Preconditions to the making of the Subdiv 815-A 2012 determinations
554 The applicant submitted that one of the statutory preconditions for the making of the Subdiv 815-A determinations which was not satisfied was the requirement in s 815-10(2) that an international tax agreement containing an associated enterprises article applies to the entity. The applicant submitted that the requirement was not satisfied because the Treaty in the present case did not contain an "associated enterprises" article.
555 Under s 815-15(5) an "associated enterprises article" is defined to mean either Art 9 of the United Kingdom convention or a corresponding provision of another international tax agreement.
556 The applicant also submitted that the Subdiv 815-A 2012 determinations were invalid as, in making them, no proper attempt was made to determine whether CAHPL had obtained a "transfer pricing benefit" or to calculate the amount of that benefit. The Court was entitled to, and should, infer that the Commissioner issued the Subdiv 815-A determinations by simply nominating the same amount that had been specified in the corresponding Div 13 determinations and, accordingly, no real attempt was made to ascertain the proper taxable income of CAHPL. The applicant referred to Avon Downs Pty Ltd v Commissioner of Taxation (Cth) [1949] HCA 26; 78 CLR 353 at 360 and to R v Commissioner of Taxation (WA); Ex parte Briggs (1986) 12 FCR 301 at 308. The applicant also submitted that this aspect of the making of the Subdiv 815-A determinations was not shielded by s 177(1) of the ITAA 1936 as part of the "due making" of the Subdiv 815-A 2012 amended assessments. This was because the discretionary power in s 815-10(1) was not enlivened, the applicant submitted, unless the Commissioner had first identified a transfer pricing benefit.
557 The respondent submitted that the "supporting document" did not demonstrate anything other than a genuine consideration of whether the applicant had obtained a "transfer pricing benefit". Given the close parallels between s 815-15(1)(c) and (d)(i) and the closing words of s 136AD(3), no breach of any requirement could be inferred from the fact that consideration of the same transactions under Subdiv 815-A led to an identical adjustment to that which had been made pursuant to Div13. Further, the respondent submitted that the power to make a determination under ss 815-10(1) and 815-30(1) was not conditioned on the Commissioner having any particular state of satisfaction, and the obtaining of such a benefit and its quantum were objective matters which may be contested in proceedings under Part IVC. Thus the taxpayer bore the onus of proving that in fact no such benefit was received or that the actual benefit was less than the figure upon which the relevant assessment proceeded. The respondent also submitted that the authorities established that the making of a determination such as that provided for in Subdiv 815-A was an aspect of the "due making" of the assessment and errors affecting the determination did not have any relevance in proceedings relating to the validity or correctness of the assessment.
558 In my opinion, the challenge to the validity of the Subdiv 815-A determinations on the ground that no real attempt was made to ascertain the proper taxable income of the applicant fails at the evidentiary level. I would not draw from the "supporting document" the inference for which the applicant contends.
559 The reference to Avon Downs does not, in my opinion, in the circumstances of this case, assist the applicant. I assume that the applicant's reference was to the dictum of Dixon J at 360 that the conclusion that the Commissioner had reached may, on a full consideration of the material that was before him, be found to be capable of explanation only on the ground of a [legal] misconception, so that it could be seen that in some way the Commissioner must have failed in the discharge of his exact function according to law. But, in my opinion, the factual basis for this inference has not been established in the present case. The mere fact that the numbers are the same as in the Div 13 assessments does not suffice.
560 Further, Briggs is to be distinguished. In Briggs, it is to be recalled, one of the agreed facts was that none of the Deputy Commissioner of Taxation and three other officers of the Australian Taxation Office had made any attempt to ascertain the prosecutor's taxable income nor intended to undertake any relevant process of calculation prior to the issue and service of the notices of amended assessment and assessment, but the Commissioner issued the notices for the purpose of forcing the prosecutor to consult with him or his officers. A further agreed fact was that the Commissioner decided to issue the notices of amended assessment and assessment knowing that they did not reflect any rational assessment of a liability of the prosecutor or with reckless indifference to whether they did or did not reflect any such assessment. It was these agreed facts which the Full Court was referring to at 308 in saying that the respondent had admitted that the documents issued by them were not, in truth, assessments of taxable income, and it was a case of the respondents asserting that they had abused their powers. Their Honours distinguished this situation from the case where there had been a genuine attempt to ascertain the taxable income of a taxpayer, even if carried out cursorily or imperfectly.
561 The applicant also submitted that other statutory preconditions for the making of the Subdiv 815-A determinations were not satisfied.
562 First, as I have noted at [554] above, the applicant submitted the "treaty requirement" in s 815-10(2) was not satisfied because the United States convention did not contain an "associated enterprises article". That term was defined in s 815-15(5) to mean Art 9 of the United Kingdom convention or a corresponding provision of another international tax agreement. The applicant submitted that the United Kingdom convention did not contain any provision that corresponded to Art 1 of the United States convention. The construction of Art 9(1) of the United States convention was affected by the presence of Art 1. Furthermore, Art 9 was agreed in 1982, prior to the publication of the relevant OECD Guidelines and prior to the entry into force of Art 9 of the United Kingdom convention. It followed, the applicant submitted, that Art 9 of the United States convention did not "correspond" to Art 9 of the United Kingdom convention. In order to correspond, the provisions must, at the very least, convey an analogous or similar meaning: they must be similar in character and function. Where two provisions contained similar text, but one was substantially modified by its context, that test could not be satisfied. Where there was an ambiguity, the domestic legislation would be construed consistently with the Treaty. To read Subdiv 815-A as not applying to the United States convention was to favour a construction of a Commonwealth statute which accorded with the obligations of Australia under the international Treaty.
563 The respondent submitted that Art 9 of each convention was headed "Associated Enterprises". The language and structure of the two articles was the same save for some minor differences and the fact that the order of paragraphs 2 and 3 of the United Kingdom convention was reversed in the United States convention. The respondent submitted that Art 9 of the United States convention was amply within the description of a "corresponding provision" to Art 9 of the United Kingdom convention. The respective articles were in sufficiently similar language.
