Taxpayer Decisively Wins Transfer Pricing Case in Commissioner Of Taxation v SNF (Australia) Pty Ltd  FCAFC 74: Full Federal Court Decision
This case considered the application of Australia's transfer pricing provisions in Division 13 of the Income Tax Assessment Act 1936 (ITAA36) in respect of purchases of products by SNF (Australia) Pty Ltd (SNF Australia) from overseas manufacturers that were part of the same worldwide group of companies as SNF Australia.
The Full Federal Court (Court) unanimously held that SNF Australia had proved that the prices paid by it were less than the prices paid by independent comparable purchasers. Thus the Court said those prices were arm's length and SNF Australia's prices did not therefore exceed arm's length consideration. Further, the Court made several comments in relation to the interpretation of Australia's domestic law and international agreements which are discussed below.
In applying our domestic transfer pricing provisions, particularly the requirements of section 136AD(3) of the ITAA36, the Court firmly rejected the Commissioner's approach in that applying the arm's length principle, SNF Australia must look at purchases in identical circumstances – refer paragraphs 101 and 102.
Further, in accepting that SNF Australia had raised appropriate comparable transactions involving the acquisition of the same or sufficiently similar products in the same or similar circumstances, the Court rejected a narrower approach to the application of section 136AD(3) which the Commissioner of Taxation (Commissioner) argued was supported, amongst other things, by the OECD's Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD TP Guidelines). This narrower approach may have allowed the Commissioner to apply a profit based method (in this case, the transactional net margin method (TNMM)) or more particularly make a determination of arm's length consideration based on the Commissioner's arguably very broad powers of section 136AD(4) of the ITAA36.
Section 136AD(4) provides a power which the Commissioner has threatened in various transfer pricing audits / reviews. It could potentially allow the Commissioner, where it is not possible or practical to ascertain the arm's length consideration with respect to an international transaction (including because of an insufficiency of information available), to deem an arm's length consideration to be applicable as per the Commissioner's determination. The Court rejected the need to apply section 136AD(4) in these circumstances and generally accepted that there may be more than one arm's length price. However, it was held that the taxpayer had demonstrated that the prices paid were arm's length or less than arm's length prices and thus it had absolved itself of the burden of proof and effectively rendered the Commissioner powerless in pursuing adjustments under sections 136AD(3) or (4).
The case concerned the deductibility of purchases by SNF Australia which was a wholly owned subsidiary of SPMC SA, formerly SNF SA (SNF France) a company resident in France. SNF Australia carried on the business of manufacturing and selling products (commonly called "flocculants and coagulants") to end users in the mining, paper and sewage treatment industries in Australia. During the years 1998 to 2004, SNF Australia purchased its supplies, at a price of some $71 million, from other subsidiaries that were resident in France, the USA and China. SNF Australia sustained trading losses in most income years between 1991 and 2004, except in 1995 and 1997, when small accounting profits were made.
Following an Australian Taxation Office (ATO) transfer pricing audit of SNF Australia, the Commissioner in March 2007 made determinations pursuant to the Australian transfer pricing provisions with respect to the prices paid for the acquisitions from these subsidiaries and issued notices of assessment with respect to the 1998 to 2000 and 2002 to 2004 income years.
AUSTRALIAN TRANSFER PRICING PROVISIONS
Generally, the transfer pricing provisions in Division 13 of the ITAA36 allow the Commissioner to adjust the consideration taken to be received or paid by a taxpayer where the consideration for a supply or acquisition of property under an international agreement is not an arm's length amount. For the purposes of these provisions, the arm's length consideration for a supply or acquisition of property is that which might reasonably be expected to arise under an agreement between independent parties dealing at arm's length with each other in relation to the supply or acquisition.
In the context of purchases of goods by an Australian resident company, the transfer pricing provisions are effectively concerned with arrangements that result in the shifting of taxable profits to an overseas related party as a result of the Australian company purchasing goods from the overseas related party at an inflated price (or rather, at a price that exceeds the arm's length consideration).
Australia has double tax agreements (DTAs) with France, the USA and China and each of these DTAs addresses the transfer pricing issue by providing for pricing as if the transactions had been between independent parties. This article is generally similar to that contained in Article 9 (Associated Enterprises) of the OECD Model Tax Convention for the Avoidance of Double Tax with respect to Taxes on Income and Capital (Model Law).
In June 2010, the Federal Court (Middleton J) in SNF (Australia) Pty Ltd v FCT  FCA 635 held that transfer pricing determinations made by the ATO could not stand and that SNF Australia had satisfied the burden of proving that the amounts it had paid for products from the suppliers had been acquired at arm's length consideration.
After evaluating expert evidence given by both parties, the Federal Court concluded that on the basis of the comparable sales methodology, the actual prices paid by SNF Australia for the acquisition of the products were in fact lower than the large majority of prices paid by purchasers in comparable transactions on a global basis over a similar period.
In relation to the fact that SNF Australia had incurred sustained trading losses over the years in question, the Federal Court said that this was irrelevant to applying the test of whether arm's length consideration had been paid in respect of the acquisitions.
DETAILS OF THE FULL FEDERAL COURT DECISION
The Court considered a number of significant issues which are discussed in detail below.
SNF Australia prepared three sets of comparable transactions to support its position that it had paid arm's length consideration. The first set, prepared by the SNF Group, consisted of five specified foreign companies; the second set, a group of Australian and New Zealand companies; the third set, prepared by an external adviser, was a larger group of 21 companies.
