Glencore Investment Pty Ltd v Commissioner of Taxation of the Commonwealth of Australia  FCA 1432
Introduction and Overview
In a major victory for the mining giant, the Federal Court has found in favour of Glencore, and held that the terms operating between the Glencore Australian subsidiary and its Swiss trader parent to calculate the price at which the Australian mine sold its entire copper concentrate production were within an arm's length range.
Importantly, the Court's decision has reaffirmed many of the key principles articulated in the Full Federal Court's 2017 decision in Chevron, and provides much needed guidance to multinationals on their cross-border transactions and transfer pricing issues in an area which is coming under increasing ATO scrutiny. Our previous client alert on Chevron can be found here.
The ATO has issued a statement outlining its intention to consider this decision and whether an appeal is appropriate.
The taxpayer was assessed as the head of a multiple entry consolidated group for Australian tax purposes, of which Cobar Management Pty Ltd (CMPL) is a member. In the relevant years, CMPL, which managed and operated the CSA mine in Cobar, New South Wales, sold 100% of the copper concentrate produced at the CSA mine to its Swiss parent, Glencore International AG (GIAG).
The purchases were historically made under a series of life of mine offtake agreements (i.e. market related arrangements) until 2007. In 2007, CMPL and GIAG entered into a fundamentally different form of offtake agreement known as a "price sharing agreement". Broadly, the copper concentrate was priced by using, as a reference point, the official London Metal Exchange cash settlement price for copper averaged over a quotational period. A deduction was then made from the copper reference price for treatment and copper refining charges (TCRCs) which, for the calendar years 2007, 2008 and 2009, were fixed at 23% of the copper reference price (as calculated) for the payable copper content of the copper concentrate.
The Commissioner issued amended assessments to the taxpayer with the following adjustments:
- adjustments to remove the effect of the 23% price sharing mechanism and to replace it with 50% benchmark/50% spot TCRCs which the Commissioner identified as the "rate previously used by CMPL"; and
- adjustments to reflect the impact of a "consistently applied quotational period".
The Commissioner's primary case that the 2007 Agreement was a non-arm's length dealing which favoured GIAG to the detriment of CMPL, and that an independent mine producer with CMPL's characteristics would not have agreed to price sharing at all or to quotational periods with back pricing optionality and, instead, might reasonably have been expected to have sold its production in the relevant years under a life of mine agreement on market-related terms and limited quotational period optionality with no back pricing.
Division 13 and Subdiv 815-A
- Div 13 applies to substitute an arm's length price for the consideration received for the supply of property or services (or given for the acquisition of such property or services as the case may be) in respect of a taxpayer in a non-arm's length dealing under an international agreement;
- Similarly, in general terms, the purpose and effect of Subdiv 815-A is to substitute an arm's length profit for the non-arm's length profits which resulted from a non-arm's length dealing under an international agreement.
The critical issue for the Court was therefore to hypothesise a reliably comparable agreement not affected by the lack of independence and the lack of arm's length dealing for the purpose of:
- Div 13- determining whether the consideration actually given for the copper concentrate that CMPL sold to GIAG in the relevant years was less than the consideration which might reasonably be expected to have been paid if the parties had been independent and acting at arm's length in relation to the supply; and
- Subdiv 815-A, whether an amount of profits might have been expected to accrue to CMPL if the transaction it entered into with GIAG had been entered into, had CMPL and GIAG not been related and been dealing with each other at arm's length.
Identifying a substitute hypothesis
The taxpayer's submissions
The taxpayer contended that the agreement that must be hypothesised is one for the sale of 100% of the copper concentrate from the CSA mine, under an agreement which is structured on a price sharing basis.
It was submitted that unlike the position in Chevron – where the controlled loan agreement, which was structured without security and covenants, would not have been seen in the market between independent enterprises – the provisions in the 2007 Agreement were observable in contracts between GIAG itself and enterprises independent of it, and there was nothing to suggest that those counterparties were acting other than in a commercially rational manner.
The Commissioner's submissions
The Commissioner, on the other hand, argued that the 23% price sharing term and the quotational period optionality provisions in the 2007 Agreement were "simply integers in how the consideration receivable by CMPL from GIAG ... was to be calculated", and that the statutory questions to be addressed are: what might reasonably have been expected to have been agreed between independent parties having relevant attributes of CMPL and GIAG as the price of (the consideration for) the copper concentrate (Div 13); and what financial conditions might have been expected to operate between those parties as to the price of the concentrate (Subdiv 815-A).
The Commissioner argued that to resolve the statutory questions under Div 13 and Subdiv 815-A, the Court must therefore determine what terms as to the price of the concentrate – which included freight, TCRCs, price participation and quotational periods – might have been expected to have been agreed between independent parties.
It was submitted that the evidence did not support a finding that it might reasonably have been expected that CMPL would have sold its copper concentrate to GIAG on the same or similar terms to the actual agreement, had CMPL and GIAG been independent and dealt with each other at arm's length in relation to the supply.
Was the arrangement arm's length?
