SingTel case: ATO wins again on transfer pricing on cross border loans

by Hugh Paynter, Graeme Cooper

Overview

The Federal Court of Australia recently handed down its decision in Singapore Telecom Australia Investments Pty Ltd v Commissioner of Taxation [2024] FCAFC 29. The case concerned a dispute between Singapore Telecom Australia Investments Pty Ltd (STAI) and the Commissioner of Taxation regarding amended tax assessments issued to STAI for the 2011, 2012 and 2013 financial years. The assessments disallowed substantial deductions claimed by STAI for interest paid on a related party cross-border loan from its parent company, Singapore Telecom Australia Investments Limited (SAI). STAI appealed against the assessments, but was unsuccessful before the primary judge. It then appealed to the Full Federal Court.

Background

In 2002, STAI acquired all the shares in SingTel Optus Pty Ltd (SOPL), which operated the Optus telecommunications business in Australia. The acquisition was funded by a $5.2 billion loan from STAI's parent company SAI under a Loan Note Issuance Agreement (LNIA). The LNIA had the following features:

• It allowed for deferral of interest payments until a "variation notice" was issued by the lender, SAI. This meant SAI could determine when STAI had to pay interest over the 10-year loan term.
• The interest rate was variable, set at the 1-year bank bill swap rate plus 1% margin, reset annually.
• The loan was effectively repayable on demand by either party.

The LNIA was amended three times, most significantly:

• - In 2003, to introduce a profitability benchmark before interest would accrue or be payable, and to add a 4.552% "interest premium" on top of the variable base rate in part to account for around $286m in interest which had accrued but which remain unpaid.
• - In 2009, to change the variable base rate to a fixed rate of 6.835% plus 1% margin for the remaining loan term.

The Commissioner made determinations under the transfer pricing rules in Division 13 of the Income Tax Assessment Act 1936 (ITAA36) and Subdivision 815-A of the Income Tax Assessment Act 1997 (ITAA97) that STAI had obtained a "transfer pricing benefit". The determinations substituted a lower "arm's length" amount of interest for the actual interest STAI had claimed deductions for in the 2011, 2012 and 2013 tax years. STAI objected against the amended assessments that followed, but the objections were disallowed. STAI then appealed to the Federal Court.

Issues on Appeal

The key issues in dispute on the appeal were:

1. Whether the primary judge erred in identifying the "arm's length" interest rate for the LNIA (the "hypothesis"). The primary judge found the original variable interest rate (1-year BBSW + 1% margin) should continue for the full 10-year term. STAI argued for a higher fixed rate based on US bond market rates.
2. Whether the primary judge erred in finding the 2003 and 2009 amendments to the LNIA would not have occurred in arm's length conditions.
3. Whether the transfer pricing benefit should be assessed over the whole 10-year LNIA term (STAI's position) or for each year within the 2011-2013 tax years (the Commissioner's position).
4. Whether the Commissioner was bound by the bases of the original transfer pricing determinations in defending the appeal.
5. Whether carried forward losses based on arm's length interest deductions in the years before 2011 should reduce the transfer pricing benefit in 2011.

The Decision

The Full Federal Court dismissed STAI's appeal. The key conclusions were:

• The court upheld the primary judge's rejection of STAI's reliance on US bond rates to determine the arm's length interest rate. The court agreed this "hypothesis" “departed too far” from the actual LNIA transaction, which was an intra-group vendor financing arrangement not an external bond issuance.
• The primary judge was correct to find that independent parties would not have agreed to the 2003 and 2009 amendments to the LNIA. There was no commercial rationale for those changes, which advantaged STAI. Thus the Court found that the taxpayer had not disproven the proposition that independent parties would have maintained the original variable interest rate (1-year BBSW + 1%) for the entire loan term.
• The transfer pricing benefit must be assessed and negated for each tax year, not on a hindsight basis over the total loan period. The determination of arm's length profits, and any "excessive" interest deductions, had to occur year by year. This was fundamental to how the transfer pricing rules operated.
• The Commissioner was not bound to adhere to the original reasoning in the transfer pricing determinations when defending the appeal. The taxpayer had the burden of proving the assessments excessive. There was no inconsistency between the determinations and the Commissioner's case.
• The claimed carried forward losses based on "arm's length" interest deductions in prior years were not relevant to determining if the assessments for 2011, 2012 and 2013 were excessive. Those losses did not actually exist, as no interest had accrued or been paid in those years to generate deductions. The transfer pricing rules only operated to negate a "benefit" within each tax year.

Key Take-Aways

The STAI decision confirms some important principles in transfer pricing disputes:

1. In applying the "arm's length test" for related party debt, the hypothetical construct should depart as little as possible from the actual loan and circumstances of the parties. Taxpayers cannot rely on a substantially different "hypothesis" (e.g. external bond issuance rates) if the real transaction (e.g. vendor financing) would not occur that way between independent parties. The trial judge considered that the taxpayer’s hypothesis “departed too far” from the actual transaction, albeit provided little guidance on the scope of adjustments which might be permitted where a transaction takes its shape due to related party factors.
2. Transfer pricing adjustments must be assessed year-by-year, not on an aggregate basis over the life of a financial arrangement. The time at which arm's length profits accrue, and non-arm's length deductions are incurred, is critical. Timing benefits conferred by non-arm's length conditions in an income year can give rise to a transfer pricing benefit, even if the arrangement is economically equivalent over its full term. Any asperity could potentially be addressed by the power to make consequential adjustments under transfer pricing law.
3. Taxpayers cannot rely on hypothetical carried forward losses from prior years based on applying arm's length conditions, when no actual interest deductions accrued in those years to generate losses. The transfer pricing rules are not a loss generation mechanism. Negating a transfer pricing benefit in one year does not automatically generate deductions or losses in other years.
4. The Commissioner does not have to adhere to the original bases of transfer pricing determinations if defending amended assessments in litigation. The onus is on the taxpayer to positively prove the assessments are excessive.

The STAI case illustrates the significant challenges for taxpayers in demonstrating that assessments are excessive in complex transfer pricing disputes. The decision affirms the extensive information gathering powers and broad discretions of the Commissioner in this area. Taxpayers must carefully consider the arm's length pricing, terms and conditions of related party financing arrangements, including potential changes over time. Robust documentation and evidence to support the arrangements as independent dealings should be prepared. That evidence must adopt to the form or shape of the transaction taking into account the circumstances of the parties. Those observations should have implications for how relates parties deal with each other real time should they contemplate that the ATO may review the transaction.