The Federal Court of Australia ("The Court") released its decision in the case of Glencore Investment Pty Ltd v. the Commissioner of Taxation on September 3, 2019. The case relates to the price paid for copper concentrate mined in Australia by Glencore and sold to its Swiss parent in the 2007, 2008 and 2009 years. The amended assessments issued by the Australian Taxation Office (ATO) increased Glencore's taxable income for the three-year period by more than A$240 million. Significantly, the amended assessments were issued under Division 13 and Subdivision 815-A of the Australian transfer pricing legislation, both of which were repealed and replaced by Subdivision 815-B with effect from 29 June 2013.
Glencore has owned and operated the Cobar copper mine since 1998/1999. Glencore had a series of mine offtake agreements over the years whereby the copper concentrate extracted from the mine was sold to Glencore's parent entity in Switzerland. The terms and conditions of the offtake agreements, structured as a "market-related" agreements, were varied from time to time. In February 2007, the offtake arrangements were revised, and a new "price sharing agreement" was entered into. A price sharing agreement uses the London Metals Exchange commodity price, adjusted for a price-sharing percentage, as the basis for the transfer price. Subsequent market events meant that, in the view of the Commissioner, the returns derived by Glencore under the new price-sharing agreement were less than the returns it would have derived if it had retained the original market-related pricing method or had negotiated different, more appropriate, arm's-length terms to that agreement.
Since Glencore and its Swiss parent were related parties, a fundamental point of the analysis was the development of the hypothesized transaction. Once identified, the second issue was the determination of an arm's length price for that hypothetical transaction.
Both the taxpayer and the Commissioner asserted that their positions were consistent with the decision in the Chevron Australia Holdings Pty Ltd v. Commissioner of Taxation transfer pricing case.
The Commissioner advanced several arguments to the effect that the evidence did not support the view that independent parties would have entered into the price-sharing agreement in February 2007. The Commissioner argued that at arm's length, an independent mining company would have entered into a long-term contract with pricing negotiated annually to reflect market conditions and this was the hypothetical transaction that should be priced.
Glencore's argument was twofold and both arguments asserted that the hypothetical transaction was the actual transaction entered into. First, it argued that the Commissioner had no power to rewrite the contractual terms under the transfer pricing rules; rather, those rules applied to price the actual transaction entered into. Second, and in the alternative, it argued the terms of the price-sharing contract were consistent with the agreements that independent parties enter into and provided a number of examples of these types of contracts. While Glencore acknowledged none of those third-party agreements were perfect comparables, it asserted that the contracts were indicative of the fact the intercompany transaction being analyzed was a normal commercial agreement and should be priced as such. Glencore did argue the third-party agreements demonstrated the 23% price-sharing percentage used in the offtake arrangement with its Swiss parent was consistent with the price-sharing percentages in those third-party agreements.
The Court spent a considerable amount of time analyzing the judgments in the Chevron case as well as the commentary in the Organisation for Economic Cooperation and Development's Transfer Pricing Guidelines (OECD Guidelines), which are the primary source of interpretation for the application of the arm's length principle in Subdivision 815-A (and now for Subdivision 815-B). Significantly, the Court stated that the policy objective of the Australian transfer pricing legislation is to ensure that the parties' fiscal obligations are based on the arm's length equivalent dealing of the actual transaction entered into. The Court noted the two exceptions to this rule in the OECD Guidelines and the fact that their application was limited to extraordinary and specific situations.
The Court rejected the Commissioner's contention that the legislation allowed the ATO to ignore the actual transaction entered into and to replace that transaction with an alternative hypothetical "arm's length" transaction for transfer pricing purposes. The Court held that neither Division 13 or Subdivision 815-A provided the Commissioner with the power to review the commercial prudence of a contract entered into between related parties. Similarly, the Court held that the arm's length principle does not introduce or involve any investigation of the purpose or motive of the taxpayer in entering into a related party transaction. In other words, the Court found that there is no ability for the Commissioner to challenge the arm's length nature of an arrangement actually entered into by related parties under Division 13 or Subdivision 815-A. The Court also rejected the use of hindsight to endeavor to evaluate the appropriateness of commercial decisions made by taxpayers.
In the end, the Court held that the transfer pricing inquiry under Division 13 and Subdivision 815-A involved testing the pricing of the actual transaction entered into and concluded, based on the range of price-sharing percentages in the various third-party agreements submitted to the Court, the pricing was arm's length.
What Does This Decision Mean?
There are several interesting points that arise from the decision:
- There are strong similarities between this case and the Commissioner of Taxation v. SNF (Australia) Pty Ltd case: that decision lead to the introduction of Subdivision 815-A (as an interim measure) and then Subdivision 815-B as the Parliament sought to redress the shortcomings of Division 13;
- Justice Robertson took a restrictive view of comparable funding transactions in the Chevron case. The ATO sought to rely on that view in challenging the probative value of the third-party offtake agreements submitted by Glencore as support for its pricing. Significantly, justice Davies rejected that argument, favoring the view from SNF Australia that comparables do not need to be perfect to be relevant in a transfer pricing inquiry;
- The ATO has previously issued Taxation Ruling TR 2014/6 that addresses how it will apply the Subdivision 815-B reconstruction provision (Section 815-130). That ruling contains the ATO's interpretation of the OECD Guidelines. Some of those interpretations were addressed by Justice Davies in this case. That may mean that the actual application of section 815-130 will be more limited, and aligned closer to the OECD Guidelines' reconstruction exceptions rather than to the ATO's more expansive view in TR 2014/6; and
- The ATO has been adamant in its view that Subdivision 815-B allows the Commissioner to challenge commercial decisions made by taxpayers from a transfer pricing perspective. In other words, it enables the Commissioner to review whether an arrangement entered into is an arm's length arrangement. Section 815-130 was seen to be the catalyst for this inquiry. That view is perhaps debatable now given the policy objective of the Australian transfer pricing rules identified by Justice Davies and the finding that the arm's length principle does not introduce or involve any investigation of the purpose or motive of the taxpayer in entering into a related party transaction. While Subdivision 815-B differs from Division 13 and Subdivision 815-A, it is unlikely the Courts will view it as a quasi-avoidance provision that allows the Commissioner to use the transfer pricing rules to challenge a decision by a taxpayer to move from one commercial arrangement to another other than in a manner consistent with the OECD Guidelines' reconstruction exceptions.
We will know in the next couple of months whether the Commissioner will appeal the decision. Given the decisions in SNF Australia, Chevron and now this case, there are numerous data points on The Court's views on the application of Division 13 and Subdivision 815-A. What will be most interesting is to see how those rulings are interpreted and applied in relation to Subdivision 815-B going forward. Duff & Phelps encourages taxpayers and practitioners to continue monitoring developments in this space.
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