The Commissioner contended that all the sets of comparables were not appropriate to determine an arm's length price for Australian transfer pricing purposes. However, the Court rejected the Commissioner's submissions and held that the first set and a modified version of the third set of comparables were appropriate in determining an arm's length price, with the key reasons being:
For the first set of comparables, the Court was satisfied that SNF Australia and the five chosen companies were all distributors (as opposed to end-users) of the products acquired from the SNF Group;
The Court also accepted the comparability analysis undertaken SNF Australia's expert witness, which was based on the five comparability factors set out in the OECD's TP Guidelines which supported the comparables used in the first set. The OECD's comparability factors were: the characteristics of the property in question; the functions of the proposed comparables; the contractual terms and conditions on which the comparable transactions took place; the economic circumstances of the markets in which the transactions occurred; and the business strategies of the respective parties;
- A key factor accepted by the Court was the existence of a global market for the products purchased by SNF Australia. Importantly, the existence of that global market meant there was nothing preventing the taxpayer from using companies and transactions from different countries as comparables for transfer pricing purposes;
- The Court held that the second set of comparables was not appropriate to determine an arm's length price since SNF Australia did not establish that the companies were in the same business as SNF Australia (in particular, as distributors);
- For the third set of comparables, which was based on the individual products sold by SNF France, the Court held that approximately half of the compared companies were not comparable because their status as distributors had not been established. Nonetheless, the Court was satisfied that the remaining companies were comparable and the price analysis for these companies demonstrated that SNF Australia generally paid lower prices than the comparables.
On this basis, the Court was satisfied that there were appropriate comparables available to determine an arm's length price for the products purchased by SNF Australia. Accordingly, the Court rejected the Commissioner's submission that a different transfer pricing methodology, in particular the TNMM, was required to be applied in these circumstances.
Statutory interpretation - use of OECD TP Guidelines and other extrinsic materials
The Commissioner relied on the OECD TP Guidelines as support in respect of its submissions relating to arm's length consideration. The Court held that the Guidelines were not a legitimate aid to the construction of the DTAs for the following reasons at paragraphs 116 to 118:
117. There was no evidence that any of the States in question had adopted the practice of applying the guidelines to any of the circumstances in which Article 9 of the Model Law might obtain in their jurisdictions. It must therefore follow that they may not be examined. This conclusion, it should be emphasised, should not foreclose any future attempt to demonstrate that the guidelines do, in fact, evidence State practice.
118. The guidelines are not a legitimate aid to the construction of the double taxation treaties."
Further, the Court rejected the Commissioner's submissions that the OECD TP Guidelines could be used to assist in the interpretation of the domestic transfer pricing provisions (ie Division 13). In this regard, the Court held at paragraphs 118 and 119:
119. Where, however, the domestic provisions are obscure or unclear then it would be unsound not to attempt to resolve that ambiguity in a way which is consistent with Australia's obligations."
However, the Court noted that it was appropriate to interpret domestic law (ie Division 13 of the ITAA36) in accordance with the ordinary principles governing the interpretation of DTAs where Parliament incorporated the whole text of a DTA in domestic law. The use of the DTA by the Parliament indicated its intention to fulfil its international obligations (refer to paragraph 119). However, the Court stated that the domestic transfer pricing provisions did not adopt and apply the whole text of the DTA.
The Court does not expressly discuss the use of the Model Law, its commentary and its role in interpreting DTAs and domestic law. However, the Court notes that the interpretation adopted in respect of the domestic transfer pricing provisions is consistent with the Model Law and its commentary (refer to paragraph 122).
Although not raised as an issue on appeal, the Court agreed with Middleton J the fact that SNF Australia had incurred sustained trading losses over the years in question was irrelevant in determining the arm's length consideration for transfer pricing purposes.
The key conclusions from this case may be summarised as follows:
- It is our view that the Full Federal Court's decision provides a clear and cogent analysis of the relevant tax issues, in particular, the interpretation of Australia's domestic transfer pricing provisions and the relevance / application of international tax agreements, commentary and other guidelines on their interpretation.
- As a starting point, domestic provisions should not be interpreted as if it were an international agreement. However, where the domestic provisions are obscure or unclear then the ambiguity may be resolved in a manner which is consistent with Australia's international obligations.
- It is appropriate to interpret domestic provisions in accordance with the ordinary principles governing the interpretation of DTAs where the Australian Parliament incorporated the whole text of a DTA in domestic law.
- The OECD TP Guidelines are not a legitimate aid to the interpretation of DTAs or Australia's domestic transfer pricing provisions.
- So long as appropriate comparable transactions are available, an analysis of relevant comparables (e.g. the 'comparable uncontrolled pricing' method) is an appropriate method to determine an arm's length price for transfer pricing purposes.
- If there is a global market for the relevant product or service, taxpayers may use comparables from countries and regions other than Australia in determining an arm's length price.
- When identifying appropriate comparables to determine an arm's length price for transfer pricing purposes, the selected entity comparables should carry out similar activities to the taxpayer (i.e. have 'functional comparability' with the taxpayer).
- In view of the 4:0 judgement (including the three judges of the Full Federal Court and the single judge of the Federal Court) against the ATO to date, the decision further suggests that certain approaches to Transfer Pricing analysis and law that the Commissioner has been propagating in recent years (e.g. acceptable transfer pricing methods and approaches, prescriptive documentation requirements and section 136AD(4) powers), may not be as settled and supportable at law as the Commissioner would like us to believe.
- Finally, at this stage it is not clear whether the ATO will seek special leave for an appeal to the High Court. Although the case was a unanimous decision of the Full Federal Court, the ATO may be attracted by the significant precedential value in obtaining a High Court decision on the transfer pricing issues raised in the case. However, in view of the unanimous decision (of the Full Federal Court and the earlier Federal Court decision) against the ATO to date, it is questionable whether special leave to appeal would be granted by the High Court (the highest court in Australia).
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