This article was originally published 4 December 2020.
On 6 November 2020, Australia's Full Federal Court dismissed the Commissioner of Taxation's appeal against the previous decision in favour of Swiss-based trader Glencore Group on all but one issue.
The case considered transfer pricing provisions within division 13 of the Income Tax Assessment Act 1936 and subdivision 815-A of the Income Tax Assessment Act 1997, and related to amended assessments that had been issued for income years 2007 to 2009. The decision is relevant because:
- Many of the matters considered have broad application on how the transfer pricing provisions are applied
- They provide particular insights as to the situations in which the Commissioner can seek to reconstruct hypothetical arm's length arrangements.
The case was built on the Commissioner challenging the sale terms of copper concentrate between two related parties:
- The seller who mined copper concentrate, a wholly-owned Australian subsidiary (and Australian resident) of the Glencore Group
- The buyer, its Swiss parent, Glencore International AG.
The related parties, who had been trading copper concentrate for some time, set the price based on the benchmarks on the London Metal Exchange (LME) less certain discounts. Various contractual changes were made over the life of the contract. In particular, in 2007, the contract was amended to set the discounts as a flat percentage of the benchmark copper price, an approach that traded off potential profits for a reduction in risk for the seller.
The Commissioner's argument indicated that the contract terms immediately before the 2007 amendments were arm's length and that third parties acting at arm's length would not have agreed to those amendments.
The decision
The Court effectively concluded that the relevant question was not whether independent parties acting at arm's length would have agreed to the amendments, but rather whether the price paid for copper concentrate reflected a true arm's length consideration.
The taxpayer provided sufficient evidence that independent parties dealing at arm's length with each other might have reasonably expected to have agreed to a similar pricing mechanism as the related parties did, given the information available to the parties at the time.
The Court's decision highlights a number of takeaways for Australian taxpayers:
- A taxpayer must be able to evidence that the pricing mechanism used would not differ from that which would have been used by unrelated parties under similar facts and circumstances
- The degree to which a transaction between hypothetical parties would be expected to be 'de-personalised' for the purposes of considering the appropriate arm's length characteristics of the transaction being priced should be carefully considered
- That there may be a range of arm's length outcomes that may reasonably be expected to be struck between independent parties, and an appropriate outcome can be considered one that is selected on a pragmatic basis using the information available at the time, rather than one identified with the benefit of hindsight.
Ultimately, the appeal by the Commissioner was dismissed on all but one issue (related to freight) which was not the key issue at hand.
Key takeaways
In approaching the task of assessing an arm's length price, the Commissioner was not able to substitute hypothetical alternative clauses that did not directly impact price under division 13. Sadly, the Full Federal Court did not consider whether subdivision 815-A would have permitted a broader substitution of the relevant 'conditions'. This leaves uncertainty surrounding this particular issue under subdivision 815-A and subdivision 815-B to be resolved in a later case.
There are a number of key observations in the judgement, which note that in transfer pricing cases, a degree of flexibility and pragmatism is required. Predicting how independent parties dealing at arm's length with each other would price a wholly controlled transaction is a difficult and complex issue.
It is important to understand the economic circumstances which give broader context to pricing arrangements and qualitative industry analysis provides this. In this case, the Court supported the use of industry reports as a reference point and considered this a common sense. In the broader sense, this may be useful to the taxpayer when interpreting the benchmarking data, which is intended to link the taxpayer's circumstances to the industry it operates in.
Third-party contracts drawn from benchmarking data, whilst not necessarily comparable, might be a good reference point in arriving at an outcome between the related parties. The judgement acknowledged the differences between comparable data and taxpayer circumstances identified by the Commissioner but concluded this did not mean the contracts should be ignored or rejected, in total. This reinforces the point that the answer is not always to be found in overly lengthy and complex expert reports and common sense is required.
The Court also noted tax authorities have the benefit of hindsight years after the transaction(s) took place, whereas taxpayers must use the data and resources available at the time. Therefore, the time delay may potentially yield different results, but this should not mean that the position of the tax authorities should be considered superior to that of the taxpayer.
If you would like to discuss how the key takeaways of this case could impact your organisation, please do not hesitate to contact your local BDO adviser.