564 The respondent also submitted that, first, Art 1 of the United States convention did not alter the meaning of Art 9. Secondly, even if the effect of Art 1(2)(a) was to read into Art 9(1) a prohibition against Australia using Art 9 to increase a taxpayer's assessment whereas Art 9 of the United Kingdom convention could have that effect, the respective Arts 9 would still correspond to each other. The differences between the United States and United Kingdom conventions that the applicant contended for could not be relevant in the statutory context. Thirdly, the language of s 815-15(5) and the extrinsic material, being the explanatory memorandum in relation to the Tax Laws Amendment (Cross-Border Transfer Pricing) Bill (No. 1) 2012, paragraph 1.68, demonstrated that to be corresponding the relevant aspect which the articles must share was the subject matter to which they applied: they were each to be the article of the respective convention that applied to and defined "associated enterprises". This was Art 9 of the United States convention and Art 9 of the United Kingdom convention.
565 I accept the respondent's submissions in this respect, although I do not find it necessary to rely on the extrinsic material. In my opinion, "corresponding provision" does not focus on the detail but refers to another provision the gist of which is the same: see New South Wales v Corbett [2007] HCA 32; 230 CLR 606 at [7] per Gleeson CJ, acknowledging that the meaning of "corresponding provision" depends on the context, see also Sackville-West v Viscount Holmesdale (1870) LR 4 HL 543 at 576 per Lord Cairns, discussed in Samarkos v Commissioner for Corporate Affairs [1988] NTSC 10; 52 NTR 1 at 10, per Asche CJ. See also Seaton v Mosman Municipal Council [1998] NSWSC 75; 98 LGERA 81 at 98 per Mason P with whom Meagher and Sheller JJA agreed.
566 In Greenock Harbour Trustees v Greenock Corporation (1905) 13 SLT 367, the question was whether the Police Acts in force in Greenock had "corresponding" provisions to those in the Burgh Police Act of 1892. The Lord Chancellor, with whom Lord Robertson agreed in separate reasons (Lord Ashbourne dissenting), said at 368:
The words "corresponding assessment" are not technical, and it must be admitted that such a mode of referring to other sections of other Acts of Parliament is calculated to confuse and embarrass. Still, the very looseness of it is what makes it, I think, applicable here. I think one would say, colloquially, if you were referring to the two statutes in question, which are the two corresponding sections? And I think the answer would be favourable to the appellants' contention. They do correspond in object and purpose, though to some extent they may differ in machinery. The force of the Lord Ordinary's reasoning, I think, is applied to the difference between the sections of the General Improvement Assessment of the Act of 1892. It is true the 42nd and the 43rd sections [of the Greenock Local Act of 1877] only give limited powers of improvement and not general improvement. I cannot think that that prevents their being corresponding sections. I think it would be a very intelligible thing to say the corresponding sections differ in such and such particulars, and indeed the use of the word suggests that the language or even the substance of the enactment is not identical in omnibus, otherwise the simplest form would be instead of "corresponding" to say "identical".
567 In Winter v Ministry of Transport [1972] NZLR 539 Turner J, for the Court of Appeal, said at 541:
[Counsel] confined his argument exclusively to the submission that the sections were not "corresponding" sections. This submission was founded upon the proposition that the 1970 provisions, taken as a whole were different from those of 1968. But this must be so whenever a new statutory provision is substituted for an old one. We read "corresponding" … as including a new section dealing with the same subject matter as the old one, in a manner or with a result not so far different from the old as to strain the accepted meaning of the word "corresponding" as given in the Shorter Oxford English Dictionary - "answering to in character and function; similar to". The new [section] answers to the old one … in character and function; it is similar in purpose, prescribes the same thing to be done, and is designed to produce the same result. We hold it to be a "corresponding section".
This passage was expressly approved by the Privy Council in Vela Fishing Ltd v Commissioner of Inland Revenue [2004] 1 NZLR 313, 324.
568 In my opinion, Art 9 is a provision of the United States convention corresponding to Art 9 of the United Kingdom convention. It is sufficient that Art 9 of the United Kingdom convention deals with "associated enterprises" as does Art 9 of the United States convention and that the gist of each Article is the same. Therefore, Art 9 of the United States convention answers the definition of an "associated enterprises article" in s 815-15(5)(b) of the ITAA 1997. It is a different question, which I consider at [580]-[585] below, whether "the requirements in the *associated enterprises article for the application of that article to the entity are met" for the purposes of s 815-15(1)(b) for the purpose of deciding whether the entity "gets a transfer pricing benefit".
569 The applicant also submitted that even if Art 9 of the United States convention could be said to "correspond" to Art 9 of the United Kingdom convention, it was not the case that Art 9 applied to CAHPL (s 815-10(2)) or contained "requirements" which applied to CAHPL (s 815-15(1)(b) and (c)). The reason for this was the presence of Art 1 and Art 9(3) in the United States convention. If Art 9 of the United States convention did not and could not operate to increase the tax burden of taxpayers resident in Australia, it must follow that in the context of the proposed adjustment to increase the Australian taxable income of an Australian resident, Art 9 did not "apply" to that Australian resident; nor contain "requirements" for its application. The applicant submitted that even without Art 1, it may be doubted whether Art 9 of the United States convention here had any "requirements" capable of "application" to CAHPL, in the sense required by s 815-15(1)(b). That was because Art 9 did not contain any rules of law which were capable of applying to delineate the liability of a particular taxpayer. Rather, Art 9 established a broad principle, capable of being used as a basis for drafting such rules for domestic application. But, by its terms, it was too vague and general to constitute in and of itself, rules of law which could be used to impose tax upon a taxpayer.
