Implications of Chevron extend beyond transfer pricing

Implications of Chevron extend beyond transfer pr...

Late in 2014, G20 leaders committed to a plan to address Base Erosion and Profit Shifting (BEPS). A clear illustration of the focus on BEPS is Chevron v FCT, an appeal against the Commissioner’s assessment currently being heard in the Federal Court.

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The key issue is whether an interest rate of 9 percent on a USD2.5bn advance to an Australian taxpayer from its US subsidiary exceeded what would be an “arm’s length” consideration.

The Commissioner has challenged the commerciality of the loan, submitting that the interest rate applied was higher than ordinary terms and that it would be unsustainable for a borrower to uphold a loan at that rate and unreasonable for a lender to provide a loan where the terms offer no actual security or covenants.

If the Commissioner’s arguments are successful, arm’s length consideration under the transfer pricing rules will become more difficult for taxpayers to satisfy. Significant uncertainties will arise for taxpayers as a result of the tightening of these rules, particularly where precedent is created for essentially allowing related party transactions to be priced based on hypothetical scenarios.

Importantly, there may be effects on other provisions of the tax legislation. For example, the reduction to the safe harbour debt amount under the thin capitalisation rules means that greater reliance will be placed on the arm’s length debt test (ALDT).

Although the concept and application of the ALDT for thin capitalisation is distinct from the transfer pricing rules, it has historically been recommended that these rules should be more closely aligned.

The success of the Commissioner in Chevron and the consequential tightening of the arm’s length transfer pricing rules would signify a departure from this recommendation, particularly in light of the work currently being undertaken to ease taxpayers’ compliance costs in applying the thin capitalisation ALDT.

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