Currency of Denomination and Credit Spreads Revisited
Chevron and the Australian Tax Office (ATO) litigated a 5-year intercompany loan to Chevron’s Australian affiliate involving US$2.5 billion in principle and an average interest rate near 10 percent. The ATO objected to the approximately US$250 million per year in intercompany interest deductions reducing these to approximately US$130 million. The Federal Court of Australia stated the intercompany policy thusly:
Central to the proceedings is a Credit Facility Agreement dated 6 June 2003 between CAHPL and ChevronTexaco Funding Corporation (CFC) under which CFC agreed to make advances from time to time to CAHPL “in the aggregate the equivalent in Australian Dollars … of Two Billion Five Hundred Million United States Dollars”. Interest was payable monthly at a rate equal to “1-month AUD-LIBOR-BBA as determined with respect to each Interest Period +4.14% per annum” and the final maturity date was 30 June 2008.
The ATO position involved two claims. One was its attempt to recast the loan from Australian dollar to US$. Since interest rates averaged more than 2 percent in Australia as opposed to in the U.S. during this period, this recasting of the terms of the loan would result in a large transfer pricing adjustment. While Chevron objected that the ATO did not have the legal authority to recast the terms, the ATO tried to argue its position on economic grounds. Our review of this litigation notes that the ATO’s position is based on fallacious economic reasoning.
The larger issue was the argument from the ATO that the loan margin should be reduced by 2.7 percent. The Court critically reviewed the expert opinions from several witnesses representing the litigants. The general tenure of the ATO’s expert witnesses was that the appropriate credit rating should be at worst BBB, while the general tenure of the taxpayer’s witnesses was that the appropriate credit rating should be at best BB. One of the ATO’s experts reviewed loan margins in a report that did not properly address credit ratings, while another offered estimates of the credit rating but with questionable assertions as to the ratings translation into a credit spread or loan margin. While our review of this litigation takes no position on the difficult issue of evaluating credit ratings, we offer information on loan margins from Dealscan and on credit spreads from the Reuters corporate bond yield tables. We believe that the value of the expert testimony would have be enhanced by the appropriate use of this information.
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