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FC of T v Glencore Investment Pty Ltd

Judges: Middleton J
Steward J

Thawley J

Court:
Federal Court of Australia, Full Court

MEDIA NEUTRAL CITATION: [2020] FCAFC 187

Judgment date: 6 November 2020

Thawley J

240. I have had the advantage of reading the reasons of Middleton and Steward JJ. I agree that the appeal should be allowed and with the orders proposed by their Honours. In relation to the freight issue, which was confined to the 2009 year, I agree with the reasons of Middleton and Steward JJ and have nothing to add. I prefer to express my own reasons in relation to the operation of Div 13 of Part III of the Income Tax Assessment Act 1936 (Cth) ( ITAA 1936 ) and Subdiv 815-A of the Income Tax Assessment Act 1997 (Cth) ( ITAA 1997) .

INTRODUCTION

241. On 2 February 2007, Cobar Management Pty Ltd ( CMPL ) and Glencore International AG ( GIAG ) altered the terms of their agreement for the supply of copper concentrate in two ways critical to the arguments put on appeal:

  • (1) First, the parties would no longer rely on benchmark and spot market charges for treatment and refining charges ( TCRCs ). TCRCs, when calculated by reference to benchmark and spot market prices, continuously moved according to the market. In place of this " market-related " basis for calculating the amount GIAG would pay, the relevant TCRCs were fixed at 23% of the relevant copper price for three years. This was referred to as " price sharing " . These alterations were effected by amendments to cl 8 of the agreement.
  • (2) Secondly, the parties amended cl 9 of the relevant agreement to give GIAG greater choice in selecting the quotational period. Clause 9 gave GIAG what was referred to as " quotational period optionality with back pricing " .

242.

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These changes were significant, involving the introduction of a new methodology for pricing. In particular, the alterations effected significant changes to the respective risks of the parties by introducing a new way of managing or mitigating risk. The reasonable expectation was that CMPL would receive less for its copper concentrate over the forthcoming three years as a result of the changes, but that risks would also be reduced.

243. The primary judge held that neither Div 13 nor Subdiv 815-A authorised the Commissioner to ascertain the consideration that might reasonably be expected to have been received by reference to a transaction or pricing formula that did not include " price sharing " or " quotational period optionality with back pricing " . The primary judge ' s reason for that conclusion was that Div 13 and Subdiv 815-A both required the determination of the arm ' s length consideration " for the actual transaction " :
Glencore Investment Pty Ltd v Commissioner of Taxation (2019) 272 FCR 30 at [324] (hereafter referred to as " J " ).

244. The primary judge understood Allsop CJ ' s reasons in
Chevron Australia Holdings Pty Ltd v Federal Commissioner of Taxation (2017) 251 FCR 40 to confirm, at least in respect of Subdiv 815-A, that the arm ' s length price must be " based on the actual transaction as structured by the parties, save in the case of the two exceptional circumstances identified in the 1995 [OECD Transfer Pricing] Guidelines " : J[40]. Her Honour considered the same conclusion obtained under Div 13 such that, under both Div 13 and Subdiv 815-A, the arm ' s length consideration had to be determined on the basis of the terms of the actual transaction unless one of the two exceptional circumstances identified in the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations published by the OECD in 1995 ( 1995 Guidelines ) applied: J[312] to [319], in particular at [317].

245. For the reasons given below, I do not consider that Div 13 and Subdiv 815-A only permit departure from the terms of the actual transaction in the limited circumstances identified by the primary judge, namely where one of the two exceptions in the 1995 Guidelines applies.

246. The primary judge also addressed the matter on the basis that she was wrong in her conclusion that it was impermissible to depart from the terms of the actual transaction and that it was necessary for the taxpayer to establish that arm ' s length parties might have entered into a transaction in the form of the transaction in fact entered into. Her Honour concluded that:

  • (1) first, the form or structure of the relevant international agreement was one which might reasonably be expected between independent parties in the position of CMPL and GIAG dealing at arm ' s length: J[320] to [322], [342], [344], [385] to [398]; and
  • (2) secondly, the consideration for the supply of copper concentrate under the international agreement so structured was one which might reasonably be expected between independent parties dealing with each other at arm ' s length: J[346] to [370], [383], [398].

