Transfer Pricing case update: Singapore Telecom Australia Investments Pty Limited v Commissioner of Taxation [2021] FCA 1597 (SingTel)

The much awaited decision in SingTel was handed down by the Federal Court on Friday 17 December 2021, with a single Judge of the Federal Court, Moshinsky J, finding in favour of the Commissioner of Taxation (Commissioner) and dismissing the taxpayer’s appeal.

Following Chevron Australia Holdings Pty Ltd v Commissioner of Taxation [2017] FCAFC 62 (Chevron), which was handed down by the Full Federal Court on 21 April 2017, the case marks only the second substantive Australian transfer pricing case on cross border intra-company financing. The Commissioner was also successful in Chevron, with the Full Federal Court (Allsop CJ, Perram and Pagone JJ), unanimously affirming the decision of Robertson J at first instance.

The factual scenario in SingTel involved a financing arrangement under which the taxpayer and related party entered into a Loan Note Issuance Agreement (LNIA) which underwent a series of amendments. The focus of both parties’ submissions was on Subdivision 815-A of the Income Tax Assessment Act 1997 (ITAA 1997). The Court therefore dealt with Division 13 of the Income tax Assessment Act (ITAA 1936) relatively briefly.

The main issue to be determined by the Federal Court under Subdivison 815-A was whether, under s 815-15(1), the taxpayer obtained a “transfer pricing benefit”. This issue needed to be determined by considering the application of the transfer pricing provisions to the LNIA.

We have set out below an overview of the case and some practical considerations for multinational enterprises (MNEs) with cross border financing arrangements. It should be highlighted that as the Federal Court decision in SingTel represents a first instance decision, there is a possibility the taxpayer may appeal to the Full Federal Court.

The taxpayer has 28 days to appeal. As such, any taxpayers guided by this decision should monitor the outcome of any further appeals. 

Key considerations in cross border financing

The type and nature of the evidence required in a cross border transfer pricing dispute will depend on the particular facts and circumstances of the case and careful consideration of the expert’s instructions and evidence is required. In particular:

• where the consideration of rating agencies practices/debt capital market (DCM) practices are involved, the merging of quantitative and qualitative considerations and varying opinions makes establishing what is an arm’s length interest rate increasingly complex;
• experts may view credit risk differently and may also base their decisions on different assumptions or give more weight to certain assumptions or considerations;
• market assumptions and the views of credit agencies and investors alike can change over time. It follows that MNEs should assess the arm’s length nature of their financing arrangements on a regular basis; and
• calculations conducted with the benefit of hindsight continue to be problematic.

Merely pricing the transaction as agreed is not the correct approach, in particular:

• in a cross border financing case, the “rationality” of the decision making is likely to come under scrutiny and it is important to consider the financing options realistically available to the party receiving the funds;
• consideration of the options available (and whether or not those options were taken) to reduce the group’s overall costs of funding may be a relevant consideration when assessing the rationality of the financing arrangement; and
• if the arrangement in question would not have occurred if a member of a multinational group raised debt from a third party, it is likely to come under scrutiny.

The assessment of credit worthiness on a standalone basis versus with implicit support continues to be an area of controversy. In particular:

• the divergence in the expert opinions in SingTel reinforce the difficulty for MNEs in understanding at a given time how implicit support may be viewed and the impact on the credit rating of the borrower company;
• implicit support needs to be considered on a case-by-case basis having regard to the unique facts and circumstances of the borrower and the group (and in light of accepted guidance and practice of credit rating agencies);
• in regards to guarantees, taxpayers should assess with rigour the pricing of arrangements where a guarantee might realistically have been available (or required) if the parties were dealing at arm’s length and be prepared to provide evidence regarding the decision making process , rationality and pricing of the arrangement;
• the presence of evidence of a guarantee (or a group policy to provide a guarantee) is not essential to a hypothesis that there might be expected to be a parent guarantee; and
• when a financing arrangement involves a financial guarantee, it is necessary to consider whether, in case of default of the borrower, the guarantor has the financial capacity to fulfil its obligations. This necessarily requires an evaluation of the credit rating of the guarantor and the borrower, as well as the business conditions between them. This may be relevant where a group is trying to evidence the reasons for no guarantee being provided.

