August 11, 2020

Volume X, Number 224

August 11, 2020

Subscribe to Latest Legal News and Analysis

August 10, 2020

Subscribe to Latest Legal News and Analysis

Implications of Chevron Case on Australian Pharmaceutical Industry

Transfer Pricing has in Recent Years Been a Focus of the Australian Taxation Office

In recent years, the Australian Taxation Office (ATO) has focused much energy in the transfer pricing arena, firstly due to the issue becoming part of the OECD's ongoing investigation into international tax practices and secondly due to the political and social issues arising from the perception that "big business" fails to pay its "fair share" of tax in Australia. 

Last month, the Full Federal handed down its much anticipated decision in Chevron Australia Holdings Pty Ltd v Commissioner of Taxation [2017] FCAFC 62(Chevron). The case involved a related party loan (Credit Facility Agreement) between an Australian Chevron entity (CAHPL) and a related US company (CFC) and the deductibility of interest borrowed from a related party. 

The Full Federal Court dismissed CAHPL's appeal regarding the deductibility of its interest expenses on the Credit Facility Agreement of US$2.45 billion (equivalent to AUD$3.7 billion). In reaching its decision, the Full Federal Court focussed upon the fiscal and commercial functionality of the provisions contained within the applicable legislation.

The Court discussed, amongst other things, the pricing of the loan and interest rate applicable to cross-border financing arrangements. CFC had raised US$2.45 billion through the issue of a commercial paper in the U.S. at an interest rate of approximately 1.25% and on-lent those funds to CAHPL at a significantly higher rate (approximately 9%) with no security or guarantee, over a five year term. The Full Federal Court held that an Australian subsidiary of a multinational group should not be treated as a standalone entity when determining if the transaction is at arm's length. 

The Court ultimately held that no independent lender and borrower dealing at arm's length would enter into a borrowing arrangement that provided no security, or financial or operational covenants, in the way CAHLP's internal financing arrangements were structured. The decision resulted in a lower interest rate being deemed deductible and a tax liability of approximately, $340 million (including penalties) being payable. The decision means that the interest rate on internal debt arrangements must be at a rate closer to the parent entity's global cost of funds thereby preventing profits from being artificially shifted offshore. 

This is an important win for the ATO and the Chevron decision will have broader implications for large multinational taxpayers, including the pharmaceutical sector where both products and debt are routinely supplied between related parties. The case highlights the need for related party transactions to be carried out in a manner which conforms with transfer pricing principles and which are on both arm's length and commercial terms. 

What the decision means for our multinational clients is that they must prepare and maintain contemporaneous documentation which satisfy the significant legislative compliance requirements to show how pricing for cross border, intra group, transactions involving goods and services has been set. These requirements include but are not limited to:

  • Preparation of records before the time of lodgement of the relevant income tax return 

  • Documentation that explains the way in which the transfer pricing rules have been applied to intra group transactions 

  • The particulars of the pricing method used and, where possible, comparisons with other transactions and industries which confirm the arm's length nature of the pricing 

  • Records that show the commerciality of the pricing applied 

The statutory documentation requirements for taxpayers to evidence the reasonableness of their position with regard to transfer pricing are stringent and can place a heavy compliance burden on multi-national companies. However, given the outcome of the Chevron decision, the expectation must be that the ATO will seek to enforce the application of the transfer pricing rules with renewed vigour. 

From a governance perspective, companies operating on a cross border basis with Australia should review their pricing of intra group transactions to ensure that the methodology for the pricing and documentation which supports it is completely compliant. 

Copyright 2020 K & L GatesNational Law Review, Volume VII, Number 123

TRENDING LEGAL ANALYSIS


About this Author

Betsy-Ann Howe, KL Gates, Australia, outbound investment attorney, asset financing lawyer
Partner

Ms. Howe is a corporate and transactional tax partner with deep experience in taxation issues associated with mergers and acquisitions, inbound and outbound investment, asset financing (with a particular emphasis on aircraft leasing) corporate and international tax. With over 25 years' experience in taxation law, Ms. Howe's experience includes advising on structured finance transactions, cross border leasing, and domestic and international tax issues.

Ms. Howe's practice focusses on all areas of corporate finance tax, managed investment trusts,...

61-2-9513-2365
Paris Petranis, KL Gates, Healthcare risk management lawyer, Contracting, Australia
Partner

Mr. Petranis is a corporate and commercial lawyer with a background in health, having previously worked as a healthcare professional for almost 10 years. His practice focuses on the health, aged care/retirement living and therapeutic goods sectors. 

Mr. Petranis advises clients on a range of issues affecting the above industries including compliance with regulatory requirements, contracting, risk management, privacy, structuring and mergers and acquisitions. 

His clients include some of Australia's most well known companies in the health, aged care/retirement living and therapeutic goods sectors and comprise for-profit and not-for-profit entities, as well as government entities. 

Mr. Petranis is an Associate Fellow of the Australasian College of Health Service Management and has previously served on the Health Services Review Council in Victoria. 

61-3-9205-2014
Rebecca Bolton, Special Counsel, Tax Planning, Attorney, KL Gates, Law firm
Special Counsel

Ms. Bolton acts for a broad range of clients providing both direct and indirect taxation advice. Her experience in tax planning and advisory work includes corporate reconstructions, acquisitions and takeovers and general structuring advice, as well as advising non-resident investors on Australian acquisitions. Ms. Bolton also has significant experience in the area of tax controversy and litigation.

Ms. Bolton regularly deals with the Australian Taxation Office (ATO) and state revenue bodies in respect of audits and rulings and advises clients on...

+61.3.9640.4285