247. For reasons equivalent to those given by Middleton and Steward JJ the primary judge ' s conclusions in this respect should not be disturbed on appeal. The Commissioner has also not shown that, on the correct operation of Div 13 and Subdiv 815-A applied to these findings, the taxpayer failed to discharge its onus of establishing that the assessments were excessive because: (a) the consideration paid by GIAG was an arm ' s length consideration for the supply of property under the international agreement (Div 13); and (b) there were not profits which, but for the conditions mentioned in Art 9 of the Agreement between Australia and Switzerland for the Avoidance of Double Taxation with Respect to Taxes on Income, and Protocol
[1981] ATS 5 ( Swiss Treaty ), might have been expected to accrue to the taxpayer, but which, by reason of those conditions, did not so accrue (Subdiv 815-A).

248. I address Div 13 and Subdiv 815-A separately in light of the significant differences in the statutory language and structure.

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DIVISION 13

249. Section 136AD(1) provided:

136AD Arm ' s length consideration deemed to be received or given

  • (1) Where:
    • (a) a taxpayer has supplied property under an international agreement;
    • (b) the Commissioner, having regard to any connection between any 2 or more of the parties to the agreement or to any other relevant circumstances, is satisfied that the parties to the agreement, or any 2 or more of those parties, were not dealing at arm ' s length with each other in relation to the supply;
    • (c) consideration was received or receivable by the taxpayer in respect of the supply but the amount of that consideration was less than the arm ' s length consideration in respect of the supply; and
    • (d) the Commissioner determines that this subsection should apply in relation to the taxpayer in relation to the supply;

    then, for all purposes of the application of this Act in relation to the taxpayer, consideration equal to the arm ' s length consideration in respect of the supply shall be deemed to be the consideration received or receivable by the taxpayer in respect of the supply.

250. Central to the operation of this provision is the identification of the three matters in para (a) of s 136AD(1). First, there must be an " agreement " as defined by s 136AA(1) which is an " international agreement " as defined by s 136AC. Section 136AA(1) defined " agreement " (unless the contrary intention appears) in the following way:

  • (1) In this Division, unless the contrary intention appears:

    …

    agreement means any agreement, arrangement, transaction, understanding or scheme, whether formal or informal, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings.

251. Section 136AC defined " international agreement " :

136AC International agreements

For the purposes of this Division, an agreement is an international agreement if:

  • (a) a non-resident supplied or acquired property under the agreement otherwise than in connection with a business carried on in Australia by the non-resident at or through a permanent establishment of the non-resident in Australia; or
  • (b) a resident carrying on a business outside Australia supplied or acquired property under the agreement, being property supplied or acquired in connection with that business; or
  • (c) a taxpayer:
    • (i) supplied or acquired property under the agreement in connection with a business; and
    • (ii) carries on that business in an area covered by an international tax sharing treaty.

252. It was common ground that the relevant " international agreement " was the agreement between CMPL and GIAG as amended on 2 February 2007.

253. The second and third matters critical to the operation of s 136AD(1) are the " supply " of " property " under the international agreement. Relevantly to these two matters, s 136AA included:

  • (1) In this Division, unless the contrary intention appears:

    …

    property includes:

    • (a) a chose in action;
    • (b) any estate, interest, right or power, whether at law or in equity, in or over property;
    • (c) any right to receive income; and
    • (d) services.
    • …

    supply includes:

    • (a) supply by way of sale, exchange, lease, hire or hire-purchase; and

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    • (b) provide, grant or confer.
    • …

  • (3) In this Division, unless the contrary intention appears:
    • (a) a reference to the supply or acquisition of property includes a reference to agreeing to supply or acquire property …
    • …
    • (e) a reference to the supply or acquisition of property under an agreement includes a reference to the supply or acquisition of property in connection with an agreement.

254. There was no dispute that there was a " supply " of " property " under the international agreement. CMPL supplied copper concentrate to GIAG under the agreement between CMPL and GIAG as amended on 2 February 2007. It follows that it was common ground that para (a) of s 136AD(1) was satisfied.

