Australian High Court clarifies meaning of “associate” and “sufficiently influenced” for tax purposes in international tax dispute
On 11 March 2020, the Australian High Court unanimously dismissed an appeal by mining multinational BHP relating to the use of a marketing hub in Singapore to reduce its tax liability, because under the dual listing structure used by the taxpayer group, all relevant entities were associates. The landmark decision lowers the bar for the “sufficient influence” test, which in this case was held not to require dominance and subservience or an abrogation of duties of directors. A legal precedent has also been established on the meaning of “associate”, a definition widely used within the tax law including stapled structure arrangements, thin capitalisation provisions and private company deemed dividend rules. The decision is relevant to both Australian-based entities and multinationals with operations in Australia.
On 11 March 2020, the High Court of Australia unanimously dismissed an appeal by the appellant taxpayer BHP against a decision by the Full Court of the Federal Court of Australia, and delivered a landmark decision on the “sufficiently influenced” test used in the application of the definition of “associate” in favour of the respondent, the Australian Taxation Office (ATO), in BHP Billiton Limited v Commissioner of Taxation  HCA 5.
BHP, formerly known as BHP Billiton, is the trading entity of BHP Group Limited (BHP Ltd) and BHP Group Plc (BHP Plc), an Anglo-Australian multinational mining, metals and petroleum dual-listed public company headquartered in Australia and listed on the London and Australian Stock Exchanges. In 2001, BHP Ltd and BHP Plc entered into a "DLC Structure Sharing Agreement" (DLC arrangement) that governed their new dual listed company structure and future conduct of their combined businesses. Both companies were required to operate "as if they were a single unified economic entity", through a common board of directors as well as through "a unified senior executive management".
The case concerned the activities of BHP’s Swiss marketing entity BHP Billiton Marketing AG (BMAG) and the assessment of BHP for a reported USD 87m (AUD 125m) in tax on income spanning the financial years ended 30 June 2006 to 30 June 2010. BMAG is a controlled foreign company (CFC) of BHP that during the years relevant to the case was 58% indirectly owned by BHP Ltd and 42% indirectly owned by BHP Plc. Collectively, BMAG was 100% indirectly owned by the "single unified economic entity" of BHP Ltd and BHP Plc. Note: in July 2019, BHP Ltd increased its ownership of BMAG from 58% to 100%. BMAG purchased commodities from BHP Ltd's Australian subsidiaries as well as BHP Plc's Australian entities for sale into the export market at a profit, and maintained a hub in Singapore that facilitated the marketing and trading of those commodities to unrelated third parties.
BHP Ltd and ATO’s arguments
Income derived by BMAG from the sale of commodities purchased from BHP Ltd’s Australian subsidiaries was treated by BPH Ltd as “tainted sales income” and included in the attributable income of BMAG for CFC purposes and ultimately the assessable income of BHP Ltd. Tainted sales income includes the sale of goods by a CFC, where the CFC has purchased the goods from an Australian resident that is also an associate of the CFC. However, the same tax treatment was not applied to the income derived by BMAG from the sale of commodities it purchased from BHP Plc’s Australian entities, on the basis that those entities were not “associates” of BMAG for the purposes of CFC rules in Part X of the Income Tax Assessment Act 1936 (ITAA 1936).
According to the CFC rules, associates of an entity are to be determined in accordance with section 318 of the ITAA 1936, which defines an “associate” of a company (amongst other tests) by reference to whether the company is “sufficiently influenced” by another entity. Pursuant to section 318(6)(b) of the ITAA 1936, a company is sufficiently influenced by an entity or entities if the company, or its directors, are accustomed or under an obligation (formal or informal), or might reasonably be expected to, act in accordance with the directors, instructions or wishes of the entity or entities (including communication through interposed companies, partnerships or trusts).
The ATO argued that BHP Plc’s Australian entities were associates of BMAG, because BHP Ltd and BHP Plc were sufficiently influenced by each other and BMAG was sufficiently influenced by both BHP Ltd and BHP Plc. Therefore, the sales by BMAG of commodities it purchased from BHP Plc’s Australian entities were tainted sales income of BMAG. The ATO issued amended assessments on the basis that BHP Ltd's Australian subsidiaries and BHP Plc's Australian entities were accustomed to act in accordance with the wishes of BHP Ltd and BHP Plc respectively. BHP Ltd objected to its amended assessment, which the ATO disallowed, so BHP Ltd sought a review by the Administrative Appeals Tribunal (AAT), which set aside the ATO’s decision on 22 December 2017. Just over a year later on 29 January 2019, a majority of the Full Federal Court (FFC) found that the AAT had erred, so BHP appealed to the High Court. A summary of both the AAT decision and FFC decision is available on the BDO Australia website here.