570 The applicant submitted there was a further reason why Art 9 did not "apply" to CAHPL in this case. Article 9 of the United States convention must also be read in the context of Art 11. Article 11 dealt with the taxation of interest arising in Australia or the United States. It was Art 11(8) which permitted amounts that are interest to be re-characterised for the purposes of the United States convention. The applicant submitted that in the case of a payment of interest between a resident of Australia and a resident of the United States, Art 11 (and in particular Art 11(8)) supplanted the operation, if any, which Art 9 might otherwise have. It was Art 11 which governed the taxing rights of the Contracting States in relation to amounts of interest - it was, in that respect, an exhaustive code. To read Art 9 as permitting an adjustment to interest was to ignore its context and to offend the principle that a general provision is to give way if it is applicable to the same subject matter as a specific provision. It was also contrary to the last sentence of Art 11(8), which was an allocation mechanism that operated to permit other Articles of the United States convention to operate only in relation to the amount not treated as interest for the purposes of the United States convention. What followed from this was that Art 9 could not be said to "apply" to an Australian resident where what was sought to be done was the exercise specifically provided for in Art 11(8) with respect to an amount of interest. If any article of an international tax agreement could be said to "apply" to CAHPL, that article was Art 11. Furthermore, if there were any "requirements" to be met, those requirements were to be found in Art 11, not Art 9. It followed that Subdiv 815-A had no field of application to CAHPL in the context of the interest here in issue.
571 The respondent submitted that Art 9(1) of the United States convention, the associated enterprises article, contained a participation requirement and a conditions requirement. The former requirement related to CAHPL participating directly or indirectly in the management, control or capital of CFC or, in the alternative, the same persons at CVX participating directly or indirectly in the management, control or capital of CAHPL, an enterprise of Australia, and CFC, an enterprise of the United States. The latter requirement was that conditions operated between CAHPL and CFC in their commercial or financial relations which differed from those which might be expected to operate between independent enterprises dealing wholly independently with one another.
572 As to the applicant's argument based on Art 1 and Art 9(3), the respondent submitted that Art 9(3) of the United States convention was relevantly the same as Art 9(2) of the United Kingdom convention and it could not have been intended to exclude Art 9 of the United Kingdom convention in light of the express inclusion of that Article by s 815-15(5). Thus Art 9(3) of the United States convention did not deprive Art 9 of any "requirements". Secondly, the respondent submitted, Art 1 and Art 9(3) of the United States convention did not alter the meaning of Art 9(1) of that convention. Thirdly, even if the effect of Art 1 and Art 9(3) was to read into Art 9(1) a prohibition against Australia using Art 9 to increase CAHPL's assessment, it did not follow that Art 9 ceased to have requirements that could apply to CAHPL. The respondent submitted that under s 815-15, meeting the requirements of the relevant associated enterprises article was a precondition to making a determination under s 815-30 but it was the application of the provisions of Subdiv 815-A and those provisions relating to assessment or amending an assessment that caused the increase or decrease in the taxpayer's liability. Thus Art 1 of the United States convention would not be engaged even on the applicant's reading of the Treaty.
573 As to the applicant's alternative argument that Art 9 of the United States convention had no requirements for the purposes of s 815-15(1)(b) because Art 9 lacked rules of law which were capable of applying to delineate the liability of any particular taxpayer, the respondent again submitted that it was not the associated enterprises article of the United States convention that delineated the taxpayer's liability which instead came about through the operation of all of the provisions of Subdiv 815-A and the provisions of the ITAA 1936 relating to assessment. The respondent in any event disagreed with the proposition that Art 9 was too vague and general.
574 As to the applicant's contention that Art 11 of the United States convention was an exhaustive code in relation to interest and that this caused Art 9 to be outside s 815-15(1)(b) in the present case, the respondent submitted that Art 11 was not an exhaustive code for all taxation relating in some way to interest but rather it set out certain restrictions on Contracting States imposing tax on interest income. For example, Art 11 had no application in the present proceedings which were not about Australia taxing the interest income earned by CFC. Secondly, even if Art 11 were an exhaustive code it would not affect s 815-15(1)(b). That provision was a precondition which applied to all potential associated enterprises transfer pricing adjustments, not just those relating to interest. It went to the relationship between the parties. Art 9(1) of the United States convention applied in terms in relation to CAHPL. The precondition in s 815-15(1)(b) was met.
575 In my opinion, the applicant seeks to give the expression "the requirements in the associated enterprises article for the application of that article to the entity" too large an operation. It is clear that Art 9 of the United States convention contains requirements, one being the participation requirement, which includes an alternative, and the other the ultimate satisfaction of which is better to be considered in the context of whether CAHPL gets a transfer pricing benefit. To that extent that requirement is not a threshold issue. I reject the applicant's submission that, at the threshold, Art 9 did not "apply" to CAHPL, nor contain "requirements" for its application. In my opinion, any separate submission that Art 9 did not apply to CAHPL with reference to s 815-10(2) fails to recognise that that provision is concerned with whether the entity gets the transfer pricing benefit at a time when an international tax agreement applies to the entity. It is that time which is the focus of the provision and there is then a further requirement that the international tax agreement applying at that time contains an associated enterprises article.
576 I also reject the submission based on Art 1 and Art 9(3) in the United States convention. I am not persuaded that Art 1 has any present application. Neither it nor Art 9(3) alters the meaning of Art 9(1) or has the consequence that Art 9 no longer contains requirements for the application of that article to the entity. In my view, the applicant's submissions do not sufficiently recognise that the requirements referred to in s 815-15(1)(b) are requirements having that character, that is, for the application of that article to the entity.
577 I also reject the applicant's submission that because Art 9 did not contain any rules of law which were capable of applying to delineate the liability of a particular taxpayer and that therefore, as I understood the argument, Art 9 did not apply or its requirements to the entity were not met. Again, in my view, this is to seek to give Art 9 too great a substantive operation. As the respondent submitted, the taxpayer's liability comes about through the operation of all of the provisions of Subdiv 815-A and the provisions of the ITAA 1936 relating to assessment. It follows that I reject the applicant's submission that there were no criteria for liability under Art 9.