255. There was also no dispute that:

  • (1) para (b) of s 136AD(1) was satisfied: the Commissioner was satisfied, having regard to the lack of independence between them, that CMPL and GIAG were not dealing with each other at arm ' s length in relation to the supply; and
  • (2) para (d) of s 136AD(1) was satisfied: the Commissioner lawfully made a determination that s 136AD(1) should apply. (The Commissioner also made determinations under s 136AD(4): J[11].)

256. The principal dispute was whether para (c) of s 136AD(1) was satisfied: whether the consideration received by CMPL in respect of the supply of copper concentrate " was less than the arm ' s length consideration in respect of the supply " .

257. The definition of " arm ' s length consideration " was contained in s 136AA(3), relevantly:

  • (3) In this Division, unless the contrary intention appears:
    • …
    • (b) a reference to consideration includes a reference to property supplied or acquired as consideration and a reference to the amount of any such consideration is a reference to the value of the property;
    • (c) a reference to the arm ' s length consideration in respect of the supply of property is a reference to the consideration that might reasonably be expected to have been received or receivable as consideration in respect of the supply if the property had been supplied under an agreement between independent parties dealing at arm ' s length with each other in relation to the supply …

258. The evident object of s 136AD(1)(c), read with the definition of " arm ' s length consideration " in s 136AA(3)(c), is to require that the consideration for a supply of property under the " international agreement " which enlivens the potential operation of Div 13 is determined objectively by reference to " an agreement " between independent parties dealing with each other at arm ' s length, namely " an agreement " which is not the product of a non-arm ' s length dealing between related parties. The provisions require an answer to a hypothetical question: what " consideration … might reasonably be expected to have been received or receivable as consideration in respect of the supply if the property had been supplied under an agreement between independent parties dealing at arm ' s length with each other in relation to the supply " ?

259. If independent parties, in the position of the parties to the international agreement, would not have agreed to supply the property with the terms affecting price on which that property was in fact supplied, then a reasonable expectation that the supplier would have received the consideration in fact received might not be established, at least on the terms of the international agreement which enlivened the potential operation of Div 13. The language of Div 13 does not indicate that it was intended to permit a taxpayer to dictate the consideration for a supply of property by implementing a transaction which included terms affecting price which might not reasonably be expected in an agreement between independent parties dealing with each other at arm ' s length. Whilst related parties might be expected to enter

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into agreements which might not be found between independent parties dealing at arm ' s length, Div 13 does not furnish parties carte blanche to structure transactions in a way which dictates uncommercial or non-arm ' s length prices. As Allsop CJ stated in Chevron at [55] of the approach of interpreting Div 13 to require determining the consideration strictly in accordance with the form of the international agreement as in fact entered into:

That approach, however, almost dooms to failure the application of Div 13 if its task is to substitute commercial reality based on independence, for intra-group reality based on group control. All one would have to do would be to constrain internally the transaction to give the highest price and include or omit terms of the agreement that would never be included or omitted in an arm ' s length transaction and which are not driven or dictated by commercial or operational imperatives, as the foundation for assessing an hypothesised arm ' s length consideration. Such unrealistic inflexibility would undermine the sensible operation of the Division by a rigid construction of the hypothesis in a shape and form controlled by the taxpayer. The difficulty is not alleviated by giving s 136AD(4) a role to play in such circumstances.

260. If the hypothetical agreement replicates all the terms of the " international agreement " , including terms which materially affect price but which might not reasonably be expected to have been agreed between independent parties dealing at arm ' s length, it would be difficult to conclude that the resulting consideration might reasonably be expected to have been received for the supply of the property under " an agreement between independent parties dealing at arm ' s length with each other in relation to the supply " . That is not to confuse the reasonable expectation about consideration with what might be expected to be the terms of the hypothetical agreement. It is to recognise that a reasonable expectation about consideration might not be able to be formed on the basis of an agreement which could not reasonably be expected to exist between independent parties dealing at arm ' s length. Thus s 136AD(1)(c), read with the definition of " arm ' s length consideration " contained in s 136AA(3)(c), permits, and even requires in certain circumstances, the consideration to be determined by reference to " an agreement " with terms which depart from those of the " international agreement " .

