The following transcript has been lightly edited for clarity. The original interview can be heard on The LCN Legal Podcast here.
Paul Sutton: Hi Andy. It's an absolute pleasure to have you on this podcast. So many thanks indeed for sparing the time. We're going to talk about three cases today: Pepsi, Singtel and Mylan. So let's just dive right in and start with Pepsi. Maybe you can give us the overview as to what the case involved and what we know about it.
Andy Bubb: Yeah, perfect. Absolutely happy to, Paul, and thank you for having me on the podcast. It's good to see you again. So, maybe a little bit of background first on the Pepsi case in Australia and talking about Australia's Diverted Profits Tax. So Australia introduced that tax in 2017 and there's a few administrative aspects of that tax that make it a little bit unusual. And it's worth just walking through a few of those first because it highlights why these cases come to the courts. When the DPT was introduced in Australia, a lot of the messaging was around it being something of a stick. So really something in terms of a tax that could bring multinationals to the table faster with the ATO, in dealing with transfer pricing disputes. And the way that it did that was through a few of the features that it has.
One is that it's a 40% tax, whereas the corporate tax rate in Australia generally is 30% for companies. The tax is also payable upfront when the taxpayer gets the assessment. And that's unusual because normally in Australia, if there's a tax dispute, only half of the tax is often paid upfront. And normally there's an arrangement with the tax office to pay half and defer half while the dispute happens. Whereas with the DPT, you need to pay the whole amount effectively immediately. It's within 21 days of getting your assessment.
The next thing that happens under our DPT is there's a twelve-month review period. And in that window, a taxpayer needs to provide the ATO with all of the evidence that it thinks shows that it's not liable for the tax. And the way that that rule works is: if the taxpayer doesn't provide certain information to the ATO in that twelve-month window, they then can't use that information in any later court proceedings. Now there's a couple of carve outs. So one example is, if you give information to the ATO and later you want to use an expert in the court case, then you can get an expert opinion in relation to that information you gave to the ATO. So the expert opinions are new information you're allowed to use, but apart from that, and apart from getting permission from the court to be able to rely on information you didn't give to the ATO, you otherwise can't use that information you didn't hand over.
So that's another way that this DPT really forces taxpayers to come to the table and engage with the ATO and provide information.
PS: Got it. It sounds like it's very much a deterrent. So a big stick to help encourage compliance with transfer pricing rules and related provisions.
AB: Yeah, absolutely it is. And it was messaged that way publicly when it was introduced through the explanatory memorandum process and so on, as that being one of the goals of this legislation. And – like some other legislation in Australia, like the multinational anti avoidance law that came before the DPT – really one of the goals of this legislation was not for the actual tax to apply to lots of different groups. But it was to encourage groups to change any aggressive structures that might have been caught by these taxes into something that was more palatable. And so while that was the goal, here we are with the DPT case, which we possibly didn't expect. I might just touch on a couple of the technical rules as well before we dive into it, because it'll help the listeners to understand why particular points are relevant in the case.
Australia's DPT has a purpose test, and having a purpose test is a bit of a hybrid in this context. Looking at diverted profits, it obviously involves elements of economics that would be normal analysis under transfer pricing rules. But then the purpose test is like something out of a General Anti-Avoidance Rule. So it's a bit of a hybrid in that sense, with the purpose test applying. But the purpose test applies in an interesting way that's different to some of our other tax legislation in Australia. One of the interesting points is that it applies a principal purpose test. Now, our General Anti-Avoidance Rule applies a dominant purpose test. And so the DPT purpose test is lower. It means that in arrangements where there's a tax purpose and some other commercial purposes, the DPT can still apply if the tax purposes are principal, not dominant. You might ask how low is that bar? Is principal much lower than dominant? Is it way lower than dominant? It has never been considered yet by a court, and we're about to find out in Pepsi.
PS: Right, exciting. So should we move on to the facts or what we know about the facts?
