Why Australia’s landmark tax ruling against Chevron is a first battle in a global war on profit shifting
At a very high level, it’s a simple concept: a multinational borrows money from a related company overseas, and then uses the interest bill and the repayment methods to reduce tax exposure in Australia.
If the loans – and the interest rates – are big enough, the tax savings can be significant – so much so, that the practice has become a point of mounting concern among policymakers and in the community. But the solutions to it are complicated and run the risk of prompting large companies to overlook Australia as a destination for further investment.
The money involved can run into enormous sums. A scheme used by multinational energy companies to reduce tax in Australia by taking out loans with associated offshore companies runs into many billions of dollars, according to documents lodged with the Senate inquiry into corporate tax avoidance.
Chevron Australia, in its own estimates given to the inquiry, sent a total of $5.15 billion in interest payments to a subsidiary in the US over five years to service loans for giant gas projects, Gorgon and Wheatstone, in Australia’s North West.
For 2014 alone, the funding costs were $1.837 billion. Add to that another $346 million paid in the same year to US affiliates for corporate, IT, insurance and technical services.
A large lump of that money, through careful accounting and planning, sees no tax paid in Australia.
This was seen as a perfectly legitimate way of keeping down the tax bills of very large multinationals operating in Australia and the method has worked for many years without challenge.
However, the system, which uses loans taken out in the US as a tax-free transport system for cash, is in danger of unraveling, sending Chevron and other big operators on deep dives of their books to see whether they can withstand extra scrutiny from the Australian Tax Office (ATO).
The Federal Court has found the scheme, at least in one instance between 2004 and 2008, did not fit the test of an “arm’s length” deal between related companies, which essentially means that it must be commercially viable as if it was done with an independent party.
The money in question is related to the massive $US56 billion Gorgon gas project, the largest in Australian history, which is is due to ship its first LNG early next year from Western Australia, and is the big hope to give Australian exports, hit by falling global prices for commodities, a kick along.
The workings of the scheme, normally reserved for big players and understood only by specialists at the big accountancy firms, were revealed in a long-running court case brought by the ATO against Chevron Australia, which is the operator of Gorgon, one of the largest natural gas projects in the world.
Chevron has 47.3% of the project, while ExxonMobil and Shell have 25% each. Other operators include Osaka Gas (1.25%), Tokyo Gas (1%), and Chubu Electric Power (0.417%).
In the Federal Court, Justice Alan Robertson found the complex lending arrangements in breach of transfer pricing rules and ruled that Chevron’s local company must pay out $322 million in back taxes and penalties.
The ruling is a significant win for the ATO which can now dig deeper into the billions of dollars being generated here by multinationals but moved offshore without local tax being applied.
The ATO, with $86 million in extra funding from a Coalition government which has campaigned against companies avoiding paying tax by using complex offshore schemes, has more specialist investigators working on bringing international companies to account than ever before. ATO staff are also embedded in 30 of those companies, digging up details on sales, expenses, profits and taxes.
Under former Treasurer Joe Hockey, the Coalition made multinational tax avoidance a cause, culminating in September with the introduction of laws to stop multinational companies using artificial or contrived arrangements to avoid a tax in Australia.
Hockey called tax cheats “thieves”. The new treasurer, Scott Morrison, has made it clear he supports the focus on multinational tax avoidance.
And this court win by the ATO has implications beyond the oil and gas industry.
“Others could face the same headache,” according to researchers at the University of Technology, Sydney.
“The recent Federal Court decision suggests significant accounting disclosure implications for large subsidiaries of other multinational companies operating in Australia which have employed similar strategies, and there will be other revelations to follow.”
Tax experts at Deloitte believe the court win may embolden the ATO to pursue transfer pricing audits.
“It is also relevant to note that while the dollars at stake in this case are large, as a consequence of major capital project developments in the resources and infrastructure sectors in Australia in recent years, there are other large funding arrangements in the market, which may now be in the sights of the ATO,” Deloitte says.
The court case, at five weeks, was one of the longest in Australian corporate tax legal history and, with about 10 barristers and 20 witnesses and experts, one of the most expensive, with costs running into millions of dollars.
How it works
At its heart is a system called transfer pricing, where a multinationals claim the cost of producing goods or services when these are sold locally in Australia.
But the key to that is the amount claimed. The higher the costs, the better the tax deduction and the lower the local declared profits. The incentive is to load as many costs as possible onto the local company making the sale.
The case centres on $US2.5 billion in loans arranged by Chevron. Normally, according to evidence in the Federal Court, a 100% subsidiary company would use the good credit rating of the head office company to arrange the best deal, the lowest interest rates possible, on any loan.