578 As to the applicant's Art 11 submission, this travels outside the terms of s 815-15(1)(b) which relates only to the requirements in the associated enterprises article for the application of that article to the entity being met. Even if Art 11 were an exhaustive code in relation to interest this would not cause Art 9 to be outside s 815-15(1)(b). I reject the submission. I am also not persuaded, in any event, that Art 11 is an exhaustive code for all taxation relating to interest.
579 There remains to consider, again in the alternative given my conclusions in relation to the 2010 amended assessments under Div 13 of the ITAA 1936, the question whether CAHPL "gets a transfer pricing benefit". Before turning to that issue, which centred on s 815-15(1)(c) of the ITAA 1997, I should record that the parties agreed that if that paragraph was satisfied, s 815-15(1)(d)(i) posed the relevant question. That is, had the amount of profits so accrued to the entity CAHPL, the amount of the taxable income of CAHPL for an income year would be greater than its actual amount. In that case the amount of the "transfer pricing benefit" is the difference between the amounts mentioned in s 815-15(1)(d)(i): see the closing words of s 815-15(1).
580 The first issue arises from the terms of s 815-15(1)(c) which states that an entity gets a transfer pricing benefit if an amount of profits which, but for the conditions mentioned in the article, might have been expected to accrue to the entity, has, by reason of those conditions, not so accrued. The conditions are those mentioned in Art 9 of the United States convention and this refers to where "conditions operate between [CAHPL and CFC] 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 …"
581 The applicant submitted that it was not apparent from the "conditions" set out in paragraph 45(b) of the respondent's appeal statement how the identified conditions were said to differ from those which might be expected to have operated between independent enterprises. The "arm's length" conditions had not been identified by the respondent Commissioner. Nor was it apparent, the applicant submitted, from paragraph 45(b) how some or all of the identified conditions were said to have impacted on the pricing of the loan to CAHPL and to have resulted in the non-accrual of profits.
582 In relation to this issue, the respondent submitted there were some eleven conditions which differed from those which might be expected to operate between independent enterprises dealing wholly independently with one another. These included: that CAHPL owned CFC and they both had a common parent, CVX; CVX Treasury decided how much debt and at what interest rate CAHPL should borrow from CFC; there was no bargaining or negotiation between CAHPL and CFC; the terms and conditions of the Credit Facility Agreement, including the terms in respect of the interest rate charged, the duration and the currency of the loan and the absence of covenants; the sole reason for CFC's incorporation, and the purpose of its commercial paper program, was to raise funds solely to on-lend to its parent CAHPL; that the credit profiles of CFC and CAHPL could be controlled by decisions made by CVX; that CFC profited from lending to CAHPL at a high interest rate; and the higher the interest-bearing loan from CFC and the higher the interest rate, the more profit CAHPL stood to make.
583 As to the currency of a loan, although it is not necessary to my conclusion, I am not persuaded that the condition as to the AUD currency which was operational between CAHPL and CFC differed from the condition as to currency which might have been expected to operate between independent enterprises dealing wholly independently with one another. I accept the applicant's submission in this respect that borrowings in AUD would avoid or limit foreign currency gains and losses. I am not persuaded Professor Boymal's opinion to the contrary.
584 I do not accept the applicant's implicit submission that for each identified condition it must be explicitly stated how it would differ from the condition which might be expected to have operated between independent enterprises or that the "arm's length" conditions must be explicitly identified by the respondent Commissioner. It is enough, in my opinion, for the respondent Commissioner to identify, as he has, which conditions operate between the two enterprises which differ from those which might be expected to operate between independent enterprises dealing wholly independently with one another.
585 Neither do I accept the applicant's further implicit submission that the Commissioner must identify how each identified condition was said to have impacted on the pricing of the loan and to have resulted in the non-accrual of profits. In my opinion, once the differential conditions have been identified the question then arises, under s 815-15(1)(c), whether an amount of profits which but for the conditions might have been expected to accrue to CAHPL has, by reason of those conditions, not so accrued and whether, here under s 815-15(1)(d)(i), had the amount of profits so accrued to CAHPL the amount of CAHPL's taxable income for an income year would be greater than its actual amount.
586 The applicant also submitted that if the Div 13 determinations remained effective, then s 136AD(3) operated to deem the consideration for the loan to CAHPL to be the consideration given by the taxpayer "for all purposes of the application of this Act in relation to the taxpayer". It followed that there could be no "transfer pricing benefit" within s 815-15 of the ITAA 1997.
587 In relation to this issue, the respondent appeared to accept that there was not a contrary intention so that the definition of "this Act" in s 6(1) of the ITAA 1936 did not apply to the ITAA 1997 but did not contend that the two determinations, one under the ITAA 1936 and one under the ITAA 1997, for each income year operated cumulatively. The respondent submitted that if the Div 13 adjustments were wholly upheld, the Subdiv 815-A determinations did not need to be considered. On the other hand, if Div 13 did not apply then the Div 13 determinations could have no effect on the availability of s 815-15.
588 I accept the respondent's submission in this respect. Indeed, as I have indicated above, these reasons consider the Subdiv 815-A issues in the alternative because, if the applicant's Div 13 case had succeeded, only then would it be necessary to consider Subdiv 815-A.
589 In any event, the applicant submitted, there was no amount of profits which, but for the conditions, might have been expected to accrue to CAHPL and therefore s 815-15(1)(c) was not satisfied. The applicant's primary submission in support of that proposition was that Art 9 and the test in s 815-15 did not permit: a re-characterisation of the entire transaction or a rewriting of the terms of the loan; and ratings, and in particular the credit rating agency concept of so-called "implicit credit support", to be taken into account in determining the arm's length interest rate for the loan. In the alternative, the applicant submitted, when viewed in its totality, it could not also be said that there were any "profits" which did not accrue to CAHPL in its commercial or financial relations with CFC and thus the requirements of Art 9 were not satisfied. CAHPL paid interest on the loan to CFC and received dividend income from CFC. The respondent had ignored entirely the dividend income CAHPL received in the years in dispute, totalling $1,110,559,595. The applicant submitted that the word "profits" in Art 9 did not refer to taxable income but profits in its more generic sense.
