The Fiction of Chevron

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.

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domestic legislation adopted almost universally. It is these principles that the court had to apply in Chevron. Applying the arm’s length requirement of the transfer pricing rules to the facts in Chevron reveal numerous fictions which can be broadly divided into two categories:

first, determining what an arm’s length loan would look like, and second, determining what a separate entity looks like.

First and foremost, the fiction of the separate entity model meant that the court had to determine what an arm’s length loan between two independent parties would look like. All expert witnesses on both sides acknowledged that no loans between independent parties would be entered into on the terms in the agreement, principally due to a lack of formal guarantee. There was no directly compara-ble loan even under the most basic of fictions. Consequently, the court broadened its deliberations to determine what was an arm’s length ‘consideration’ to find that ‘consideration’ not only included the price of the loan but broader factors such as the security that came with being part of the Chevron group. The result was that the determinations centered on not only the interest rate but also the terms of the loan and the role of third parties to the transaction, in particular the parent company and any guarantees, insurance, or credit default swaps associated with that relationship. The Court also considered the currency of the loan and whether the taxpayer’s deci-sion to borrow in AUD should be respected or whether the arm’s length determination should be in USD.

Perhaps the greatest fiction in the case, however, centered on whether CAHPL should be treated as what was labeled an ‘orphan’, that is, as if it were a truly independent party dealing at arm’s length.

Such an approach would remove any implicit parent company sup-port and allowed Chevron to argue that the interest rate of 9 percent was due to a lack of any guarantee. The Full Federal Court rejected this argument stating that

the independence hypothesis does not necessarily require the detachment of the taxpayer, as one of the independent parties, from the group which it inhabits or the elimination of all the commercial and financial attributes of the taxpayer being part of the circumstances that gave the commercial shape to the property the subject of the acquisition and that may be relevant to the consideration for the property. (Chevron, 2017: para. 43)

multinational entity finance schemes | 147 The Full Federal Court held that the question to be asked is:

What is the consideration that CAHPL or a borrower in its position might reasonably be expected to have given to an independent lender if it had sought to borrow AUD 2.5 billion for five years? The answer to this question is to be found in the evidence. Here the borrower in the independence hypothesis is a company in the position of CAHPL. It is part of a group the policy of the parent of which was to borrow externally at the lowest rate possible. Further, it was usual commercial policy of the parent of the group for a parent company guarantee to be provided by it (the parent) for external borrowings by subsidiaries. In those circumstances, the consideration that might reasonably be expected to be given by a company in the position of the taxpayer CAHPL would be an interest rate hypothesised on the giving of a guarantee of CAHPL’s obligations to the lender by a parent such as Chevron. (Chevron, 2017: para. 62) The result was that the fiction created was not that of a truly inde-pendent entity, rather it was one which did have connections with the parent company but only in so far as the parent company might give a guarantee for the loan. This is a reality that simply does not exist. To reach its decision the court effectively had to imagine the

‘property’ that was part of the transaction, whether the simple loan or the bundle of rights, the fictional borrower, and whether they were a stand-alone entity, the fictional lender and the fictional price that the parties would pay (Frost et al., 2017).

Ultimately, the court did not have to decide whether the Commissioner’s amended assessments resulted in an arm’s length price being applied, as the onus was on Chevron to prove the assess-ments were excessive. While the Full Federal Court found in favor of the revenue authority and the decision was declared a win in the fight against profit shifting, both the facts of the case and judgments reveal the fiction that the current laws impose. This case not only high-lights the transfer pricing issues around the use of intra-group debt, but also excessive debt loading or thin capitalization (Ting, 2017).

As Ting’s (2017) investigation reveals, an analysis of the Chevron group’s financial position in 2014 suggests that the group as a whole had no external interest expense despite intra-group debt between

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Australia and the US of $35 billion, amounting to AUD 1.84 billion in interest tax deductions in Australia. There is little doubt therefore, that the transactions were entered into for tax related purposes and even an interest deduction of 5 percent is a fiction as the money could have been easily provided through equity which, absent tax benefits, is a less expensive, and therefore more profitable, option.