However, in this case Chevron Australia setup its own company in the US, Chevron Texaco Funding Corporation, which borrowed money in US dollars at an interest rate of 1.2% but then made an Australian dollar loan at 8.97% to the Australian company, Chevron Australia Holdings Pty Ltd.
This markup had the effect of increasing Chevron’s tax deductible costs, and reducing local profits. It also shifted funds, without being taxed, outside Australia in the form of interest payments.
These interest payments, which also didn’t attract tax when they arrived in the US, then came back to Australia in the form of dividends. Again, these didn’t attract tax under Australian tax rules.
According to evidence in the Federal Court, the US company, Chevron Texaco Funding Corporation, was essentially a shell created for the purpose of raising funds in the commercial paper market and then on-lending those funds to the Australian company. It did no other business.
Chevron argued that the higher interest rate was because of the risk of raising loans written in US dollars and then turning that into an Australian dollar loan for the Australian operation. This put the transaction at a risk of big movements in currencies.
The court didn’t agree.
The judge noted that the proceedings didn’t involve the general anti-avoidance provisions of Australian tax laws. And neither, he said, did they involve any allegation that the loan was a “sham”.
However, the judge did draw on evidence given by current and former Chevron employees, mainly accountants and finance managers.
In court, William Dalzell, a now-retired chartered accountant and former finance and compliance manager at Chevron, agreed under questioning that borrowing $2.5 billion from an independent party at 8.97% would not normally have been sustainable.
The scheme only worked because the arbitrage — the difference between 1.2% and 8.97% — would be received back by the Australian company.
More companies could be drawn in
Dalzell agreed he would have been aware that one of the benefits of the loan being in Australian dollars was to create an interest rate margin, and that the margin would not be subject to tax in the US, and that the dividends coming back would not be taxable in Australia.
This scheme used by Chevron is called a “round robin” by tax expert Antony Ting, an associate professor at the University of Sydney.
He says he’s seen similar schemes, where the money leaves the country and returns as tax free dividends, promoted in the oil and gas industry round the world.
“This possibly is one of the most important tax cases in Australia on multinationals so far,” Ting told Business Insider.
“This structure, which is basically an intergroup loan within Chevron, has its aim to create an interest rate deduction in Australia. We call it profit shifting and base erosion, basically shifting profits out of Australia. There are some very clever tax advisers around.”
Ting expects to see more multinational subsidiaries drawn in.
“This is definitely not a one off,” he says. “It will have significant implications not only for Chevron but for other companies. And most people believe that Chevron will appeal so it is likely to be the beginning and not the end of the case.”
Chevron, the developer of the $80 billion Gorgon and Wheatstone gas projects in Western Australia, is likely to appeal the decision but, at the same time, the ATO is further investigating the company’s tax affairs.
The judgement has been noticed by the Senate economics committee into tax avoidance which is chasing schemes to move revenue offshore from to other countries where the company tax rate is less than Australia’s.
Chevron Australia says it’s reviewing the decision and does not intend to comment further while appeals are being considered. “Chevron abides by a stringent code of business ethics, under which we comply with all applicable laws and regulations in the countries in which we operate,” a spokesman said.
However, Chevron has made a submission to the Senate inquiry. The energy company says the major tax revenue contribution from it to the Australian government will come after completion of the Gorgon and Wheatstone gas projects.
“Given where Chevron Australia is in the investment lifecycle, our current income tax profile should come as no surprise,” Chevron said in a submission to the Senate committee.
“However, once Gorgon and Wheatstone have completed construction and are in full production they are expected to commence delivering significant taxation receipts to Australia over their operating lives.”
In the three years to December 2014, Chevron Australia says it paid more than $3 billion in Federal and State taxes.
The ATO won’t comment directly on the Chevron case, mainly because everyone expects an appeal. “We are currently considering the decision and won’t be commenting at this time,” an ATO spokesperson said.
However, tax commissioner Chris Jordan last month, in a joint press conference with treasurer Scott Morrison, said: “We are presently doing everything we can to ensure multinationals pay tax in Australia on the income that they earn here.”
And part of that is testing the current law, as the ATO has done in the Chevron case, and drawing experience from these cases to provide policy advice to the government.
“I should acknowledge that the majority of corporates do pay the right amount of tax in Australia and are open and transparent in their dealings with us,” said Jordon. “However, there is a minority that try to avoid their obligations and we do act on behaviour that is questionable.”
The ATO is now talking to about 80 multinational companies which will potentially be affected by the new anti-avoidance law which is expected to come into force from January.