590 The respondent Commissioner submitted that but for the conditions he identified, CAHPL would have derived an additional amount of profits. Its interest expenses would have been less, with the difference representing an additional amount of profits. The respondent submitted the precise amount of profits which CAHPL would have derived depended on whether CAHPL was treated as a subsidiary of CVX, or a group having the same characteristics as the CVX group, or as a stand-alone company, whatever that meant.
591 In my opinion, the question posed under s 815-15(1)(c) has a focus different from that which arises under Div 13. What is here required is the assessment of an amount of profits which might have been expected to accrue but for the conditions identified by reference to Art 9 but which, by reason of those conditions, have not so accrued. It follows, in my view, that the question of re-characterisation of the transaction in question or rewriting the terms of the loan does not directly arise. If, as I understand it to be, the applicant's proposition is that the statutory regime does not permit a departure from the actual "commercial or financial relations" between the parties which in this case was the relationship of debtor and creditor in respect of an AUD credit facility in the sum of AUD3.707 billion, then I do not accept the width of that proposition.
592 Neither do I accept the related submissions by the applicant that where the thin capitalisation rules (Div 820) were engaged, it was those rules that expressed the legislature's determination of the appropriate amount of debt with which an entity can be financed and the transfer pricing rules should not be taken to override or interfere with that limit. Section 815-25 modifies the transfer pricing benefit an entity gets, or apart from that section would get, in an income year in the circumstances there set out. One of those circumstances is if Div 820 applies to the entity for the income year. This shows that Div 820 does not stand outside Subdiv 815-A. It follows, in my opinion, that the applicant's reliance on what was said at [1.76]-[1.77] in the explanatory memorandum to the New Business Tax System (Thin Capitalisation) Bill 2001 is misplaced for the reason that it cannot qualify or contradict the terms of the statute, s 815-25, which remains paramount, and because the explanatory memorandum was not directed to Subdiv 815-A, a later enactment. Further, a reading of [1.78] of the explanatory memorandum suggests that the thin capitalisation rules do not always prevail. That paragraph states as follows:
However, the thin capitalisation rules do not have the same scope as Division 13 and comparable provisions of DTAs - the latter apply to a wider range of transactions. Further, there may be instances where the purpose of the application of the arm's length principle under Division 13 and comparable provisions of DTAs to a particular case is not the same as for applying the arm's length test under the thin capitalisation rules. In these cases, the arm's length principle articulated in Division 13 and comparable provisions of DTAs should apply. For example, the application of the arm's length principle to determine whether a rate of interest is greater than an arm's length amount can only be done under Division 13 and comparable provisions of DTAs.
I therefore reject the applicant's submissions that the thin capitalisation rules are an exclusive code or that the thin capitalisation rules confer an entitlement outside the terms of Subdiv 815-A.
593 A related submission made by the applicant was that a negative inference should be drawn from the existence and terms of Subdiv 815-B. The applicant submitted that there was no provision in Subdiv 815-A that authorised the Commissioner to substitute for the actual terms of the loan other terms (including security or financial covenants or currency). Section 815-25 did not authorise such substitution and to the extent the explanatory memorandum suggested otherwise, it was wrong. An express power to re-characterise could easily have been included, and was in fact drafted as part of the same programme of legislative reform: s 815-130 of Subdiv 815-B of the ITAA 1997 expressly permitted a reformulation of the commercial and financial relations between the taxpayer and the other entity. The contrast between the language of Div 13 and Subdiv 815-A, on the one hand, and the language contained in new Subdiv 815-B - which was not in issue in these proceedings - on the other, was instructive. Section 815-115 expressly substituted the "arm's length conditions" for the "actual conditions" that operated between the parties. The starting point or "basic rule" for determining the arm's length conditions was that one adopted the actual conditions, but those could be changed or re-characterised if one of the three express exceptions applied: s 815-130(2)-(4).
594 The applicant expanded on its submission that Art 9 of the United States convention and the test in s 815-15 did not permit a rewriting of the terms of the loan as follows. The applicant submitted a contextual analysis of Art 9 revealed that it did not permit a rewriting of the terms of a loan but only an examination of the "conditions". Further, there was no provision in Subdiv 815-A that authorised the Commissioner to substitute for the actual terms of the loan other terms (including security or financial covenants or currency). Further, there was nothing in the OECD Guidelines which permitted the Commissioner to substitute the actual loan for some other loan in determining the dealing that was to be priced. The circumstances in which the OECD Guidelines did contemplate the possibility of re-characterisation (assuming domestic legislation permitting this) were very limited. The applicant submitted, in applying these principles, that although the Commissioner disavowed re-characterising, his case was that the prohibition applied only to the characteristics of the parties and not to the terms of the transaction itself.
595 The applicant referred to the explanatory memorandum to the Tax Laws Amendment (Cross-Border Transfer Pricing) Bill (No. 1) 2012 and, I understood, particularly paragraph 1.109 and example 1.6. The applicant submitted that at least the final paragraph of example 1.6 was wrong. It was that Bill, once enacted, which inserted Subdiv 815-A into the ITAA 1997. For completeness I reproduce that material, so far as relevant:
1.109 The following examples illustrate the interaction of Subdivision 815-A and Division 820. They are intended purely to illustrate the respective fields of operation of Subdivision 815-A and the thin capitalisation rules and are not intended to suggest that a particular method for pricing debt must be applied to the circumstances of a particular case. Nor are the examples intended to preclude the use of other methods that produce an arm's length outcome.