High Court Decision
The High Court noted that despite the fact that there was a written contract that outlined the terms of the relationship between BHP Ltd and BHP Plc, forming a contract does not necessarily preclude a finding that one entity sufficiently influences another. Instead, the relationship needs to be objectively considered, based on the facts, to prevent entities from contracting out of being an associate. The High Court unanimously upheld the FFC decision and confirmed that “sufficient influence is not, in contrast to control, necessarily unidirectional”. “Effective control” was not required to establish that a company was "sufficiently influenced" by an entity, which was dependent entirely on the evidence available and involved a consideration of past or present circumstances, the behaviour of the parties, and future expectations.
BHP Ltd and BHP Plc "sufficiently influenced" each other and were associates because they had a common board of directors, were committed to operating as combined businesses and had a unified senior executive management team resulting in their interests being aligned. The common shareholding in BMAG also resulted in coordinated voting by shareholders and obligations on directors to consider the interests of all shareholders, including uniform dividends. The DLC arrangement provided a further obligation on BHP Ltd and BHP Plc to act in accordance with the “directions, instructions or wishes” of the other.
Furthermore the group level documents issued by BHP Ltd and BHP Plc that applied to BMAG supported the conclusion that they "sufficiently influenced" BMAG, which was indirectly owned and operated by the single unified economic entity. The dual-listed structure, common shareholding and group level documents, which facilitated BMAG’s purchase and on-sale of commodities from BHP Ltd's Australian subsidiaries and BHP Plc's Australian entities, also led to the High Court deeming BHP Plc’s Australian entities to be associates of BMAG.
Consequences for BHP and multinationals
As a result of the High Court decision, BHP Ltd was held liable for an additional AUD 87m in tax for income generated between 2006 and 2018. The ATO released a statement on the day of the High Court decision, in which it said the precedent provided clear guidance that would help the ATO in its efforts to ensure that other multinationals paid their fair share of tax, and finalised the dispute over marketing hub profits, which would be “fully taxed in Australia”.
However, it is interesting to note that whilst BHP agreed that from 1 July 2019 that the Singapore arm would be wholly owned by BHP Australia, so that all of its profits would be taxable in Australia, through an agreement that BHP had with the Singapore Government that it would not pay any tax in Singapore, this agreement expires on 30 June 2020. From 1 July 2020, Singapore will charge tax at 11% of the profits of BMAG, and the effect of the Australia-Singapore double taxation agreement means that the Singapore tax payments will be credited against tax payable in Australia. Nonetheless, the ATO continues to target offshore marketing hubs, and its victory in the High Court combined with its enhanced powers developed in recent years through successful transfer pricing cases, a new Diverted Profits Tax and strengthened Multinational Anti-Avoidance Law means that the ATO is likely to further challenge centralised marketing and related hubs in the coming years.
In 2018, BHP settled a separate transfer pricing dispute with the ATO for AUD 529 million, ending a battle over whether the company had been underpaying tax by basing its marketing arm in Singapore. BHP is also now one of at least 15 multinational groups, including Glencore and Rio Tinto, that have been investigated by the ATO in relation to possible tax avoidance facilitated by sales and marketing hub arrangements in Singapore. Rio Tinto, which pays 5% tax in Singapore and less than BHP overall for its UK-owned marketing operation, is currently objecting to the ATO’s claims on its marketing hub.
Broad implications for taxpayers and required actions
The High Court decision lowers the bar for the “sufficiently influenced” test used in the application of the definition of “associate” and distinguishes it from ‘effective control’. While companies with the same boards of directors will not automatically be associates of each other, the relationship between companies and their behaviour needs to be considered to determine if otherwise independent parties have sufficient influence over one another.
When taking a position on issues of potential dispute in Australia, taxpayers should carefully assess the risk of their position against the actual evidence that will be available to the ATO on review. Board minutes, resolutions and decisions should be documented, as they will often be the first point of reference. Companies should also consider entering into contracts containing the terms of existing relationships with other companies, so if a CFC is deemed to exist, then income may be attributed to the Australian taxpayer giving rise to an unforeseen tax liability.
The legal precedent also has broad application beyond dual-listed structures to stapled structures and joint venture agreements, which often have common boards of directors, common economic ownership and mutuality of interest. Furthermore, it has wide-reaching consequences because the concept of “associate'' is relevant not only to international tax CFC provisions, but a litany of general income tax law measures in Australia, including the thin capitalisation rules, debt-equity regime, employee share scheme provisions, anti-avoidance rules with respect to prepayments, elements of the share buy-back provisions, non-portfolio interest test and withholding tax rules.
There has been a potentially significant reassessment of the concepts of sufficient influence and associate which appear throughout the tax law. The ATO is expected to issue a Decision Impact Statement and revise current guidance to provide greater clarity on these issues.