261. However, nor does Div 13 enable the Commissioner to determine reliably the arm ' s length consideration by arbitrarily re-writing the relevant international agreement or by ignoring terms in the international agreement which might reasonably be expected to have been agreed between independent parties dealing at arm ' s length in relation to the supply. It is the " international agreement " which enlivens the potential operation of Div 13. It is the supply of property under that particular international agreement which is the underlying subject matter of the relevant pricing exercise. Division 13 requires that a hypothetical agreement be posited in order to determine whether the consideration for the supply of property under the " international agreement " was one which " might reasonably be expected to have been received or receivable as consideration in respect of the supply if the property had been supplied under an agreement between independent parties dealing at arm ' s length with each other in relation to the supply " (emphasis added).

262. The more the hypothetical agreement required to be posited by s 136AA(3)(c) ( " an agreement " ) departs from the terms of the international agreement under which the supply of property occurred, the less the hypothetical agreement is apt to reveal " the consideration that might reasonably be expected to have been received or receivable as consideration in respect of the supply if the property had been supplied under an agreement between independent parties dealing at arm ' s length with each other in relation to the supply " . Whilst the Commissioner can, as a matter of law, " substitute " terms or undertake the statutory task by reference to " an agreement " which is different from the " international agreement " , the greater the substitution of terms or the more different the hypothetical agreement is from the international agreement, the less likely it is that the hypothetical agreement is probative of the arm ' s length consideration for the supply of the property under the

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international agreement which engaged Div 13. It is one thing to determine the arm ' s length consideration by reference to " an agreement " which substitutes terms which would not be found in an international agreement between independent parties dealing with each other at arm ' s length (or to add terms - such as security and covenants - which would have existed if the international agreement had been between independent parties dealing at arm ' s length as in Chevron ); it is another to determine the arm ' s length consideration by reference to " an agreement " which ignores terms in the international agreement which are terms to which independent parties dealing at arm ' s length would have agreed (this case).

263. A taxpayer might discharge the onus of establishing that the consideration for the supply of property might reasonably have been expected under an agreement between independent parties dealing with each other at arm ' s length, by demonstrating that: (a) the terms of the agreement in fact entered into might reasonably have been expected between independent parties in the position of the parties to the international agreement dealing with each other at arm ' s length in relation to the supply; and (b) the consideration payable in respect of the supply of the property on those terms might reasonably have been expected. That is not the only way to discharge the onus, but it is an available way.

264. In its application to the present case, if the taxpayer established that the form of the " international agreement " was one which might reasonably have been expected between independent parties dealing at arm ' s length, containing both " price sharing " and " quotational period optionality with back pricing " , then it could succeed in discharging its onus if it also established that the consideration for the supply of copper concentrate on those terms was one which might reasonably have been expected between independent parties dealing at arm ' s length. On the facts as found by the primary judge, the taxpayer established those matters.

265. If the conclusion had been reached that independent parties dealing at arm ' s length might not reasonably have been expected to have " an agreement " (s 136AA(3)(c)) with " price sharing " or " quotational period optionality with back pricing " or those two terms in combination, then the arm ' s length consideration for the supply of the copper concentrate would have needed to have been determined by reference to an agreement without those terms being one which might reasonably be expected between independent parties dealing at arm ' s length in relation to the supply of the copper concentrate. As a matter of substance, that is what was decided in Chevron : the loan which was the " international agreement " would not have been made between independent parties dealing at arm ' s length unless it included security and operational and financial covenants; accordingly, the consideration which might reasonably be expected could not be established by reference to " an agreement " without security and covenants.

266. Middleton and Steward JJ at [154] conclude that it is permissible, in the sense of the Commissioner having legal capacity, to substitute a different formula or methodology to that found in the international agreement being one which he considers will result in the ascertainment of the arm ' s length consideration. Their Honours ' conclusion rests on the fact that those terms " define the price " in the international agreement, or are part of the formula or methodology for determining consideration, and that such clauses are to be distinguished from other clauses which affect consideration: at [155]. The former may be " substituted " , the latter may not.

267. I agree that it is permissible, in the sense of the Commissioner having legal capacity, to " substitute " a different formula or methodology to that found in the international agreement being one which he considers will result in the ascertainment of the arm ' s length consideration. In my view, that conclusion rests on the fact that those clauses affect consideration, not on a potentially " unsatisfactory " classification of those terms as ones which " define price " . As explained above, Div 13 permits the arm ' s length consideration to be determined by reference to terms affecting consideration which are not found in the international agreement or which are different to those terms. As noted at [259] above, it not consistent with the

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statutory language or object for Div 13 to be construed as allowing for parties to the international agreement to control what would be determined to be the arm ' s length consideration by structuring their agreement such that non-arm ' s length terms affecting consideration cannot be said to define price or are to be distinguished from clauses which are part of the methodology for determining consideration.