Example 1.4: Thin capitalisation adjustment and transfer pricing adjustment
Aus Co is an Australian resident subsidiary company of For Co, a resident of the UK. Aus Co is an 'inward investment vehicle (general)' for the purposes of Subdivision 820-C.
For an income year, Aus Co has:
• a 'safe harbour debt amount', determined in accordance with section 820-195 of $375 million;
• 'adjusted average debt' determined in accordance with subsection 820-185(3) of $400 million, of which $200 million is borrowed from For Co at an interest rate of 15 per cent, and $200 million from an independent lender at an interest rate of 10 per cent; and
• equity of $100 million.
Aus Co's only debt deductions are for the interest incurred at a rate of 15 per cent on its $200 million related party debt, and 10 per cent on its $200 million debt from the independent lender, meaning that it has $50 million of debt deductions for the income year.
The Commissioner considers whether Aus Co has received a transfer pricing benefit under section 815-15. In doing so, the Commissioner has regard to the arm's length rate in relation to the debt interest (that is, the arm's length interest rate), applied to the actual amount of the related party debt.
Assume that the loan from the independent lender is sufficiently similar to the loan from For Co and the circumstances in which each amount of debt funding was provided do not present material differences that would affect the rate applicable to the debt interest or Aus Co's ability to obtain $400 million in debt funding (that is, the independent loan is directly comparable to the related party loan). As a result, the Commissioner determines that using a comparable uncontrolled price is the most appropriate method for determining the arm's length rate. In these circumstances it is commercially realistic for the Commissioner to determine that the arm's length interest rate is 10 per cent. In this case, Aus Co gets a transfer pricing benefit of $10 million (being the difference between an arm's length rate of 10 per cent applied to the debt interest arising from the loan from For Co ($200 million) and the actual interest rate of 15 per cent on the debt interest).
Further, to the extent that Aus Co has 'excess debt', Division 820 will apply to deny a corresponding proportion of Aus Co's debt deductions remaining after the $10 million reduction under Subdivision 815-A.
Example 1.5: Transfer pricing adjustment and no thin capitalisation adjustment
Assume the facts and circumstances are the same as in Example 1.4, except that Aus Co has $300 million of debt ($150 million from For Co and $150 million from an independent lender) and $100 million of equity, producing a safe harbour debt amount for Division 820 purposes of $300 million. The interest rate on Aus Co's debt to For Co is 15 per cent, so that, before applying Subdivision 815-A and Division 820, Aus Co has total debt deductions of $37.5 million.
As was the case in Example 1.4, the Commissioner determines that an arm's length interest rate of 10 per cent is to be applied to the debt interest from For Co. As such, Aus Co gets a transfer pricing benefit of $7.5 million (being the difference between the arm's length rate of 10 per cent applied to the debt interest from For Co ($150 million) and the actual interest rate of 15 per cent on the debt interest).
Example 1.6: Transfer pricing adjustment and no thin capitalisation adjustment
Assume the facts and circumstances are the same as in Example 1.5, except that the entire $300 million of debt is borrowed from For Co at an interest rate of 15 per cent. Aus Co's debt deductions for the interest incurred on its $300 million debt total $45 million for the income year.
Unlike the previous examples, there is no internal comparable uncontrolled price that provides an arm's length rate. As such, the Commissioner determines the arm's length rate of interest for the loan having regard to available data of market reference rates and the credit standing that the capital markets would be likely to give Aus Co. The market data shows that Aus Co's credit standing would allow it to borrow $250 million from independent lenders. Having regard to the information available, the Commissioner determines that the closest commercially realistic arm's length scenario at which a loan might reasonably be expected to exist between independent parties dealing wholly independently with one another is a loan of $250 million at 10 per cent.
In this case, the Commissioner is able to determine the amount of the transfer pricing benefit by reference to an amount less than the actual amount of the debt interest (being an arm's length amount). (The fact that Aus Co's debt amount is less than its safe harbour debt amount for Division 820 purposes is not relevant to determining the amount of the transfer pricing benefit.)
The Commissioner determines that Aus Co's transfer pricing benefit is $15 million (as required under subsection 815-25(2)). This is worked out by applying the 10 per cent arm's length interest rate to Aus Co's actual debt amount ($300 million), and comparing this to Aus Co's actual debt deductions of $45 million.
596 The respondent submitted in this respect that Subdiv 815-B provided no comfort to the applicant, first, because this was an inappropriate approach to construction and, secondly, because on the very terms of Div 13, Subdiv 815-A and Art 9 there was no warrant for an approach which set in stone all aspects of the non-arm's length agreement save as to interest rate.
597 As to the first of these matters, the respondent submitted that Subdiv 815-B was enacted after each of Div 13 and Subdiv 815-A and was for a different purpose, which was to apply the arm's length principle to relevant dealings between both associated and non-associated entities, looking to supplies and acquisitions under international agreements. Further the machinery of Subdiv 815-B was quite different from the determination provisions which appeared in Subdiv 815-A and Div 13. Therefore no expressio unius implication arose. Subdivision 815-B did not apply to the income years in issue in the present proceedings. Subdivision 815-A continued to operate in respect of income tax years after 1 July 2004 and until the commencement of the Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Act on 29 June 2013 which repealed Div 13 and added Subdiv 815-B at the end of Div 815. In those circumstances that Act shed no light on the earlier provisions and judicial authorities recognised the difficulties in attempting to construe words used in a statute by reference to later amendments, let alone later separate legislation: see Ajinomoto Company Inc v NutraSweet Australia Pty Ltd [2008] FCAFC 34; 166 FCR 530 at [92]-[99] and the authorities there referred to.
598 I agree with this submission made by the respondent. It is necessary to start and finish with the words of Subdiv 815-A, both as to what they do provide and as to what they do not.