The Court held that the price sharing arrangement was on arm's length terms (both for Division 13 or Subdivision 815-A purposes). Importantly, Davies J made the following observations:
- The decision in Chevron, makes it clear that the hypothetical should be based on the form of the actual transaction entered into between the associated enterprises but on the assumption that the parties are independent and dealing at arm's length, in order to identify a reliable substitute arm's length consideration for the actual consideration given or received. The Commissioner's approach impermissibly restructures the actual contract entered into by the parties into a contract of a different character;
- The 1995 OECD Guidelines also state that in the examination of whether a "controlled transaction" satisfies the arm's length principle "in other than exceptional circumstances", the actual transaction should not be disregarded or other transactions substituted, and that restructuring of legitimate business transactions would be a wholly arbitrary exercise the inequity of which could be compounded by double taxation created where the other tax administration does not share the same views as to how the transaction should be structured;
- Instead, any reconstruction is
limited to the two "exceptional circumstances" referred
to in the 1995 OECD Guidelines, namely:
- where the economic substance of the transaction differs from its form; and
- where, while the form and substance of the transaction are the same, the arrangements made in relation to the transaction, viewed in their totality, differ from those which would have been adopted by independent enterprises behaving in a commercially rational manner and the actual structure practically impedes the tax administration from determining an appropriate transfer price.
- The present case is not a case falling within either of the exceptions referred to in the 1995 Guidelines. The economic substance of what the parties transacted does not differ from the legal rights and obligations created by the 2007 Agreement and there was no suggestion at all that tax considerations shaped the terms of the Agreement such that it can be said that the totality of the terms derived from the relationship of the parties and "the actual structure practically impedes the tax administration from determining an appropriate transfer price";
- The 2007 Agreement was a form of agreement seen in the commercial market between independent enterprises in the relevant years and, the price sharing methodology adopted by the parties under that Agreement was a recognised, legitimate and an accepted way for copper concentrate to be priced.
- While the decision deals with the very special circumstances of the sale (and processing) of minerals (copper concentrate), it also provides highly useful guidance in determining arms-length consideration or arms-length profits across a broad range of international transactions and industry sectors, including focus transactions for ATO like intra-group debt, Intellectual Property rights and distribution/marketing arrangements.
- A key on-going aspect of applying Australia's transfer pricing provisions will be evaluating a hypothetical arrangement (or comparable hypothetical agreement) for the purpose of ascertaining the arms-length consideration; fundamentally a factual enquiry into what might reasonably be expected to have been paid or received by way of consideration.It is critical that the comparable hypothetical arrangement is explored on the basis that the relevant parties and actual arrangement had been unaffected by the lack of independence and the lack of arms-length dealing.
- Most importantly (separately to this decision), for current and prospective transfer pricing risk management and planning, Sub-division 815-A was replaced by Sub-divisions 815-B to 815-E which are Australia's principal Transfer Pricing Laws operative for income tax years commencing from 1 July, 2013.
- Section 815-130 (in Sub-division
815-B) includes a specific transfer pricing reconstruction
provision which empowers the ATO to reconstruct or disregard actual
transactions, where these are not considered to be arm's length
and to replace them with arm's length conditions where;
- firstly, the form and substance of the actual commercial or financial relations is inconsistent,
- secondly, independent multinationals would not have entered into these relations and would have entered into alternative commercial or financial relations, or
- thirdly, independent entities would not have entered into commercial or financial relations at all.
These are significant powers available to the ATO which we can expect the ATO to rely more heavily on in the context of and following this Glencore decision.
- The ATO has readily recognised that Davies J. of the Federal Court rejected key aspects of its interpretation of Australia's Transfer Pricing Rules (Division 13 and Sub-division 815-A) as applicable to the relevant years of income ie. years ended 30 June 2007, 2008 and 2009. Senior Officers of the ATO, including Deputy Commissioner Jeremy Hirschhorn and Deputy Commissioner Jeremy Geale, have recently been re-emphasising the ATO's focus on multinational tax avoidance, on ensuring multinationals have arm's length dealings with their Australian entities and that transactions are fairly priced and multinational companies do not underpay tax in Australia.
- Given the precedential value and the material tax in dispute, we would expect that the ATO would likely appeal this case which is due on or before 1 October 2019. However, if the case does not go on appeal we would expect that the ATO would issue a Decision Impact Statement on the decision and perhaps some form of taxpayer guidance for example, a Practical Compliance Guideline dealing with technical and practical issues associated with the Case.
- Given the Court's strong view on why form and substance were aligned in these circumstances for Glencore (including why the price sharing model was acceptable), we would expect that the decision will have important consequences for other areas of tax analysis dealing with Form v Substance including, amongst others, Australia's Hybrid Mismatch Rules (including the Integrity Rule). Multinational Anti-Avoidance law, Diverted Profits Tax and our Double Tax Treaties/Multilateral Instrument (including the principal purpose test).
- Each of the ATO and Glencore relied on expert witnesses covering mining, financial and accounting experts however, Davies J. was clear in stating that the decision did not turn on preferring the evidence of one expert over another.She reminded the Court of the importance of the accuracy, reliability and objectivity of such experts and their opinions and the importance of not straying into or making comments on matters which they were not qualified to give.
- The examples of various offtake agreements (provided by Glencore) between independent mine producers and traders for the sale of copper concentrate containing price sharing mechanisms and/or quotational period optionality clauses (including back pricing) were well regarded, despite the ATO's views on these agreements.
- Finally, it is noted that the decision also dealt briefly with certain aspects of the interaction of Australia's Tax Consolidation Rules (Single Entity Rule) and our Transfer Pricing Rules.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.