Background facts

• On 18 May 2001, Singapore Telecommunications Limited (SingTel Limited), through Singtel Australia Investment Ltd (SAI), a company incorporated in the British Virgin Islands and resident in Singaporei), made a takeover offer for the majority of the shares in Singtel Optus Pty Ltd (SOPL) (formerly Cable & Wireless Optus).
• The takeover bid was successful and a series of steps were undertaken subsequently to raise additional funds required for the acquisition, including to refinance a short term bridge facility.
• In June 2002, SAI, exercised a put option and sold 100% of the issued capital of SOPL to SingTel Limited’s Australian subsidiary, Singapore Telecom Australia Investments Pty Ltd (STAI) (taxpayer), in consideration for approximately $14.2 billion.
• The consideration paid by the taxpayer comprised the following:
  • the taxpayer issuing ordinary shares to SAI ($9 billion) and
  • the taxpayer issuing loan notes under a Loan Note Issuance Agreement (LNIA) to SAI ($5.2 billion).
• As a result of transactions that took place in June 2002 (including the issuing of the shares to SAI), the taxpayer became a wholly-owned subsidiary of SAI. The taxpayer also became the holding company of a group of companies, including SOPL, that operated the Optus telecommunications business in Australia.
• Pursuant to the LNIA as originally entered into, the taxpayer issued ten loan notes (the Loan Notes) totalling approximately $5.2 billion to SAI with each redeemable at any time, and the maximum period for an advance was the period commencing on the first day on which interest accrued on the advance and ending on the last day of the tenth year following the year in which the advance was made.
• The interest rate under the original LNIA was the 1 year Bank Bill Swap Rate (BBSW) plus 1% per annum. The applicable rate was the interest rate multiplied by 10/9.
• The LNIA was subsequently amended by the following agreements:
  • an agreement dated 31 December 2002 (the First Amendment);
  • an agreement dated 31 March 2003 (the Second Amendment); and
  • an agreement dated 30 March 2009 (the Third Amendment).
• The First Amendment provided that the maturity date in respect of a Loan Note could not be later than the tenth anniversary of the issue date less one day. The amendment was expressed to have effect from the date when the LNIA was originally entered into (28 June 2002).
• The Second Amendment purported to make the accrual and payment of interest contingent on certain benchmarks being met and it also increased the applicable rate by adding a premium of 4.552%. The amendment was expressed to have effect from the date when the LNIA was originally entered into.
• The Third Amendment changed the interest rate by replacing the 1 year BBSW with a fixed rate of 6.835%. The applicable rate under the LNIA, as amended by the third amendment, therefore became 13.2575%
• The Commissioner made transfer pricing determinations under Division 13 of Part III ITAA 1936 (Division 13) and under Subdivision 815-A of the ITAA 1997. The determinations underlying the assessments under Division 13 and Subdivision 815-A respectively were in the alternative¹.
• The taxpayer received amended assessments for the years ended 31 March 2010, 2011, 2012 and 2013 on the basis that the interest rate on the loan notes was considered to be in excess of an arm’s length rate.
• The taxpayer objected to the amended assessments in December 2019 and the objections were disallowed by the Commissioner on 27 September 2019.
• The taxpayer appealed the objection decisions in the Federal Court of Australia on 11 November 2019.

The Federal Court decision

Broadly, the taxpayer argued that the effective credit spread of the LNIA over the life of the LNIA was lower than the credit spread that might reasonably be expected to have been agreed in an arm’s length debt capital markets (DCM) transaction between independent parties.

Accordingly, it was argued that the taxpayer’s actual cost of borrowing under the LNIA was not greater (and in fact was less) than the costs that a party in the taxpayer’s position might be expected to have paid to an independent party acting wholly independently.

The Commissioner outlined three alternative cases. The one ultimately accepted by the Court was the Commissioner’s secondary case which was based on the interest rate as it stood under the original LNIA, referred to as the ‘no amendment’ model.

This ‘no amendment’ model reflected the impact on the LNIA interest deductions if it was assumed that the original LNIA terms remained in place over the life of the financing and the Second and Third Amendments did not take place.

Despite the Court having received evidence about other commercially rational alternatives for how the base debt (the $5.2 billion) and the ancillary debt (being the compound interest that had accrued) could be financed; the Commissioner’s calculations were not based on any distinction between the base or ancillary debts. Rather, the calculations were premised on the provisions and rates as provided under the original LNIA, with the exception that it was assumed interest was accrued and capitalised to principal every 31 March.

The Court’s reasoning

Broadly under the statutory test, the Court was required to consider whether ‘but for’ the conditions identified, an amount of profits that might have been expected to accrue to the taxpayer; and, by reason of those conditions, the amount of profits has not so accrued.

In this regard, the Moshinsky J held that this involves forming a reliable hypothesis based on probative material as to what independent parties in the positions of the taxpayer and SAI might have been expected to have done.

