This article was originally published 5 June 2020.
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 and establishes a legal precedent on the meaning of “associate”, a definition widely used within the tax law including thin capitalisation provisions and withholding tax rules. Furthermore, the decision also has broad application beyond dual-listed structures to stapled structures and joint venture agreements and is relevant to both Australian based entities and multinationals with operations in Australia.
Background
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 [2020] HCA 5.
BHP, the Australian mining multinational 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 $USD87m (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 per cent indirectly owned by BHP Ltd and 42 per cent indirectly owned by BHP Plc. Collectively, BMAG was 100 per cent 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 were 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, which prepared its tax return on this basis. 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. The same tax treatment was not applied however, 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 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 (whether formal or informal), or might reasonably be expected to, act in accordance with the directors, instructions or wishes of the entity or entities (whether those directions, instructions or wishes are, or might reasonably be expected to be, communicated directly or 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).
AAT decision and Full Federal Court decisions
On 22 December 2017, the AAT set aside the ATO’s decision, after finding that BMAG was not likely to follow the directions of BHP Ltd or BHP Plc unless it was in its best interests to do so. The AAT also found that in the event of a disagreement neither company could dictate to the other and that the DLC arrangement did not "abrogate the effective control" of BHP Ltd and BHP Plc by their respective shareholders and directors.
On 29 January 2019, a majority of the Full Federal Court (FFC) found that the AAT had erred by focusing on the powers of directors and on the lack of a relationship of control and subservience. BMAG was held to have been sufficiently influenced by its owners BHP Ltd and BHP Plc, as it was likely to follow their wishes or directions despite undertaking an assessment of its own best interests in deciding whether to do so. Sufficient influence was deemed to be a lower threshold than control as it does not require dominance and subservience or an abrogation of duties by directors. There was also a satisfactory level of sufficient influence between BHP Ltd and BHP Plc owing to the special voting arrangement and obligation to pay matching dividends. The FFC also dismissed BHP Ltd’s argument that it sufficiently influenced BMAG by virtue of its 58% shareholding and therefore BMAG could not be sufficiently influenced by BHP Ltd and BHP Plc jointly and held that the spheres of sufficient influence were not mutually exclusive.
BHP Ltd appealed to the High Court on the grounds that the FFC erred in concluding that a person or entity acts “in accordance with” the directions, instructions or wishes of another entity for the purposes of the Act section 318(6)(b) even if they merely act “in harmonious correspondence, agreement or conformity with” those directions, instructions or wishes. The FFC should have found that to satisfy this test a person or entity must treat that other entity’s directions, instructions or wishes as themselves being a sufficient reason so to act.
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 necessary 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. It 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 A$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”.
It is interesting to note however, 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 per cent 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 A$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 per cent tax in Singapore and less than BHP overall for its UK-owned marketing operation, is currently objecting the ATO’s claims on its marketing hub.
Broad implications for taxpayers
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.
There are likely to be a number of commonplace commercial dealings that now have the increased potential of creating an associate relationship between entities. The decision 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, mutuality of interest and a unified senior executive management team and will be highly relevant to on-going practical application of Australia’s Public Trading Trust rules and related entities/structures/provisions.
This decision also has wide-reaching consequences more generally because the concept of “associate'' is relevant not only to international tax CFC provisions, but a litany of general income tax law measures as well. These include the thin capitalisation rules, debt-equity regime, employee share scheme provisions, certain targeted anti-avoidance rules with respect to prepayments, elements of the share buy-back provisions, non-portfolio interest test and withholding tax rules.
Action required
It is important to note that the High Court’s decision does not necessarily mean that companies with the common boards of directors will automatically be associates of each other because they sufficiently influence each other. Rather, it is important to apply the look through principle and examine, beyond the legal form and tax law, the substance of the relationship.
Taxpayers should consider the manner in which their business arrangements are conducted and the extent to which the High Court’s decision could be applied in ascertaining when parties might be taken to have sufficient influence over one another. If one entity has been accustomed to, is presently obligated to will be reasonably be expected to act in the accordance with the directions or best interests of another entity, these entities may be associates of each other.
When taking a position on issues of potential dispute in Australia taxpayers should also 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.
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.