599 As to the broader point, the respondent submitted that the applicant would have the Court approach the arm's length pricing analysis by reference to the exact terms of the Credit Facility Agreement, which would not have been agreed between arm's length parties, as opposed to the terms that might be expected to have been agreed between CAHPL and CFC had they been independent of each other. The respondent submitted that the provisions in Subdiv 815-A (as in Art 9) required that there be an examination of the "conditions" operating between the two associated enterprises - not just the price - and an evaluation of profits absent the identified "conditions". That is, the respondent submitted, Subdiv 815-A did not envisage that one should take a related party loan transaction exactly as one found it and price the interest payable on the transaction (if that was even possible). Rather, by focusing on "conditions" as the matter that was to be hypothesised on the counterfactual analysis, Subdiv 815-A recognised that associated entities may have dealings which are non-arm's length for reasons apart from the price that is attributed to them. It followed, in the respondent's submission, that the applicant's contention that the Commissioner or Court may not depart from any of the actual terms of the Credit Facility Agreement, other than interest rate, found no basis in the express terms of the provisions of Subdiv 815-A.
600 In my opinion, the applicant's submissions suffer from the use of a shorthand as to not "re-characterising" or not "rewriting" as a substitute for the statutory language and thereafter to describe what the respondent Commissioner has done as impermissible because it involved "re-characterisation" or "rewriting". On the other hand, the respondent's submissions seek to align Div 13 and Subdiv 815-A without sufficient regard to the different language of the two sets of provisions: Div 13 focuses on "consideration" whereas Subdiv 815-A focuses on the broader term "conditions". Having said that, I accept the respondent's submission that by focusing on "conditions", Subdiv 815-A recognised that associated entities may have dealings which are non-arm's length for reasons apart from the price that is attributed to them.
601 Another significant difference between the parties in construing the provisions was that the applicant submitted, under the heading "Implicit Support" that the terms of Art 9 meant that one must consider the conditions that one might expect to see between a lender and a borrower who are independent, and are dealing wholly independently with one another. In the applicant's submission, the relationship between the lender and the borrower must therefore be eliminated in order to undertake this task, and in a situation where the entities in question were sister companies, so too must the relationship between each of them and their common parent. If that latter relationship were permitted to subsist, then it could not be said that the lender and borrower were independent or were dealing independently. Their hypothetical dealing would be infected by the characteristics of each party, the borrower in particular, that were referable to ownership by the common parent.
602 The applicant submitted that a textual analysis of Art 9 supported the contention that the concept of "independent enterprises" was used in contradistinction to, and as the converse of, "associated enterprises". The OECD Guidelines provided that two enterprises were "independent" if they were not "associated enterprises". It followed therefore, in the applicant's submission, that all and any attributes that give rise to entities being "associated" within the meaning of Art 9 must be disregarded in determining the attributes of the independent parties. Within Art 9 there were two conditions that could result in parties being regarded as associated. The first was participation by one entity in the management, control or capital of the other. Negating this attribute required one to ignore the parent-subsidiary relationship that in fact existed between CAHPL and CFC. The second condition of association was the same persons participating in the management, control or capital of the two enterprises. Negating this attribute required one to ignore the ownership by CVX of each of CAHPL and CFC. The terms of Art 9 thus required one to hypothesise a stand-alone borrower and a stand-alone lender. There was no room for implicit parental support which of necessity derived from the common owner, CVX. This was further confirmed in the OECD Guidelines, which said that Art 9 required one to treat members of a multi-national group as if they were operating as separate entities rather than part of a single "unified business", and thus "attention is focused on the nature of the dealings between those members".
603 The respondent submitted that while the transfer pricing rules required the affiliation between the parties to the transaction to be ignored, there was no warrant for ignoring the affiliation between a party to the transaction in question and other members of the group of companies of which it formed a part. To do so, the respondent submitted, would be contrary to the natural language of the relevant provisions, their judicial interpretation and the object and purpose of the transfer pricing rules. Each of the relevant provisions focused on the relationship between the parties to the relevant transaction.
604 While I accept the applicant's submission that one must consider the conditions that one might expect to see between a lender and a borrower who are independent, and are dealing wholly independently with one another, which is the language of Art 9, it by no means follows that where, as here, the entities in question are sister companies, also to be eliminated is the relationship between each of them and their common parent on the basis that, otherwise, it could not be said that the lender and borrower were independent or were dealing independently. In my opinion, independent enterprises dealing wholly independently with one another may still be subsidiaries and may still have subsidiaries even if the enterprises are independent of each other. I therefore accept the respondent's submission insofar as he contended that there was no legislative warrant for ignoring affiliation between a hypothesised party to a transaction and other members of that party's group of companies. At the factual level, at [606] below, I have accepted the applicant's submission as to implied parental support.
605 This conclusion means that the applicant's high-level contention about "implicit support' also fails. "Implicit support" may be generally relevant when assessing a borrower's credit rating. The high-level contention fails because it relies on the proposition that the relationship between CAHPL and CVX and the relationship between CFC and CVX, CVX being the common parent, must be eliminated from the analysis.
606 The applicant's submission that the existence and worth of "implicit support" is a matter of fact remains unaffected. I accept the applicant's submission, that in the absence of a legally binding parental guarantee, implicit credit support had very little, if any, impact on pricing by a lender in the real world. This was the evidence of Mr Martin and Mr Gross and the conclusion of an article published in 2014 of which Mr Hollas was a joint author: "Intercompany Financial Transactions: Factors to Consider in Analysing the Impact of Implicit Parental Support".
607 As to the applicant's reliance on a differentiation between the language of "association" and "independence", it seems to me that that distinction involves a non sequitur: to say that a party is independent of another party does not mean or require that either party is independent of all parties.
608 A further broad submission put by the applicant was that Art 9 mandated a determination of the "profits" which might have been expected "but for those conditions" and thus proceeded to consider a hypothetical situation in which commercial or financial relations take place, but absent the operation of the identified conditions. By its terms, the applicant submitted, Art 9 did not permit the addition of new "conditions" but was, instead, an "annihilation" provision.
