In a major Australian transfer pricing decision on April 21 2017, the Full Federal Court dismissed Chevron Australia Holdings Pty Ltd's appeal related to the deductibility of interest on the Australian dollar equivalent of $2.45 billion loans from its US subsidiary, Chevron Texaco Funding Corporation.
The unanimous decision of the Full Federal Court provides significant guidance on Australia's transfer pricing laws. Whilst the decision deals with certain administrative, constitutional and procedural issues, the decision is most important in terms of determining the arm's-length consideration (particularly interest rates) applicable to cross-border financing arrangements.
The court, taking a commercial and pragmatic approach, found that no independent lender and borrower dealing at arm's length would have entered into the borrowing arrangements in place without taking security or requiring covenants. In coming to this conclusion, their honours gave consideration to Chevron Group's external borrowing policy and effectively imputed a parent company guarantee to the loans in order to determine the arm's-length consideration. This resulted in a lower interest rate and a subsequent tax bill (including penalties) of approximately A$340 million ($259 million).
Following this decision, the Australian Taxation Office (ATO) has released draft guidelines (in Practical Compliance Guideline PCG 2017/D4) which outline its compliance approach to cross-border related party financing arrangements; in particular, in considering the level of risk and application of compliance resources to such arrangements.
Latest budgets impose higher taxes and costs on foreign owners of Australian real estate
The Australian 2017-18 federal budget was released on May 9 2017. A number of Australia's state governments have also recently released their 2017-18 state budgets. A common theme in these budgets is the focus on housing affordability for Australian residents and, consequently, an increase in taxes and other costs for foreign owners of Australian real estate. These measures include:
- Increasing the federal capital gains withholding tax rate from 10% to 12.5% from July 1 2017. This non-final withholding tax applies to disposals by foreign residents of assets that are direct interests in Australian real property, certain indirect Australian real property interests (being shares or other interests in entities that own Australian real property) and options or rights to acquire such assets;
- The Australian government will introduce a new charge on foreign owners of Australian residential property where the property is not occupied or genuinely available on the rental market for at least six months per year. The charge will be levied annually and will be equal to the relevant foreign investment application fee (of at least A$5,000) levied on the property at the time it was acquired by the foreign investor;
- Foreign residents and temporary tax residents will no longer be able to access to the capital gains tax 'main residence' exemption (properties held prior to May 9 2017 will be grandfathered until June 30 2019); and
- The state government of Queensland announced that a 1.5% land tax surcharge for foreign resident (or absentee) landowners will be introduced from July 1 2017. The current top rate of land tax in Queensland is 2%, thus the surcharge represents a significant increase in the land tax rates for foreign residents. The states of Victoria and New South Wales have previously introduced a land tax surcharge for foreign residents.
Broadening the Multinational Anti Avoidance Law (MAAL) for trusts and partnerships
The MAAL has been in operation since January 1 2016 and applies to multinational entities (i.e. with annual global revenues of A$1 billion or more) which enter into schemes to artificially avoid having a taxable presence in Australia. Broadly, the MAAL applies where, amongst other things, a foreign entity derives income from the making of supplies to Australian customers. The government has proposed to strengthen the MAAL so that it will also extend to corporate structures involving foreign partnerships and foreign trusts that would otherwise fall outside the scope of the MAAL rules.
ATO compliance guidelines: The use of internal derivatives by multinational banks
Generally, under Australian transfer pricing rules, the taxable income (or loss) of a branch is to be determined by allocating an appropriate amount of the actual third party income/expenses of the relevant company to the branch, rather than treating the branch as a notional separate entity (i.e. the functionally separate entity (FSE) approach) that is commonly adopted by other OECD countries. However, for certain transactions involving the branches of multinational banks, the ATO accepts the use of an FSE-style approach.
The ATO has released guidelines (Practical Compliance Guideline PCG 2017/8), which outline the ATO's approach to extending its FSE approach to internal derivatives. In particular, PCG 2017/8 outlines the circumstances in which multinational banks can use internal derivatives as an appropriate proxy to attribute profits between a branch and head office (or between two branches) for transfer pricing purposes.
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