268. I agree with Middleton and Steward JJ that the " price sharing " and " quotational period optionality with back pricing " terms were part of the methodology for determining price, being included in cl 8 and cl 9 of the 2 February 2007 Agreement which directly defined and affected price. Clause 8 defined price and cl 9 was incorporated into cl 8 by reference. I agree that it is legally permissible for the Commissioner to undertake the statutory task under Div 13 by ignoring those terms. It is difficult to see why the Commissioner would adopt such a course if the terms were ones which might reasonably be expected between independent parties dealing at arm ' s length. The explanation in the present case lies in the Commissioner disputing that those terms were ones to which independent parties dealing at arm ' s length would have agreed. The primary judge accepted, however, that the terms were arm ' s length ones, with the result that the Commissioner determined the consideration by reference to " an agreement " which substituted or ignored arm ' s length terms affecting price and thus determined the consideration for the supply under " an agreement " which differed substantially from the " international agreement " which engaged Div 13 and which did not supply the answer to the questioned posed by s 136AD(1)(c) because the terms which had been substituted or ignored were ones which might reasonably be expected between independent parties dealing at arm ' s length. The resulting assessments were excessive.

269. Most terms of an agreement affect price and many may properly be characterised as part of the consideration, whether or not the terms are found in a contractual clause specifically directed at, or defining, price - cf: Chevron at [46]. In the context of a loan for example, the provision of security directly affects price even though it is not expressed as part of the methodology for determining price. The provision of security also affects risk and cost to the lender. A customer who provides a first mortgage for a home loan might borrow from a bank at an interest rate of 5%. The same bank might only be prepared to lend to the same customer at 10% if security were more limited. If the bank would not have lent to the customer at all unless security were provided, what might reasonably be expected to be the consideration would not generally be able to be determined by reference to " an agreement " without security. At the risk of oversimplification, that is what Chevron decided: a reasonable expectation that the consideration is an arm ' s length one is not proved by establishing the consideration which would be received under an agreement to which independent parties dealing at arm ' s length would never have agreed. Chevron is not authority for the proposition that the arm ' s length consideration for the purposes of Div 13 may reliably be determined by ignoring or substituting arm ' s length terms. An assessment would likely be excessive if it were issued on the basis of " an agreement " which departs from terms in the " international agreement " which both affect consideration and might reasonably be expected between independent parties dealing with each other at arm ' s length in relation to the supply. If the arm ' s length consideration is determined by reference to such " an agreement " , then the issue raised by s 136AD(1)(c) would not have been reliably answered because the ignored terms of the " international agreement " which engaged the operation of Div 13 might reasonably have been expected in " an agreement " between independent parties dealing at arm ' s length.

270. Each case turns on its own facts. However, generally:

  • (1) If a taxpayer establishes that the terms in the " international agreement " which affect consideration were terms which might reasonably have been expected in " an agreement " between independent parties dealing at arm ' s length, then the consideration which might reasonably be expected for the supply of property should be determined by reference to " an agreement " with those terms. That is so whether or not the arm ' s length terms are characterised as

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    defining price.
  • (2) On the other hand, if terms in the " international agreement " affecting price were not ones which might reasonably have been expected between independent parties dealing at arm ' s length, then the consideration for the supply might be established by reference to " an agreement " of sufficient similarity or probative value to that in fact entered into as to permit the statutory question to be answered, being an agreement which might reasonably be expected between independent parties in the position of the relevant parties dealing with each other at arm ' s length in relation to the supply.

271. In the present case, Glencore Investment Pty Ltd ( GIPL ) discharged its onus of establishing that the consideration received by CMPL was one which might reasonably be expected to have been received as consideration on the assumption that the supply of copper concentrate under the international agreement had been made under an agreement between independent parties dealing at arm ' s length with each other in relation to the supply. GIPL discharged its onus by showing that:

  • (1) first, the terms of the " international agreement " were ones which might reasonably be expected between independent parties, in the position of CMPL and GIAG, dealing with each other at arm ' s length; and
  • (2) secondly, the consideration for the supply of copper concentrate under " an agreement " with those terms was within an arm ' s length range.

