Our recent Riposte outlined Glencore’s success against the Commissioner in a transfer pricing dispute (Glencore Investment Pty Ltd v FCT [2019] FCA 1432). This Riposte looks at another, unusual element of the case involving issues related to the operation of the tax consolidation ‘single entity rule.’ It seems the Federal Court is not convinced the single entity rule works the way that the ATO, the profession and taxpayers all understand. This is a serious divergence of views and will have important ramifications for the consolidation system if the discrepancy is not quickly resolved.

The issue arose because Glencore put forward a novel, but ultimately unsuccessful, argument that Division 13 could not apply where the Australian party to the ‘international agreement’ was a subsidiary member of a tax consolidated group, rather than the head entity being assessed. The argument was that, ‘the single entity rule does not deem an international agreement under s 136AD(1) to have been entered into by a head company when it was in fact entered into by a subsidiary member of the relevant tax group.’

The single entity rule in s.701-1 provides that subsidiary members of a consolidated group are ‘taken [for relevant purposes] to be parts of the head company of the group, rather than separate entities’. Advisers, taxpayers and the ATO generally operate on the basis that the single entity rule operates as a statutory fiction which essentially ignores all transactions occurring, and all assets and liabilities existing, only between members of the same consolidated group. But just how much further do the implications of the rule extend: does it also change the identity of the parties to an agreement? For example, does it mean that money borrowed by a subsidiary should instead be regarded as borrowed by all the members of the consolidated group? If all the subsidiaries ‘are taken … to be parts of the head company’ then is the head company now the borrower? The answer will matter if the creditworthiness of the group differs from that of the actual borrower.

Despite the brevity of the single entity rule and its critical importance to the operation of the tax consolidation rules, it has been the subject of surprisingly little dispute or judicial comment. However, in his minority judgement in Channel Pastoral Holdings Pty Ltd v FCT [2015] FCAFC 57 (Channel Pastoral – discussed in our previous Tax Brief) with which Davies J agreed, Pagone J commented that the single entity rule operated as a ‘statutory direction concerned with the calculation of a composite liability’ rather than as a ‘statutory fiction … that a subsidiary of a consolidated group is to be treated as non-existent’. The ATO updated its ruling on the single entity rule (TR 2004/11) following Channel Pastoral to include an Appendix which states that Pagone J’s statutory direction approach is contrary to the majority reasoning in that case and is not binding on the ATO (refer to our earlier Riposte).

In Glencore, the taxpayer adopted Pagone J’s statutory direction interpretation and argued that the single entity rule did not deem a head company to be party to an international agreement which was in fact entered into by a subsidiary member of the consolidated group, thereby limiting the application of the transfer pricing rules in the former Division 13.

Given that Davies J agreed with Pagone J in Channel Pastoral, it is not surprising that she did not challenge the correctness of the statutory direction interpretation in Glencore. She reiterated this position stating:

The single entity rule does not have the effect that a subsidiary of a consolidated group is to be treated as non-existent, or that it ceases to be a taxpayer or that it does not derive or make assessable income or gains, or does not incur losses or outgoings.

As a result, there are now 2 separate Federal Court judgments endorsing an interpretation of the single entity rule which is not consistent with industry or ATO practice, and is arguably contrary to the manner in which a number of legislative provisions envisage the single entity rule operating. Something has to give.