We provide an overview of the full federal court's decision between Glencore and the Commissioner of Taxation.
The Commissioner of Taxation has recently been focussed on examining the transfer pricing outcomes of multinational arrangements and has taken a strong position in respect of many transfer pricing audits. The first of those cases since the Chevron decision has been handed down by the Federal Court and it is adverse to the Commissioner. On 3 September 2019, the Federal Court overturned amended tax assessments issued to Glencore Australia in respect of the sale of copper concentrate to its Swiss parent company. In her judgment, Davies J held that Glencore had demonstrated that the price of the sales was within an arm's length range, and also clarified the scope of the landmark Chevron transfer pricing case.
Key takeouts of the Glencore case
Since the Full Federal Court in 2017 upheld the Robertson J's first instance decision in the landmark Chevron transfer pricing case, the Commissioner of Taxation has had at his disposal powerful judicial authority with which to engage taxpayers in respect of financing arrangements. The Glencore case is the first transfer pricing case to be handed down post-Chevron and involves the pricing of goods.
In her Honour's reasons in the Glencore case, Davies J held that Chevron is not authority for the propositions that the former Division 13 of the Income Tax Assessment Act 1936 and Subdivision 815-A of the Income Tax Assessment Act 1997 (ITAA 1997):
- Can alter the form of agreement negotiated between entities dealing at arm's length; or
- Permit a wholly differently structured transaction to be hypothesised as an alternative to the actual tested transaction
Davies J held that the task to determine whether Division 13 and/or Subdivision 815-A applies involves two statutory questions which should be determined separately:
- Firstly, identify whether there has been a non-arm's length dealing between the entities (Div 13) or whether the conditions are different to those that might be expected between independent entities (Subdiv 815-A); and
- Secondly, identify whether the consideration was different to an arm's length amount (Div 13) or whether there was a causal relationship between the non-arm's length conditions and the profits that did not accrue to the taxpayer (Subdiv 815-A).
Davies J held that the Commissioner's approach incorrectly conflated these two statutory questions by seeking first to identify what independent parties might reasonably be expected to have agreed.
The better view is that the arm's length hypothetical adopted to test the actual transaction should be based on the form of the actual transaction entered into between the associated enterprises with the arm's length consideration substituted for the actual consideration.
The exception will be where the specific circumstances referred to in the 1995 OECD Guidelines apply. These circumstances are (1) where the form of the arrangement differs to the substance, and (2) where the actual arrangement differs from those which would have been adopted by independent enterprises. Neither of these exceptions applied to Glencore's arrangement.
Davies J further held that the construction and application of Division 13 and Subdivision 815-A should be consistent with the internationally accepted 'arm's length principle', outlined in the OECD Transfer Pricing Guidelines.
The Court set out further points to be borne in mind in applying the transfer pricing rules correctly:
- Neither Division 13 nor Subdivision 815-A directs an inquiry into the commercial prudence of the actual related party contract or transaction;
- Purpose is not relevant to the transfer pricing analysis;
- The assessment of arm's length consideration does not involve an inquiry into what profits might reasonably be expected to have been obtained on a differently structured transaction; and
- Hindsight cannot be used to second-guess the commercial judgment made at the time.
It is important to note that the Glencore case does not involve the application of Subdivision 815-B of the ITAA 1997 so it unclear the extent to which the analysis in the Chevron and Glencore cases applies to income years commencing on or after 1 July 2013.
Evidence required to satisfy the court
The transfer pricing rules require a factual inquiry to identify a reliable substitute consideration for the actual consideration given or received.
Glencore tendered a number of agreements between unrelated parties for the sale of copper concentrate. These agreements included terms that were comparable to those adopted by Glencore who submitted that its agreements were consistent copper concentrate market pricing structures.
While not directly analogous to Glencore's agreements, Davies J held that the example agreements in evidence had probative value as illustrations of contracts between independent mine producers and traders for the sale of copper concentrate between 2002 and 2011.
Glencore did not contend, and it was not necessary for it to prove, that the independent contracts in evidence were directly comparable. Applying the Full Federal Court's 2011 decision in SNF, such a requirement would set the bar that a taxpayer must reach at an unattainable height.
While the role of experts in providing independent assistance to the court was acknowledged in the Glencore case, the factual analysis in the Glencore case did not turn on the parties' experts. Nonetheless, Davies J observed that:
- An expert should not be an advocate for the party calling them;
- The expert's opinion should be confined to his or her expertise; and
- To be admissible opinion evidence, the expert's report must be based wholly or substantially on his or her specialist knowledge rather than a third party firm providing support services to the expert.
Where to from here?
There is currently a large volume of cases progressing through ATO review, audit and objection processes. It is unclear the extent to which the Glencore decision will alter the direction of these cases or whether it will have application in respect of the Commissioner's reconstruction power in section 815-130 of the ITAA for income tax years commencing on or after 1 July 2013. It will be important for corporates to carefully consider the impact of the case on transfer pricing positions that have been adopted and the most appropriate approach to future years..
The Commissioner will have 28 days to file an appeal with the Full Federal Court. Accordingly, Davies J's judgment may not represent the last word on Glencore's copper concentrate pricing and caution should be taken in adopting positions based on the reasoning in this case, particularly having regard to differences in facts.
However, taxpayers facing ATO audit hypotheses that involve the proposed reconstruction of a transaction under Division 13 of Subdivision 815-A should carefully consider the findings in the Glencore case in light of their own facts and having regard to expert evidence as required. If the audit hypotheses involve the application of section 815-130 taxpayers should carefully consider whether those provisions permit the ATO to disregard the actual commercial or financial relations in connection with which actual conditions operate in light of relevant evidence, including expert evidence..