Tax games when independent – yet separate and dependent
When you buy an internet coupon deal from Groupon Australia you are likely to find the receipt says Groupon Zurich. You the customer reside here, the service which you are buying is provided here, Groupon has companies registered in Australia, yet the transaction routed through Zurich. Why?
The corporate income tax rate in Switzerland is 20 per cent, here it is 30 per cent. That might be one reason. Turning to the latest Groupon financial statements, you will find the largest borrowing on the Groupon Australia balance sheet is a loan from Groupon Europe, with no fixed maturity, at an interest rate of 7 per cent.
The question is: Is Groupon Australia really acting in the interests of its own body corporate in Australia or as an agent of the ultimate parent company Groupon Inc?
The latter, a billion-dollar US multinational, borrows at half the price of the subsidiary. You the customer can even borrow more cheaply than 7 per cent for your mortgage.
In its case against Chevron, the Australian Tax Office claims the parent of the US oil giant approved loans that they knew were struck for tax purposes. In this instance, the claim filed before the Federal Court says Chevron’s US treasurer recommended the Australian subsidiary incur a $2.5 billion debt to create “the most tax-efficient corporate capital structure”.
It also claims the company created an entity in Delaware, a US tax haven, for the “sole function” of lending money to the Australian subsidiary. The pleadings say a US-based entity raised the loan at an interest rate of 1.2 per cent. It then allegedly on-lent the money to the Australian entity at an interest rate of 9 per cent, netting Chevron up to $862 million in tax-free payments over five years.
There are hundreds of these deals going on, yet scant resources available to pursue but a handful. The ATO might also wonder if Australia’s largest corporate bookmaker, William Hill Holdings, decided to take out a loan of £334 million ($580 million) from a mysterious company in Gibraltar. Why would the local directors agree to $40 million of pre-profits going to a rock in the Mediterranean?
If the “dominant purpose” of a transaction is not commercial but rather driven by tax, it is fair game for prosecution but until now authorities have been loath to test the proposition of subsidiary acting as undisclosed agent for the parent.
Tom Spencer, a law academic with University of Queensland, has some interesting work in the area. He says it is open to test the presumption of independence and determine that a corporate group can act as a separate entity while being a dependent entity at the same time.
If this is the case, it would be open for the ATO to pursue hundreds of cases, billions of dollars of related party payments, where the subsidiary is really acting in the interests of the parent.
Spencer refers to an English case involving FG Films Limited, a subsidiary of an American company, trying to register a film as being of English origin. The subsidiary had nominal paid-up capital, no staff and no place of business other than its registered office. It was in fact incapable of making films as it claimed. The court held that the subsidiary was acting as an undisclosed agent of the parent.
It is likely the same principle applies when product is being passed through wholly owned subsidiaries incorporated in low-tax countries such as Singapore, particularly when the Singapore government is offering what amounts to subsidies to these Singapore subsidiaries in the form of even lower tax rates than it applies to local companies.
Spencer refers to another judgment in which it was found that the subsidiary had not been maintained as a separate legal entity because the parent had disregarded the corporate boundaries. This situation now occurs in almost all subsidiaries of multinationals. The new multinational corporate governance model is based on delegation of authorities direct from the parent’s board as if both sovereign and legal entity boundaries don’t exist.
One multinational finance expert says there had often been conflicts of interest involving directions from directors and officers of the parent to directors and officers of the Australian subsidiary in the past. However, the CLERP amendments to Corporations Act Law had diluted directors’ best-interest obligations.
“CLERP has facilitated the subsidiary’s ability to benefit its parent. Case law and the evidence of transfer pricing (not necessarily illegal) would seem to support the view that the subsidiary, by engaging in transfer pricing, is in fact acting as undisclosed agent for the parent for the dominant purpose of having the Australian subsidiary avoid Australian income tax,” he said.
When subsidiaries of multinationals are borrowing at far higher rates from their offshore parents than the rate an average householder gets from the bank, it would seem a lay-down misere that the subsidiary is acting in the interest of the foreign parent. There are multinationals borrowing at 9 per cent and more. Yet the principle of subsidiary as agent is yet to be properly tested here in the courts.