AB: Yeah, and interesting to touch on what we know about the facts. So the Pepsi case is due to be heard soon in Australia. We're a couple of weeks out from the hearing and it's scheduled to be heard for ten days. And the relevance of the case not having yet been heard is that the information that's available in the public domain is still a bit limited, but there is some information based on the court filings. So the transaction that is at issue involves Pepsi entities that are located in the US, in Singapore and in Australia, and those entities entered into agreements with a bottler in Australia, and that entity or group is called Schweppes in Australia. Schweppes is owned by the Asahi Beverage Group. The specific transactions that are at issue involve the arrangements around the concentrate being sold by Pepsi into Australia, being sold to the Schweppes third party entity. And the court case will focus on those agreements and, in particular, what rights were exchanged and what's being paid for under those agreements.
And from what we can tell from the filings that have happened so far, the Schweppes Australia entity makes payments to Pepsi in Singapore for use of certain IP and other concentrate that it acquires to be able to bottle the concentrate and sell it in Australia. And the ATO’s concern is with what those payments that are being made to Pepsi Singapore are payments for, and specifically whether there's a payment being made for any IP and therefore a royalty being paid. And the reason the ATO is interested in that, it's possibly twofold. First, there's a 10% Royalty Withholding Tax on payments that are made from Australia to Singapore. And in the court documents that have been filed, the ATO is asserting that no Royalty Withholding Tax was paid here under these contracts. Now, that might be because the contracts didn't draw a distinction between what a lump sum was paid for in these circumstances, and so it didn't draw a division to say ‘These are all of the different rights that are being obtained by Schweppes in Australia’. So it might have said that Schweppes Australia was being given a bundle of rights and in return for that was paying a lump sum amount. I think the ATO's assertion here is that there wasn't a clear IP being provided and royalty being paid in return.
Now, all of that is a bit unclear based on what we can and can't see so far in the filings, but the case is listed for ten days. So there'll be quite a lot of analysis around exactly what was contained in those contracts in terms of rights and obligations, what exactly was being paid for, and also what activities exactly were happening in Australia in connection with the IP that either was or wasn't being provided and used.
PS: So does it look like the main focus of the case is Withholding Tax as opposed to transfer pricing? Because the way I understand it, it's actually about payments between unconnected parties. The Schweppes group is not controlled by the Pepsi group, it's an entirely separate enterprise or separate group. And it looks like it's about the character of those payments from Schweppes in Australia to the Pepsi entity in Singapore for a bundle of rights.
AB: Yeah, that's right, Paul. So there's really a couple of ways of looking at it. There is that third party transaction, and the question goes to whether or not a royalty should be paid. And given that the DPT has been applied, it's probably been concluded that no Royalty Withholding Tax is actually payable under the primary Australian provisions. And so it's been arguably avoided and that's why we land in these provisions. For the DPT to apply, there does need to be arrangements between an Australian entity and its foreign affiliates. And so the way that that requirement is probably triggered here might be by looking at what the arrangements are between the different Pepsi entities. So even though the transaction that's being focused on here is one between third parties, there might also be focus in the case on what the arrangements are between, say, Pepsi in the US (in terms of Headco) and what arrangements it has down the line with Pepsi Singapore, and then what arrangements they have in Australia with Pepsi Australia.
So that will come into play as well, we expect, because there ordinarily would be some sort of division of who holds what IP, who performs what functions in relation to that IP within the Pepsi group around the world.
PS: In other words, just in my simplistic way: so there's one question about the character of the payments and Withholding Tax and so on, in terms of elements relating to royalties. The other question is who should the counterparty to that arrangement with Schweppes have been? Is it appropriate that it was the Pepsi entity in Singapore? Or should it be the combination of that and other entities receiving the benefit of those payments, for want of a better term?
AB: Exactly right. And these cases are hard because when you look for comparable arrangements between independent third parties in relation to use of IP, it's inherently difficult. Because I don't know the Pepsi group, but presumably their formula is a very tightly held piece of IP. How do you work out what the arrangements might be with an independent third party, and therefore how do you reflect that between the US and Singapore and Australia? So the case will be really interesting from that perspective because there are different layers to this analysis. There's the Pepsi internal arrangements, and then the transaction with a third party on top of that as well. But all of these issues in relation to the use of intangibles, cross-border licencing of IP, they're obviously arising here in a DPT context, but clearly very relevant to normal transfer pricing analysis, as well as other provisions like the standard Royalty Withholding Tax provisions in Australia. And other countries too.