272. The Commissioner approached the principal issue in this case on the basis that independent parties, in the position of CMPL and GIAG, dealing with each other at arm ' s length, would not reasonably be expected to have agreed to a consideration for the supply of copper concentrate on the basis in fact agreed on 2 February 2007, because independent parties dealing at arm ' s length would not have altered their existing agreement. Whilst facts relevant to this argument might also be relevant to the issues under Div 13, this did not correctly frame the issue under Div 13. The argument hints at a case under Pt IVA of the ITAA 1936, but no such case was made. Whilst Pt IVA and Div 13 were introduced at a similar time, Div 13 does not require an investigation or consideration of purpose or motive:
W R Carpenter Holdings Pty Ltd v Commissioner of Taxation (2008) 237 CLR 198 at [38] . The real question under Div 13 is whether the consideration received by CMPL under the " international agreement " as it stood on 2 February 2007 was an arm ' s length consideration within the meaning of Div 13. On the basis that, as the evidence established, the international agreement was in terms which might be expected between independent parties in the position of CMPL and GIAG, dealing with each other at arm ' s length, the real issue thrown up by the facts was the arm ' s length consideration for the supply of property under that agreement. This devolved into the question of whether TCRCs fixed at 23% of the copper price was arm ' s length consideration. By reason of the amendments to the agreement, CMPL reduced its risk but would likely receive less consideration. The primary judge concluded, after a detailed examination of all of the evidence, that this reflected what might reasonably have been expected between independent parties in the position of CMPL and GIAG dealing with each other at arm ' s length. Her Honour also concluded that the consideration was arm ' s length. The reasons of Middleton and Steward JJ show why her Honour did not err in so concluding.

THE 1995 GUIDELINES

273. As to the 1995 Guidelines, I make the following observations. First , the expression " arm ' s length consideration " in Div 13 is resolved by reference to its terms read in context. No serious attempt was made to show how the 1995 Guidelines could be regarded as throwing significant light on the correct interpretation of Div 13. The 1995 Guidelines were a revision of the OECD Report, Transfer Pricing and Multinational Enterprises , adopted by the Committee on Fiscal Affairs (the main tax policy body of the OECD) in January 1979 and approved for publication by the OECD Council on 16 May 1979 ( 1979 Report ). At [15], the 1979 Report stated:

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CHAPTER 1

SUMMARY OF PROBLEMS

THE ARM ' S LENGTH PRINCIPLE

…

Minor adjustments and substitution of methods

15. The starting point for scrutinising transfer prices would frequently be the appearance of a discrepancy between the profits returned by an associated enterprise and those which might be expected to be made by comparable enterprises in the uncontrolled situation. Since the assessment of an arm ' s length price depends very often on careful judgement and the resolution of many, perhaps conflicting, considerations by negotiation between the tax authorities and the enterprise concerned, it follows that if the prices actually paid can be substantiated by acceptable evidence as being arm ' s length prices there would be no justification for seeking to make merely minor or marginal adjustments to them for tax purposes. Similar[l]y a tax authority should hesitate to disturb without good reason a pricing arrangement reasonably and consistently operated between associated enterprises if it is also reasonably and consistently operated in comparable dealings with independent parties. Moreover, as a general principle, tax authorities should base their search for an arm ' s length price on actual transactions and should not substitute hypothetical transactions for them, thus seeming to substitute their own commercial judgement for that of the enterprise at the time when the transactions were concluded (though there may be some circumstances where the form of transaction has effectively to be ignored - see paragraphs 23 and 24).

274. At [23] and [24], the Report stated:

Recognition of actual payments and transactions

23. In general, the approach which is adopted in this report to the adjustment of transfer prices for tax purposes is to recognise the actual transactions as the starting point for the tax assessment and not, in other than exceptional cases, to disregard them or substitute other transactions for them. The aim in short is, for tax purposes, to adjust the price for the actual transaction to an arm ' s length price. Similarly, it is considered that transactions between associated enterprises should not be treated differently for tax purposes from similar transactions between independent parties simply because the parties to the transaction are related. The report does, however, recognise that it may be important in considering, for example, what is ostensibly interest on a loan to decide whether it is an interest payment or, in reality, a dividend or other distribution of profit.

