 8.97%

Figure 6.2 Chevron arrangement

rather than general anti-avoidance provisions, the Commissioner of Taxation (the Commissioner) issued amended income tax assess-ments on the basis that the consideration paid by CAHPL to CFC exceeded the arm’s length price that might reasonably have been expected in an agreement between independent parties acting at arm’s length. CAHPL appealed the amended assessments, which were based on an interest rate of approximately 5 percent (Preshaw, 2016). Attention around Chevron was significant, with many of the media depicting both the simplicity of the arrangement and the tax benefits which resulted. For example, the Australian Financial Review published Figure 6.1, which clearly explains the structure adopted.

A more technical version of the structure, explaining the legal arrangements in place, along with the fiscal significance, is depicted in Figure 6.2.

multinational entity finance schemes | 145 At first instance, Federal Court Judge, Robertson J, upheld the transfer pricing (amended) assessments finding for the Commissioner on the basis that Chevron was not able to demonstrate that ‘the con-sideration in the Credit Facility Agreement was the arm’s length consideration or less than the arm’s length consideration nor proved that the amended assessments were excessive’ (Chevron, 2015: para.

525). In reaching this decision, Robertson J found that no reasonably accurate independent third-party agreement could be identified for comparison purposes. As such, it was necessary for His Honour to determine what one might look like and to take a broad view of what was to be taken into account to determine an arm’s length price. This resulted in not only price being relevant but also other factors such as security over assets and loan covenants that a borrower would have provided to a lender.

In April 2017, Chevron lost its appeal to the Full Federal Court against the decision of Robertson J. The predicted special leave to appeal to the High Court was lodged but, on August 15, 2017, Chevron withdrew its application. While the case may bring to a close one of the largest tax disputes ever seen in Australia, it is unlikely to be the end of transfer pricing disagreements on the issue of intra-company debt and the effects are likely to be felt across other jurisdictions. More importantly, the case of Chevron reveals the unquestionable problems of excessive debt loading and loan mispric-ing of financial arrangements and the economic fictions contained in current tax regimes to deal with these kinds of tax arrangements.

The case specifically dealt with transfer pricing provisions but also reveals the difficulties that arise in the tax system as a result of debt loading and how the thin capitalization rules are not adequate to deal with them.