PS: Yeah, absolutely. And one of the interesting things for me in speaking to someone like you, a tax litigator, is we probably look at transactions ten years apart. In other words, I'm looking at things trying to create the arrangements in advance of the relevant periods during which they're being operated. And you're looking at it maybe ten years down the line when not only has the challenge happened, but they've been unable to resolve the dispute and therefore you are helping to resolve. The kind of issues that you're talking about – basically unbundling the bundle, or deconstructing the bundle when it comprises physical products like the actual concentrate itself knowhow, brands, maybe the whole marketing method. If there are similarities with the Coca Cola arrangements, then it will be fascinating to see how that is looked at by the court.
AB: Yeah, it will be. And maybe taking up your point on looking at arrangements ten years down the line. It is an interesting feature here of the DPT that this Pepsi case concerns, I think, the 2018 and ‘19 years or around that sort of time. So we're looking about five years ago, which in a disputes context – we'll talk about Singtel and Mylan in a minute, but those other cases concern transactions that happened 15 years ago or 20 years ago. So, in part, this taxpayer is at least thinking about transactions that only happened a few years ago, and can hopefully find the documents for around that time to be able to put this case together in a relatively easy format. As compared to maybe the more traditional tax dispute that might take five additional years on top of that.
PS: Yeah, absolutely. So I guess with the Pepsi case, it's a little bit early in the journey of the dispute to take any kind of action points or learning points from it. Is there anything that you particularly highlight at this point?
AB: Probably the key point to highlight is that the case is going to be running about two weeks’ time, which, unfortunately for your listeners, means that they might know about it by the time they're listening to this! I think a couple of the things we mentioned on the way through there, the DBT has a principal purpose test and it will be really interesting to see how that's applied. That test is a new test that was introduced in Australia with this legislation. So, for example, the General Anti-Avoidance Rule has a dominant purpose test. So we know that this is a lower bar. How much lower? We'll wait and see what the court says.
But initial cases like this one for a new set of legislation are very interesting for how the ATO will go about its compliance programme for all of the other cases where it's thinking about applying DPT, or might have already issued DPT assessments. So any taxpayers that are in that space will obviously be watching this case go through and waiting to see a judgment as well, because that'll really inform whether they feel quite good or quite bad about their cases, seeing where this one goes.
PS: Yeah, excellent. And I guess from my perspective, in terms of designing transactions in advance, we often talk about legal anchor points. In other words, we need to map the transfer pricing analysis onto the way that the group actually interacts with the outside world: which entities are granting licences or receiving licences or making supplies or receiving supplies and so on. But what this case really reminds us all is that those anchor points are not set in stone, as it were. It's not a given. And groups do need to think about their supply chains and the routing of third party transactions so that it stacks up from an overall transfer pricing and value chain perspective. and hopefully minimise the risk of challenge.
AB: Yeah. And another reminder that this DPT gives to groups who have done transactions and might have done it in the most perfect way that you just described: if they did that in 2016, the DPT hadn't yet come along and our DPT in Australia can apply to structures that were already in place before the implementation of this law. So it does remind you that you need to reassess from time to time, because with any significant legislation you do need to cross-check whether historical structures get grandfathered or whether they might be subject to new laws that are introduced.
PS: So let's move on and talk about the Singtel case. Andy, would you mind just giving us an update on the story so far?
AB: Sure. So I think, Paul, you might have had a previous episode that covered some of the Singtel case, so I won't go through the whole first instance decision in detail, but the case is a related party financing case. It's a TP dispute, and it concerns intragroup debt that the Singtel group put in place around the time of acquiring the [Cable & Wireless] Optus telecommunications business in Australia. Now, we've just spoken about how long ago some transactions happened that are still in dispute. The acquisition of Optus was way back in around 2001, 2002, and so we are 20 years on since that time. The years that are in question here are sort of the back years from the financing that was put in place then. So around the 2009, ’10, ’11, ‘12 sort of range. And of course, the case has already gone through the Federal Court, where the taxpayer lost at first instance.