Intra-group contracts and arrangements

24. Associated enterprises are, however, able to make a much greater variety of contracts and arrangements than can unrelated enterprises because the normal conflict of interest which would exist between independent parties is often absent. Associated enterprises may and frequently do conclude arrangements of a specific nature that are not or are very rarely encountered between unrelated parties (cost contribution arrangements for research and development expenditure as discussed in Chapter III of the report would be one example). This may be done for various economic, legal or fiscal reasons dependent on the circumstances in a particular case. Moreover, contracts within an MNE could be quite easily altered, suspended, extended or terminated according to the overall strategies of the MNE as a whole and such alterations may even be made retroactively. In such instances tax authorities would have to determine what is the underlying reality behind an arrangement in considering what the appropriate arm ' s length price would be.

275. Division 13 was introduced in 1982.

276. The 1995 Guidelines were approved for publication some thirteen years later, in 1995. The 1995 Guidelines set out a position reached after considering various OECD reports and competing and perhaps conflicting positions of member states and delegates. Included in the reports considered were OECD reports issued to promote acceptance of common interpretations of the various Articles in bilateral treaties, including Art 9 of the Swiss Treaty, recognising

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that such interpretations differed. As indicated by its full title, the 1995 Guidelines were " intended to help tax administrations (of both OECD Member countries and non-Member countries) and MNEs by indicating ways to find mutually satisfactory solutions to transfer pricing cases " : Preface at [15]. They were also intended " to govern the resolution of transfer pricing cases in mutual agreement proceedings between OECD Member countries and, where appropriate, arbitration proceedings " : Preface at [17]. The 1995 Guidelines were issued in a looseleaf format because the 1995 Guidelines focussed on the main issues of principle, work was continuing and regular reviews of the experiences of OECD Member and selected non-Member countries was anticipated: Preface at [19]. The 1995 Guidelines were not intended to guide legislators in enacting domestic laws. The 1995 Guidelines were supplemented on numerous occasions and, in 2010, a new revision of the 1979 Report was approved, namely the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations ( 2010 Guidelines ). The 2010 Guidelines continue to be supplemented, reviewed and revised.

277. The text of [C.1.36] to [C.1.38], appearing in the 1995 Guidelines, are not a sure way to understanding the correct operation of Div 13 according to its terms.

278. Secondly, contrary to the primary judge, I do not read the reasons of Allsop CJ in Chevron as stating or implying that the identification of the arm ' s length consideration must be " based on the actual transaction as structured by the parties, save in the case of the two exceptional circumstances identified in the 1995 Guidelines " : J[40]; J[312] to [319].

279. Allsop CJ ' s decision so far as it concerned Div 13 was based on the text of Div 13 and, more specifically, what might reasonably be expected if the consideration had been received under an agreement between independent parties dealing with each other at arm ' s length in relation to the supply. His Honour concluded, in substance, that it would not reasonably be expected that the loan would have been made without security or a parent guarantee and, accordingly, the arm ' s length consideration could not be reliably established by reference to " an agreement " which did not contain those features.

280. The Chief Justice ' s reference to the two exceptions in the 1995 Guidelines was in the context of considering the application of Subdiv 815-A. However, his Honour was not applying the exceptions referred to in the 1995 Guidelines. There was no suggestion that the first exception applied. No conclusion was expressed that the second exception applied and nor did his Honour make findings which would have been required to engage the second exception, namely that the agreement reached: (a) differed from one " which would have been adopted by independent enterprises behaving in a commercially rational manner " ; and (b) " practically impede[d] the tax administration from determining an appropriate transfer price " . Rather, the Chief Justice ' s reference to the two exceptions was merely to support the conclusion otherwise reached by his Honour from the text of Subdiv 815-A that the inquiry under s 815-15(1)(c) was one which required a " comparative analysis that gives weight, but not irredeemable inflexibility, to the form of the transaction actually entered between the associated enterprises " : Chevron at [90].

