Huge Chevron Fine Highlights Transfer Pricing Risks
By Lee Sheehan, Head of Tax, Radius
Change is afoot in the international regulation of transfer payments, and recent developments serve as a warning to multinationals that they need to be extremely cautious to avoid hefty fines when structuring these deals.
Transfer pricing — the setting of prices for goods and services sold between legal entities within a corporate group — is one of the top tax concerns for multinational companies. The Organisation for Economic Co-Operation and Development (OECD) and the United Nations Tax Committee have endorsed an “arm’s length” principle in setting transfer prices, meaning that a company should set them at the same level they would use if the other trading party were an outside company rather than part of the same entity. Companies are instructed not to use the pricing “creatively” to avoid taxes in the higher-tax jurisdiction.
In practice, the “arm’s length” rule, which many countries have enacted into law, is hard to enforce. It creates tension between companies, which want to minimize taxes and maximize revenues, and tax authorities, which want to maximize their own revenues.
Taking It to Court
Under pressure to raise money, governments around the world, particularly in North America and Europe, are investing more resources into their taxing authorities to increase audits and enforce violations more rigorously, collecting money on transfer payments they judge as not meeting the standard.
Governments’ increased scrutiny of transfer payments means more uncertainty and risk for companies that use them.
The US IRS has made a significant investment in transfer pricing resources, and is pursuing more cases. In September, Coca-Cola was cited for owing over $3 billion in back taxes resulting from its transfer pricing. Microsoft and Amazon have also been investigated for transfer pricing deals.
A recent ruling in Australia is attracting international attention. The oil company Chevron is being charged $300 million in taxes after losing a case brought by the Australian Tax Office (ATO) in the country’s federal court.
The company created a US subsidiary for its Australian operations in Delaware, where it was able to borrow $2.45 billion at an interest rate of 1.2%. It then loaned the money to its Australian counterpart at 9%. The court said that Chevron used the loan to raise millions in tax-free dividends. Chevron claimed its main purpose was to refinance its Austalian-dollar-denominated debt. It may appeal the ruling.
The ATO is now examining similar Chevron transactions that could cost the company an additional $35 billion.
These cases provide a rare glimpse into the workings of transfer pricing, which is generally hidden from the public unless it is pursued in court. The cases are being closely watched by the international tax and business communities, as they are likely to give Australia and other governments greater confidence in challenging multinationals about tax payments.
More Documentation — Even in Singapore
Singapore, a popular destination for global expansion because of its relative friendliness to business, is also starting to pay more attention to the “arm’s length” transfer pricing rule. This year, the government issued new guidelines that for the first time require transfer pricing documentation. Companies will be required to provide an overview of their structure and pricing, the methods they use to fulfil the “arm’s length” requirement, an analysis of comparable transactions, and more.
While countries vary in their handling of transfer pricing rules, the international trend has been to increase documentation requirements and stiffen penalties for violations.
For more information, watch our webinar Transfer Pricing: Core Issues and Best Practices.