The associated enterprises article and s 815-15(1)(c) generally requires that the parties in the hypothetical have the characteristics and attributes of the actual enterprises. In this regard the Court found that it was therefore appropriate, in the hypothetical, to proceed on the basis that the party in the position of the taxpayer is a member of a multinational corporate group like the SingTel group. Likewise, it was therefore appropriate to proceed on the basis that the party in the position of taxpayer was a holding company of an operating subsidiary like SOPL. However, it is not necessary for the purposes of the hypothetical to address the precise ownership structure.

The Federal Court found that the principal difficulty with the taxpayer’s approach was that it departed too far from the actual transaction and the characteristics of the parties to that transaction.

In this regard, the actual transaction involved a vendor and a purchaser of shares, and an issue of loan notes totalling approximately $5.2 billion by way of partial consideration for the acquisition of the shares. It did not involve a DCM bond issue. Moshinsky J also found there to be significant differences between the terms of the LNIA and the terms of a typical DCM bond issue. It followed that Moshinsky J held that the approach advocated by the taxpayer was inconsistent with the approach required under Subdivision 815-A.

A further difficulty with the taxpayer’s approach according to Moshinsky J, was that rather than focusing on what independent parties in the positions of the taxpayer and SAI might be expected to have agreed in June 2002 it required the calculation (in hindsight) of the effective credit spread of the LNIA, and a comparison of this credit spread with that of a taxpayer-issued DCM bond issue.

Significantly, there was no parent guarantee in the actual transaction and Moshinsky J found that, factually, a guarantee was unnecessary owing to the ownership structure of the parties. However, Moshinsky J found that in the hypothesis of a transaction between independent parties, dealing wholly independently, there was nevertheless a strong indication that a parent guarantee would be provided. In this regard, Moshinsky J did not consider the presence of evidence of a guarantee (or a group policy to provide a guarantee) to be essential to a hypothesis that there might be expected to be a parent guarantee.

Interestingly, in regards to assessing the transaction from a stand-alone versus with implicit support perspective, there was not a great deal of difference between the expert for the taxpayer and the expert for the Commissioners as to the stand-alone creditworthiness of the taxpayer. The critical distinction appeared to relate to the extent of the uplift in the taxpayer’s credit quality for ‘implicit support’. As a result, in broad terms, the credit ratings evidence was directed towards understanding the effect of ‘implicit support’ – being the benefit assumed to be received by the taxpayer (the borrower) by reason of it being in a group. Broadly, when there is a period of stress the market – implicit support may be regarded as something that means a company can move forward constructively.

In this regard all of the experts agreed there would be some enhancement to the taxpayer’s rating as a result of implicit support but differed as to the extent of the enhancement.

On this point, Moshinsky J noted that during oral evidence, Dr Chambers accepted that there is “a continuum of implicit support outcomes from a no rating impact at one end to full equalisation with the parent at the other”. The tenor of Mr Weiss’s evidence suggested that he would also agree with that proposition.

The Court weighed up the various expert opinions but preferred the evidence given by Dr Chambers for a number of reasons – importantly because he adopted a more ‘cautious’ approach when assessing the effect of implicit support. Moshinksy J considered that this approach seemed to better reflect the Standard & Poor’s (S&P) criteria and the Moody’s criteria for assessing implicit support.

The Federal Court held that the original interest rate (i.e. 1-year BBSW plus 1%, grossed-up by 10/9) would have (or might be expected to have) continued through the whole life of the LNIA. The consequence of this finding was that the taxpayer failed to discharge its burden of demonstrating that the amended assessments were excessive.

In summary, Justice Moshinsky found that:

• the relevant consideration was what independent parties, dealing wholly independently, might be expected to have agreed having regard to the relevant facts and circumstances;
• certain conditions operating between the taxpayer and SAI in their ‘commercial and financial relations’ differed from those which might be expected to operate between independent enterprises, dealing wholly independently with one another;
• the approach advocated by the taxpayer was inconsistent with the approach required under Subdivision 815-A and in regards to the evidence relied on by the taxpayer, the principal difficulty with the taxpayer’s approach was that it departed too far from the actual transaction and the characteristics of the parties to that transaction;
• a further difficulty with the taxpayer’s approach was that, rather than focusing on what independent parties in the positions of the taxpayer and SAI might be expected to have agreed in June 2002 it required the calculation (in hindsight) of the effective credit spread of the LNIA, and a comparison of this credit spread with that of taxpayer-issued DCM bond issue. The Court found that this was too far a departure from the actual conditions that operated relating to the transaction entered into;
• a reliable hypothesis is that independent parties in the positions of the taxpayer and SAI would not have agreed to make the changes contained in the Second or Third Amendments to the LNIA; and
• as regards the rates, a reliable hypothesis was that independent parties in the positions of the taxpayer and SAI (and SingTel) might have been expected to have agreed that the interest rate applicable to the loan notes would be the same rate as was actually agreed in the original LNIA, interest under the loan notes could be deferred and capitalised; and, there would be a parent guarantee from a company like SingTel of the obligations of the company in the position of the taxpayer.