So the ATO challenged the interest rate that was charged on that debt. It was inbound debt to Australia; the ATO challenged the interest rate, arguing that it was too high based on arm's length comparables. And, interestingly, both parties had sought to rely on expert evidence in the Federal Court, and led significant amounts of expert evidence, both on credit ratings and on what the credit rating therefore meant for what margin should have been charged on the loan.
Like some cases that had gone before – including Chevron in Australia, where a whole lot of the expert evidence was essentially thrown out – the Federal Court at first instance here also rejected large aspects of the expert evidence that was put, and essentially landed on the arm's length interest rate being the one that the parties actually adopted when they first implemented the arrangement back in 2002. The parties put in place a 1% margin when they did the transaction. There were then amendments to the loan agreements over time and the interest rate moved around as a consequence of those. But the court looked at the experts’ reports, each party challenged aspects of the other side's expert evidence, and where the court ultimately landed was that the arm's length interest rate that independent parties might have been expected to charge in the circumstances was the 1% margin that the actual Singtel Singapore and Singtel Optus in Australia actually charged when they put the transaction in place.
PS: I think it was December 2021 was the first instance decision, wasn't it? So what's happened since then?
AB: So there was a judgment then, and there was then a subsequent judgment that was in either February or March in 2022 last year, so about a year ago, which clarified some of the arguments that were unresolved from the first instance judgment. So that first judgment set out all of the principles: the judge’s key findings and so on. And he then ordered the parties to deal with a couple of consequential issues, which they did reasonably quickly. And there was that other judgment that was issued a few months later. Singtel then appealed and so after filing that appeal, it would then have needed to crystallise what arguments it was going to make on appeal. And that case is now set down to be heard for four days in April, so we're getting relatively close to that appeal being heard.
Four days is a relatively long time for an appeal. Often in tax matters, the appeal is often narrower substantially than trials are. It's not usually much or any evidence that needs to be put in for an appeal. It's normally legal argument on a couple of particular points. And so maybe it might take a day of the court's time, sometimes two days of the court's time, but this case is down for four days of hearing the appeal. Which probably reflects that some of the principles in the case are relatively contentious, and also that there's quite a few.
So some of the key findings at first instance were in relation to parent company guarantees. So the court concluded, based on all of the evidence that was before it, that it might be expected that there would be a parent company guarantee in relation to this loan. So if Singtel in Australia just went off to the market needing a loan, the court concluded that that loan would have been guaranteed by its parent, with the obvious consequences for the rate: the company's rating being much higher and the interest rate being much lower as a consequence. That got a lot of airplay in the judgment, and so you'd expect that Singtel would be raising that as a key point in their appeal.
And a related issue that arises is: if you're going to assume that there's a parent company guarantee, under the hypothetical where you're assuming that the parties are all independent of one another, then there's a related question about whether you should assume that there's a guarantee fee that Singtel in Australia would pay to Singtel Singapore in return for getting the guarantee. I don't know, maybe that adds another day to the four-day hearing! Or taking a bit of time to work through, because they're not necessarily issues that there's a lot of case law on.
Australia has only had, I think, five substantive transfer pricing disputes ever. Those have happened over the last 15 years or so. But we've had different legislation that's applied through that time, a couple of different sets of laws, and of the five cases, only two of those have been in relation to financing; three have been in relation to goods. So this is only the second case [of its kind]: there's not a lot of case law to point to. And so quite evidence-heavy, and a lot of material for the court and the parties to get through to work out what outcome the court might land on.
PS: OK, so it sounds like it's ‘watch this space’ in terms of what the specific issues to be raised and arguments are going to be and obviously the reaction to that? Any other observations or thoughts from a litigator's perspective?
