Transfer Pricing Adjustments Upheld For Optus Parent Company – Tax Authorities

Summary

• The Full Federal Court has dismissed an appeal by Singapore
  Telecom Australia Investments Pty Ltd (STAI) against transfer
  pricing assessments issued by the Australian Taxation Office (ATO)
  in relation to interest deductions claimed on related party
  debt.




• By reconstructing the reliable hypothetical transaction to be
  on independent vendor financing terms, including an implied SingTel
  parent guarantee, the Court concluded STAI received transfer
  pricing benefits in the income years under review.




• The decision provides useful guidance for the application of
  Subdivision 815-A of the Income Tax Assessment Act 1997
  (Cth) (ITAA 1997) and Division 13 of the Income Tax
  Assessment Act 1936 (Cth) in complex related party
  arrangements, which although now no longer applicable, should
  remain relevant in construing Subdivision 815-B of the ITAA 1997.
  It highlights the importance of considering both commercial
  substance and the timing effects of a transaction.




• With transfer pricing adjustments expected to trend upward
  globally, the implications of this case will be keenly followed.
  Revenue office activity continues to impact the ability of global
  groups to claim related party deductions.

Introduction

Singapore Telecom Australia Investments Pty Ltd v
Commissioner of Taxation [2024] FCAFC 29, concerned the
ATO’s review of interest deductions claimed by STAI, a
subsidiary of Singapore Telecommunications Limited (Singtel), for
income years ending 2011 to 2013. STAI had acquired the shares in
SingTel Optus Pty Ltd in 2002 through related party vendor
financing amounting to $5.2 billion from another Singtel
subsidiary, Singtel Australia Investments Limited (SAI), documented
via a complex 10-year Loan Note Issuance Agreement (LNIA).

Under the LNIA, STAI was able to defer payment of accrued
interest until the Optus business became profitable and a
“variation notice” was issued by the lender, SAI.
However, the liability to pay the interest still accrued. The
interest rate payable under the LNIA was initially set to be
adjusted each year by reference to the one year bank bill swap rate
from time to time plus one percent. Over time, the LNIA was amended
on three occasions in ways that affected the timing and calculation
of interest. Relevantly:

• The second amendment forgave any accrued obligation to pay
  interest and retrospectively ensured that there could be no
  liability for interest (and therefore no withholding tax) until a
  profitability benchmark was met. It then added a further interest
  premium of 4.552 percent to equate to the overall interest expected
  to be paid over the term for the LNIA if the amendment had not been
  made.




• The third amendment introduced a fixed rate of 13.5275 percent
  for the balance of the term of the LNIA.

  In a judgment confirming the ATO’s approach, the Full Federal
  Court found STAI had failed to discharge its onus to prove that the
  assessments were excessive. Led by Justice Wigney, the Court
  considered issues around:

• Formulating the appropriate reliable hypothetical scenario for
  transfer pricing analysis




• The amendments of the LNIA diverging from expected independent
  dealing characteristics




• STAI’s expert evidence assessing the “effective credit
  spread”

Issues

Timing of Assessing Non-Arm’s Length
Conditions

The Court rejected arguments of the taxpayer suggesting that the
timing effects of the LNIA should be disregarded. In this regard,
STAI sought to demonstrate that the total interest in fact paid by
STAI over the entire 10-year term was less than the interest that
might have been expected to be paid if an arm’s length rate had
been agreed upon at the start of the arrangement, and that the
assessment of whether there was a non-arm’s length dealing
could be made at the end of the arrangement with the benefit of
hindsight.

In this regard, the Court considered that the statutory context
required the Court to consider whether a transfer pricing benefit
arose in a particular income year, rather than over the life of an
arrangement.

Reliable hypothesis

To apply the relevant tax provisions, the Court had to determine
an appropriate basis for comparison to the actual arrangements.

Subdivision 815-A and Division 13 require identifying a
hypothetical scenario reflecting independent commercial dealing in
similar circumstances. This is called the “reliable
hypothesis.”

The Court examined factors like the nature of the transaction,
characteristics of the parties and evidence from experts.

The Court did not find any errors with the primary judge’s
characterisation of the reliable hypothesis. In this regard, the
Court agreed with the primary judge that the taxpayer’s expert
evidence regarding interest rates based on a U.S. bond issue in the
debt capital market should be rejected, as this departed too far
from the actual transaction and the characteristics of the parties.
The taxpayer also failed to produce any probative evidence that
suggested that parties dealing at arm’s length would have
entered into the LNIA amendments, or enter into a vendor financing
arrangement, without a parent guarantee. The Court also found that
there was no evidence to suggest that an arm’s length fee would
be payable for such a parent guarantee provided in a vendor
financing situation.

Implications of Singapore Telecom Australia
Investments Pty Ltd v Commissioner of Taxation [2024] FCAFC
29

This case provides further guidance (following Chevron
Australia Holdings Pty Ltd v Commissioner of Taxation [2017] FCAFC
62 and Commissioner of Taxation v Glencore Investment Pty Ltd
[2020] FCAFC 187) on reconstructing a suitable hypothetical
for the transfer pricing of related party transactions and the
extent to which the actual terms of the transaction and
characteristics of the parties are relevant in this exercise.

Of particular relevance in this case was the fact that the
commercial substance of the funding was a vendor financing
arrangement, which then impacted the relevance of the
taxpayer’s expert evidence, which largely relied on comparables
in the debt capital market.

The case highlights that taxpayers carry the legal burden of
proof and must prepare evidence based on the appropriate
hypothetical transaction, rather than rely on theoretical
arguments. Further, care should be taken when relying on expert
evidence to formulate the reliable hypothesis as this is a legal
concept.

Overall, the decision confirms tax authorities’ ability to
challenge related party arrangements and the high threshold for
taxpayers to prove that their international related party dealings
do not diverge from independent market conditions between third
parties.