For completeness, at paragraph 156 Moshinsky J helpfully summarised what he described as the key propositions which, in his view, emerge from Chevron and Glencore (emphasis added):

1. In relation to s 815-15(1)(b) and the reference to “conditions” in the associated enterprises at least two members of the Full Court in Chevron accepted that the “identification of those conditions permits a broad and wide ranging inquiry into the relations existing between the enterprises concerned” and that the factual inquiry into the conditions operating between the enterprises “is unconfined by the terms of [the associated enterprises article], or by the terms of s 815-15(1)(b), by any circumstance other than that there be identified those conditions which bear relevantly and probatively upon whether they operate between the relevant enterprises ‘in their commercial or financial relations which differ from those which might be expected to operate between independent enterprises dealing wholly independently with one another’”: Chevron at [153] per Pagone J (Perram J agreeing); see also at [1], [82] per Allsop CJ.
2. In relation to the causal test in s 815-15(1)(c) based on the associated enterprises article all members of the Full Court in Glencore endorsed the observation of Allsop CJ in Chevron at [90] that the test “is a flexible comparative analysis that gives weight, but not irredeemable inflexibility, to the form of the transaction actually entered into between the associated enterprises”: see Glencore at [189] per Middleton and Steward JJ, at [280] per Thawley J.
3. the form of the transaction “may, to a degree, be altered if it is necessary to do so to permit the transaction to be analysed through the lens of mutually independent parties”: see Glencore at [189] per Middleton and Steward JJ; see also at [280], [292], [297]-[298] per Thawley J.
4. At least two members of the Full Court in Glencore endorsed the observations of Pagone J in Chevron at [156] that the comparison required by s 815-15(1)(c) and the associated enterprises article “will generally require that the parties in the hypothetical will generally have the characteristics and attributes of the actual enterprises in question” and that in the circumstances of Chevron the exercise “required hypothesising circumstances in a dealing between an enterprise like CAHPL and an enterprise like CFC where, however, the conditions operating between them were between independent enterprises dealing wholly independently with each other”: see Glencore at [190] per Middleton and Steward JJ; see also at [291] per Thawley J.
5. In relation to whether non-price terms of a transaction may be the subject of substitution in the exercise required by s 815-15(1)(c) and the associated enterprises article, I consider that this matter was left open by Middleton and Steward JJ: see the last sentence of [156] in Glencore. Thus, it is not clear to me that their Honours necessarily expressed a different view to that expressed by Thawley J at [296]-[298] of Glencore. I respectfully agree with the observations of Thawley J at [296]-[298] regarding the operation of Subdiv 815-A. However, as already indicated, it is not clear to me that Middleton and Steward JJ necessarily expressed a contrary view.

Thawley J’s minority judgment in Glencore has been the subject of much interest. It follows that Moshinsky J’s observation in (e) above will no doubt be the subject of much interest with the ability (or not) to substitute conditions that do not define ‘price’ likely to feature in future litigation heard under the relevant provisions.

Potential application of SingTel to cases decided under subdivision 815-B

It is noted that both Chevron and SingTel were heard under Division 13 of the ITAA 1936 and/ or in the alternative Subdivision 815-A of the ITAA 1997.

Subdivision 815-A of the ITAA 1997 was replaced by Subdivisions 815-B to 815-D of the ITAA 1997 for income years commencing on or after 29 June 2013 (Transitional Act, ss 815-1(2) and 815-15).

The question which many multinationals with financing arrangements falling outside those provisions will be asking is whether the implications may be quarantined to those cases heard under Division 13 and/ or Subdivision 815A and how the learnings from Chevron and SingTel may apply to cases heard and decided under 815-B.

Whilst it is recognized that the transfer pricing provisions have undergone major surgery, particularly when comparing Division 13 of the ITAA 1936 with Subdivision 815-B of the ITAA 1997, the arm’s length principle underpins all of the provisions, with the amendments in the form of Subdivisions 815-B, 815-C, 815-D and 815-E being made to ensure that Australia’s transfer pricing provisions better align with the transfer pricing approaches and arm’s length principle as described by the Organisation for Economic Cooperation and Development (OECD) guidelines and Australia’s double tax agreements (DTAs).