AB: Well, Singtel is probably interesting because, compared to the Pepsi DPT case, it's more of a pure TP analysis. And so it's probably more likely that some of the consequences from Singtel – particularly around those parent company guarantee points – that those consequences will be relevant for a lot of taxpayers in Australia.
So working out how to price intercompany financing involving Australia and other jurisdictions has been a key issue the ATO focused on for a long time. The ATO were successful in the Chevron case in around 2015, ‘16 and ‘17. And after winning that case, they've had a pretty rigorous compliance programme around the pricing of intercompany loans – both into and out of Australia, but particularly loans into Australia. Australia is a capital-importing country and we have a 30% tax rate. So the ATO is very keenly focused on how much interest is being paid out. And so any of the principles that come out of Singtel will be applied across the whole market presumably, because the case will be, after it's decided on appeal, a full Federal Court authority. So three Federal Court judges, which is only one level below the High Court in Australia.
PS: Great stuff. Well, look forward to hearing all about that. Shall we move on to the last case? So Mylan, and I hadn't heard of this one before you mentioned it, so I'll be really interested to hear the background.
AB: Sure. So as for the Pepsi case as well, the Mylan case has been filed in the Federal Court, but it hasn't been heard yet. And so it means that there's some information that's out in the public domain, but not a lot. But from what we can see, this case concerns both the transfer pricing provisions as well as the General Anti-Avoidance Rule in part 4A. And that's the first time that there's been a court case in Australia which has concerned both sets of provisions. So the ATO is making alternative arguments that either the transfer pricing rules apply or, alternatively, the General Anti-Avoidance Rule applies. And the ATO... in some cases it has run before there have been arguments sort of alluding to the taxpayer's purpose being to shift profits out of Australia, and therefore the transfer pricing rules apply. But it hasn't argued in any of the transfer pricing cases – it hasn't argued expressly – that the General Anti-Avoidance Rule also applies in the alternative. This case is the first time that it is running both of those arguments in the same case.
So to touch on the facts, the case concerns a transaction that happened in 2007. So, a long time ago. Mylan bought a pharma business from Merck. And as part of the transaction, there was a debt pushdown into Australia, and it resulted in the Australia entity being geared up to the thin cap limit, which at that time was 75%. And the ATO's challenge is in relation to some of those interest deductions. Not necessarily all of them, from what we can see, but its main arguments point to the debt levels that the whole global group had after that transaction, which were closer to 50 or 60%. And so the ATO is seeking to knock out the additional deductions that were taken up to 75%. And, as I mentioned, arguing either that the TP rules apply and parties operating independently wouldn't have geared up to a 75% level, they would have only geared up to the global group level. Or alternatively, based on the General Anti-Avoidance Rule, essentially arguing that the dominant purpose of that aspect of the structure was to obtain a tax benefit, being the extra interest deductions that were claimed in Australia.
PS: I see. OK. And what stage is the case at now and what are the next steps?
AB: So, it's been filed only a few months ago, late last year. And there's usually quite a period of time – especially in evidence-heavy matters like transfer pricing matters and anti-avoidance matters – for all of the taxpayer’s evidence and the ATO's evidence to be filed in court. That could take a year or so to occur. It often takes quite a while to work out exactly how much evidence is needed, and to assemble all of that evidence. For matters like this one, it would probably need what we call lay evidence. So evidence just from the business about – I mean, the ACO probably already knows how much debt there was, but to the extent the taxpayer needs to put in any evidence from its business records and so on. As well as gather and put in any expert evidence it needs as well. And in transfer pricing matters in particular, that's very important because the taxpayer will be trying to prove that this level of interest would have been justified between independent parties. And that's a hypothetical test that taxpayers need to get economic expertise on as well.
PS: Yeah, absolutely. And it sounds like there are potentially significant amounts involved in terms of that case, so perhaps it will have legs and we'll all end up with a greater level of learning in terms of how these kind of situations should be managed in the future.
