In the last 12 months we have seen plenty of interesting developments both in terms of legislative announcements and cases that have a direct impact on the taxation of cross border business and investment structures. This article explores a few selected tax cases and highlights the key learnings.
Transfer Pricing – “Australia’s biggest tax case”
The first item is the conclusion of a tax case in what one newspaper labelled as “Australia’s biggest tax case”. The case was Chevron Australia Holdings Pty Ltd (CAHPL) v Commissioner of Taxation  FCAFC 62. Through this case the Australian Taxation Office (‘ATO’) successfully sought to recover the unpaid tax plus penalties and interest which was in the hundreds of millions of dollars on multi-billion dollar related party loans.
The case involved Chevron, a large US based resources company that operates a large scale gas project in Australia. The facts of the case are complex but the central issue was whether the local subsidiary could deduct interest on moneys borrowed from an offshore related party. To be more precise, it wasn’t the “ability” to deduct the interest that was in issue but rather the amount that could be deducted. The ATO considered that the amount of interest deducted was excessive which had the effect of excessively reducing the amount of corporate tax that would have otherwise been payable. It was also noted by the judges in this case that the related party lender had borrowed the money at vastly reduced interest rates compared to the interest rate it charged when on-lending and this had the effect of shifting profits elsewhere. Interestingly, the related party lender was not taxed on those profits in the US or Australia.
After the Full Federal Court case was handed down in favour of the ATO, Chevron decided to appeal to the High Court of Australia but subsequently withdrew the appeal which means that the Full Federal Court decision is now final.
Related party loans are the focus of transfer pricing rules which aims to ensure that related party transactions (not just loans) are conducted at arm’s length. From a government revenue perspective, related party dealings are more readily susceptible to non-arm’s length terms and therefore could potentially erode Australia’s tax base and tax collections.
Whilst the Chevron case concerned a very large multinational business, it does highlight the important concepts that any cross border related party dealings require planning, thought, benchmarking, and documentation that meet Australia’s stringent transfer pricing rules.
In recent times, there is a considerable focus on multinational operations though the introduction of various tax administration and legislative measures of the anti-avoidance flavour including the following:
- Additional ATO funding through the “Tax Avoidance Taskforce”;
- The introduction of the Multinational Anti-Avoidance Legislation (‘MAAL’);
- The introduction of the Diverted Profits Tax.
A consideration of these measures is beyond the scope of this article but we note that the ATO are showing increasing focus on cross-border structures and transactions, especially when armed with the new legislative powers mentioned above.
Tax residency for corporates
For income tax purposes, Australia asserts its jurisdiction to tax an entity based on the concepts of residency or source. Generally, a resident entity is taxed on worldwide income and a non-resident is taxed only on Australian sourced income. There are exceptions.
This article considers the recent case which applied the residency rules to a foreign incorporated corporation.
In November 2016, the High Court of Australia handed down the decision in the case Bywater Investments Limited & Ors v Commissioner of Taxation; Hua Wang Bank Berhard v Commissioner of Taxation  HCA 45; 2016 ATC 20-589 (‘Bywater’).
Bywater was a case about whether a foreign incorporated company was a resident of Australia by reason of its central management and control (‘CM&C’) being located in Australia.
The test of corporate residency is as follows:
A company may be a resident of Australia if:
- It is incorporated in Australia; or
- Its voting power is controlled by shareholders who are residents and it carries on business in Australia; or
- Its central management and control is located in Australia and it carries on business in Australia.
The Bywater case concerned a number of offshore companies that made large profits from share trading on the Australian Stock Exchange. The ATO issued assessments to Bywater seeking tax on the basis that it was an Australian resident company for tax purposes since the business decisions were made by an individual in Australia.
The High Court agreed with the first judge in the case who considered that central management and control was a factual question and in this instance was located in Australia due to the following factors:
- The ‘real’ business was conducted by a person in Australia;
- The offshore directors only ‘rubberstamped’ the decisions of the Australian operator.
In plain language, the court considers that a company’s CM&C is located where the substantive business decisions were made i.e. the place where the real decision makers act. This level of decision making can be described as the ‘strategic’ decisions of the company and can be contrasted with the ‘day to day’ or operational decisions.
Another interesting facet of the case is that in concluding that Bywater’s CM&C was in Australia, the High Court also held that it automatically results in that company also carrying on business in Australia.
Since the decision was handed down, the ATO has issued guidance on its views in the form of Draft Taxation Ruling TR 2017/D2 which sets out the Federal Commissioner’s preliminary but considered view on how to apply the central management and control test of company residency following the Bywater decision. At the same time, the ATO withdrew Taxation Ruling TR 2004/15 which previously provided its view on this test.
Some practical examples of acts of CM&C from TR 2017/D2 are as follows:
- Setting investment and operational policies;
- Appointing company officers and agents (including revocation of appointments);
- Overseeing those appointed to carry out the day to day decisions; and
- Matters of finance e.g. how profits are used and whether to declare dividends.
The Bywater decision and the ATO draft ruling turns on its head the long held and widely believed notion that a company’s CM&C was solely located where the board met to make and ratify decisions. Accordingly, foreign incorporated companies that operate in Australia at any levels of management may be required to revisit the issue of residency again.