Accordingly, broadly speaking, the provisions have the same overriding objective, however, the text of the legislation and therefore the statutory tests are markedly different. It follows that there will no doubt be technical difference between the cases determined under the former and current provisions as a result of the markedly different language. There will also no doubt be technical challenges which will arise that will be specific to 815-B (in particular in regards to cases where the Commissioner seeks to utilise the specific ‘reconstruction provisions’ in section 815-130 of Subdivision 815-B).

Notwithstanding the above, both Chevron and SingTel provide guidance in regards to economically relevant conditions and practical considerations which may be relevant when considering transfer pricing risk associated with cross border financing arrangements under 815-B of the ITAA 1997³.

Closing remarks

Whilst traditionally there has been a lack of guidance globally regarding related party financing, in recent years the prominence of cross border financing as a key risk through the OECD’s Base Erosion and Profit Shifting project⁴ and the suite of guidance available has increased⁵. There is logic to the increased focus and guidance when you consider that related party financing crosses all industries and market sectors and, from a revenue authority perspective, may present a key area of transfer pricing risk. It follows that it is important to be aware of the guidance and how it may apply to your business

With revenue authorities becoming increasingly concerned with cross border financing, the thorough consideration of related party financing arrangements with supporting documentation is a necessity. It should also be noted that in Australia companies can (and in certain circumstances are required to⁶) assess their financing arrangements against  the ATO’s published guidance⁷.

Undertaking the risk assessment against the Commissioner’s compliance approach (see PCG 2017/4) assists in appreciating the level of risk of an arrangement and determining what evidence may be gathered in the event of a review.

Should the company’s financing arrangement come under scrutiny, taxpayers would be well advised to be ready to produce evidence regarding the commercial context of the intercompany arrangement. Depending on the specific facts and circumstances of the case, evidence you may be asked to provide may include:

• general description of how the group is financed (including financing arrangements with unrelated lenders);
• any existing group policies on financing, including those with respect to the provision of parental security/ guarantees;
• the identification of any members of the MNE group that provide a central financing function for the group, including the country under whose laws the entity is organised and the place of effective management of such entities;
• the role of subsidiary companies in the group structure;
• any alternative related party arrangements which were considered (and evidence documenting any reasons for rejection);
• evidence in regards to existing arrangements and previous arrangements;
• if an arrangement has been modified or amended – be prepared to explain the rationale for the change and consider the transfer pricing impact and arm’s length nature of the outcome as a result of the change;
• any other evidence which supports the commerciality of the pricing of the taxpayer’s arrangement;
• witness statements: in certain circumstances, it may also be prudent to capture relevant witness statements regarding decision making processes;
• any self-assessment against Practical Compliance Guideline 2017/4; and
• if you have concluded the actual conditions of your related party debt do not reflect arm’s length conditions, you should prepare and retain comprehensive analysis and data in order to support your choice of substituted conditions which do satisfy arm’s length conditions.

This article was written by Kristie Schubert, Partner and Jacqueline McGrath, Special Counsel.

¹ Subdivision 815-A of the ITAA 1997 was enacted in 2012 by the Tax Laws Amendment (Cross-Border Transfer Pricing) Act (No 1) 2012 (Cth) and, pursuant to s 815-1 of the Income Tax (Transitional Provisions) Act 1997 (Cth) (Transitional Act), was made to apply retrospectively to income years starting on or after 1 July 2004.
² Commissioner of Taxation v Glencore Investment Pty Limited [2020] FCAFC 187
³ For completeness, readers would also be well advised to monitor for any public statements issued by the ATO
⁴ Whilst many if not all of the BEPS actions potentially have the ability to indirectly impact cross border financing arrangements, two in particular have a direct impact on funding and are therefore likely to impact MNEs decisions in respect of the form and the amount of debt raised in Australia, they are: Action 2: ‘Neutralising the effects of hybrid mismatch arrangements’ and Action 4: ‘Limiting base erosion via interest deductions and other financial payments’.
⁵ OECD (2020), Transfer Pricing Guidance on Financial Transactions: Inclusive Framework on BEPS Actions 4, 8-10, OECD, Paris, www.oecd.org/tax/beps/transfer-pricing-guidance-on-financial-transactions-inclusive-framework-on-beps-actions-4-8-10.htm
⁶  If the company meets the criteria to complete a Reportable Tax Position (RTP) schedule, the company will be asked to disclose its self-assessed risk zone rating under PCG 2017/4 for certain financing arrangements
⁷ See Practical Compliance Guideline 2017/4 which sets out the ATO’s compliance approach to taxation issues associated with cross-border related party financing arrangements and related transactions. The tax risk associated with the related-party financing arrangement is assessed having regard to a combination of quantitative and qualitative indicators and is used by the ATO to “tailor” taxpayer engagement.