AB: Yeah, I think that's right. And the other point around the Mylan case, because it concerns a transaction in 2007 and a whole range of years through to – I think not quite this year, but it might roll through to 2018 or ‘19 or thereabouts – it spans both sets of the newest transfer pricing rules in Australia. So the current transfer pricing rules in Australia (what we refer to as subdivision 815B) have applied since 2014, and so those rules of themselves have not yet been tested in a court. So it means that the Mylan case is both the first test of the current transfer pricing rules in court, but also the first time there's been a transfer pricing and anti-avoidance case run together. So hopefully it does make it to the end, because there'll be some interesting learnings one way or the other.
PS: Great stuff. Well, thank you very much. We talked about those three cases: Pepsi, Singtel and Mylan. Any key takeaways from your perspective, whether from a purely Australian point of view or from a global perspective?
AB: Yeah, I've got a couple of comments that I thought were Australian-driven when I put them together, but on reflection they're probably things that taxpayers all around the world need to think about in their own jurisdictions. And something you often see as a tax litigator is obviously we're looking at transactions well after they’ve happened.
And so taxpayers are, of course, in the unfortunate position of needing to decide as they move along through transactions and then through dealing with revenue authorities making strategic decisions at all of those junctures, around whether they're asking for tax certainty upfront and trying to get APAs in place or rulings. And the time and cost that's associated in trying to go through those programmes, which may or may not be successful. That's one option.
The other option is belts and braces, and making sure you're very happy with your structure and ready to defend it later if it does come under scrutiny. And we can assure you from Australia's jurisdiction that the ATO is very well resourced. It issues a lot of public guidance for multinationals, and through the justified trust reviews that it does on a rolling basis – for the top 100 very frequently, but the top 1000 taxpayers every couple of years as well – the ATO looks quite closely at material transactions and, does it on a rolling basis. So it does mean for multinationals that you need to be prepared for that routine review. That's possible to do, and you can make sure that you have your ducks in a row, but you do need to stay on top of things.
And back to the point we were talking about before, whether DPT can apply to transactions that were put in place even before that legislation was passed. Even having the perfect ‘transaction bible’ that was prepared at the time and put in the draw to hopefully never be used again. Obviously something like that requires reassessment when there's legislative change, and we're about to see another layer of that in Australia soon, with a multinational tax integrity package that's been announced. And we all know in every jurisdiction that Pillar 1 and Pillar 2 are on the way as well. So that's going to cause a lot more reviewing of existing tax structures, working out what might need to change and having a sufficient level of comfort that what is in place is OK if and when the scrutiny arrives.
PS: Yeah, OK, I guess those points that you made are a common theme across the board as you are flagging. So it's not just looking at transactions as they happen and the unbundling type examples such as Pepsi, it's also the regular review because risk profiles change and therefore reconsidering. Is it appropriate to maintain those structures or do they need to be modified? And also taking the Singtel learnings, certainly from a corporate perspective or legal perspective, which is: when you're making changes it's to document the rationale for those changes as much as you can, or as far as reasonably possible, so that you do have a paper trail for when it's needed maybe ten years later or whatever. So that kind of discipline is clearly key.
AB: Yeah, that's right, Paul. And even regulator views on different areas of law, or their priorities, change as well. The global business environment can move so fast. And these focuses on royalties, for example – because the amount of money that's in the technology sector and crossing borders around the world is now so much higher than it was even five years ago, let alone ten years ago – really brings into focus these things, like the tax treatment of royalty payments. And the Pepsi case is possibly a case that could have existed 100 years ago in relation to manufacturing physical goods and selling physical goods across borders around the world. But there's a renewed focus on intangibles, because of the amounts of money that are tied up in those sectors and crossing borders. And as a consequence, royalties are a hot area to be focused on. And that doesn't just affect the tech companies. It affects everyone else who's paying royalties, or things that are like royalties, as well.
PS: Yeah, absolutely. Well, it looks like we're running out of time on this podcast. Thank you so much, Andy, for sharing your thoughts, sharing your insights with us. It's been an absolute pleasure. Hope to catch up with you again soon and look forward to hearing the updates from the decisions as they come.
AB: Great. Thanks Paul, and look forward to you getting back to Australia sometime soon.
PS: Absolutely. Take care.
AB: Thanks. You too.
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