609 In my opinion, the correct approach is to identify the conditions mentioned in Art 9 and then ask if there was an amount of profits which, but for those conditions, might have been expected to accrue to the entity but which has, by reason of those conditions, not so accrued: s 815-15(1)(c). As I have set out above at [27], Art 9 involves a comparison between, here, conditions which operate between CAHPL and CFC in their commercial or financial relations and whether those conditions differ from those conditions which might be expected to operate between independent enterprises dealing wholly independently with one another. It seems to me a distraction, in that context, to speak about "annihilation" provisions: conceptually the comparison between the actual conditions and the conditions which might be expected to operate between independent enterprises dealing wholly independently with one another is straightforward although its application may not be. In my opinion, nothing is "annihilated" but I accept that what must be compared are conditions which operate.
610 Once the approach I have outlined is borne in mind, in my view, the applicant's submission: "By its terms [Art 9] does not permit the addition of new 'conditions'" does not assist. It follows that I do not accept the applicant's submission that "Article 9 negates non-arm's length conditions but does not supply any condition which is absent and leaves the commercial or financial relations (as opposed to its terms) exactly as it finds it". It follows that I reject the applicant's submission that the "requirements" of Art 9 permit only an adjustment to the price of a transaction (in this case an adjustment to the rate of interest) for the purpose of determining the quantum of profits which might have been expected to accrue, and they might justify, but go no further than, the elimination of other terms or conditions upon which CFC lent to CAHPL. As I have said, in the present case Art 9 involves identifying conditions which operate between CAHPL and CFC in their commercial or financial relations and seeing where they differ from conditions which might be expected to operate between independent enterprises dealing wholly independently with one another.
611 It is necessary to return to the applicant's submission, referred to at [589] above, that viewed in its totality, it cannot also be said that there were any profits which did not accrue to CAHPL in its commercial or financial relations with CFC and thus the requirements of Art 9 were not satisfied. The applicant's submission was that CAHPL paid interest on the loan to CFC and received dividend income from CFC. The Commissioner ignored the dividend income CAHPL received in the years in dispute. It may be that the Commissioner overlooked the dividends received by CAHPL because he did not consider them to be "profits" of CAHPL for the purposes of Art 9. He may have read "profits" to mean "taxable income" because of s 3(2) of the International Tax Agreements Act, set out at [22] above.
612 The applicant submitted that the word "profits" where first appearing in Art 9 did not refer to taxable income, but profits in its more generic sense. The applicant submitted that this was supported by the history of Art 9. The reference to profits in this part of Art 9 was the same profit referred to in the old Art 5 of the 1933 Draft Convention for the Allocation of Business Income between States for the purposes of Taxation: it was a diverted profit which must be allocated to "one of the enterprises". It would make no sense, the applicant submitted, to read the word "profits" in that phrase as meaning taxable income, as the enterprise which may get allocated those profits may not be resident in Australia. The profits which might be expected to accrue as mentioned in Art 9 were therefore to be taken to refer to profits generally. Once this condition of Art 9 was satisfied, namely that there were profits which might be expected to have accrued to one of the enterprises, the mechanism whereby such profits may be domestically taxed (i.e. included in the taxable income computation) followed in Art 9 with the concluding language of that Article: "may be included in the profits of that enterprise and taxed accordingly". It followed that the profits of CAHPL included the dividends it had received from CFC for the purposes of the first condition in Art 9 relating to profits. In that respect, it could not be suggested that because of the conditions operating between CFC and CAHPL, "profits" did not accrue to CAHPL which should have. In other words, there had been no diversion of profits to CFC, and CAHPL's expense, precisely because they had returned to CAHPL. The respondent Commissioner submitted that s 3(2) of the International Tax Agreements Act applied to the profits referred to in Art 9(1) and deemed them to be taxable income derived by CAHPL. Neither party referred to any authority on the point.
613 In my opinion, s 3(2) of the International Tax Agreements Act has a limited purpose, as set out in the explanatory memorandum to the Income Tax (International Agreements) Bill 1953, circulated by the Treasurer, the Rt. Hon. Sir Arthur Fadden:
The proposed sub-section (2.) is, subject to minor drafting variations, the same as the corresponding provision enacted in 1947 as sub-section (2.) of section 160F of the Assessment Act. Its purpose is to permit references in agreements to profits to be construed, unless the context requires otherwise, as references to taxable income. The provision is required because the Australian law imposes tax upon taxable income and not upon profits as such.
I do not, therefore, regard s 3(2) as having a substantive or deeming operation. The applicant's argument based on the former Art 5 seems to me to be unnecessary to reach this conclusion which involves construing the different language of the present Art 9. It seems to me that the words "and taxed accordingly" are included in the text of Art 9(1) so as to make it clear what the relevant Contracting State may do. Section 815-15(1)(c) has effect accordingly. I am not, however, persuaded of the correctness of the applicant's consequential argument that "profits" means that in the present case there can be a net profit position arising from the particular arrangements between the parties. What is being dealt with by Art 9 is profits which, but for the difference between the actual conditions operating and the conditions which might be expected to operate, have not accrued to, here, CAHPL. I therefore do not accept the applicant's submission that there were no profits which accrued to CAHPL.
614 Having rejected the applicant's submissions, primarily submissions as to the proper construction of Art 9 and of Subdiv 815-A, and having considered at [505]-[524] above the evidence of the applicant's main witnesses, I find that the requirements in the *associated enterprises article for the application of that article to CAHPL are met. I also accept the respondent's submission identifying conditions, set out at [582] above. I find that but for the conditions operating between CAHPL and CFC which differ from those which might be expected to operate between independent parties dealing wholly independently with one another an amount of profits might be expected to have accrued but has not so accrued. It follows that the applicant has failed to show that the assessments under the ITAA 1997 were excessive. As I have said, my consideration of these matters is in the alternative to my conclusion as to the assessments made under Div 13 of the ITAA 1936.USD