281. Thirdly , notwithstanding that I differ from the primary judge in my understanding of Allsop CJ ' s reasoning in Chevron , I would observe that, if the relevant agreement is one which " differ[ed] from [that] which would have been adopted by independent enterprises behaving in a commercially rational manner " ([C.1.37] of the 1995 Guidelines), then:

  • (1) for the purposes of Div 13: the consideration which might reasonably be expected to have been received for the supply of property under the " international agreement " is unlikely to be reliably established by reference to " an agreement " in the same commercially irrational form;
  • (2) for the purposes of Subdiv 815-A: the commercially irrational agreement might constitute a " condition " operating, or tend to indicate that " conditions operate " , " between the two enterprises in their commercial or financial relations which differ from those which might be expected to operate between independent enterprises dealing wholly independently with one

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    another " such that the question arises under s 815-15(1)(c) whether " an amount of profits which, but for the conditions … might have been expected to accrue to the entity, has, by reason of those conditions, not so accrued " .

DIVISION 815-A

282. The object of Subdiv 815-A so far as presently relevant is set out in s 815-5(a) of the ITAA 1997:

815-5 Object

The object of this Subdivision is to ensure the following amounts are appropriately brought to tax in Australia, consistent with the arm ' s length principle:

  • (a) profits which would have accrued to an Australian entity if it had been dealing at *arm ' s length, but, by reason of non-arm ' s length conditions operating between the entity and its foreign associated entities, have not so accrued; ...

283. Section 815-10 provides for two matters which must be established in order for the Commissioner to make a determination under s 815-30(1):

815-10 Transfer pricing benefit may be negated

  • (1) The Commissioner may make a determination mentioned in subsection 815-30(1), in writing, for the purpose of negating a *transfer pricing benefit an entity gets.

Treaty requirement

  • (2) However, this section only applies to an entity if:
    • (a) the entity gets the *transfer pricing benefit under subsection 815-15(1) at a time when an *international tax agreement containing an *associated enterprises article applies to the entity; or
    • (b) the entity gets the transfer pricing benefit under subsection 815-15(2) at a time when an international tax agreement containing a *business profits article applies to the entity.

284. Relevantly to s 815-10(1), s 815-15 sets out when a taxpayer " gets a transfer pricing benefit " :

815-15 When an entity gets a transfer pricing benefit

Transfer pricing benefit - associated enterprises

  • (1) An entity gets a transfer pricing benefit if:
    • (a) the entity is an Australian resident; and
    • (b) the requirements in the *associated enterprises article for the application of that article to the entity are met; and
    • (c) an amount of profits which, but for the conditions mentioned in the article, might have been expected to accrue to the entity, has, by reason of those conditions, not so accrued; and
    • (d) had that amount of profits so accrued to the entity:
      • (i) the amount of the taxable income of the entity for an income year would be greater than its actual amount; or
      • (ii) the amount of a tax loss of the entity for an income year would be less than its actual amount; or
      • (iii) the amount of a *net capital loss of the entity for an income year would be less than its actual amount.

    The amount of the transfer pricing benefit is the difference between the amounts mentioned in subparagraph (d)(i), (ii) or (iii) (as the case requires).

285. Relevantly to s 815-10(2), the " treaty requirement " in the present case was Art 9 of the Swiss Treaty. Article 9 provided:

Where -

  • (a) an enterprise of one of the Contracting States participates directly or indirectly in the management, control or capital of an enterprise of the other Contracting State; or
  • (b) the same persons participate directly or indirectly in the management, control or capital of an enterprise of one of the Contracting States and an enterprise of the other Contracting State,

and in either case conditions operate between the two enterprises in their commercial or financial relations which differ from those which might be expected

ATC 23785

to operate between independent enterprises dealing wholly independently with one another, then any profits which, but for those conditions, might have been expected to accrue to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly.

286. Section 815-20 provides:

815-20 Cross-border transfer pricing guidance

  • (1) For the purpose of determining the effect this Subdivision has in relation to an entity:
    • (a) work out whether an entity gets a *transfer pricing benefit consistently with the documents covered by this section, to the extent the documents are relevant; and
    • (b) interpret a provision of an *international tax agreement consistently with those documents, to the extent they are relevant.
  • (2) The documents covered by this section are as follows:
    • (a) the Model Tax Convention on Income and on Capital, and its Commentaries, as adopted by the Council of the Organisation for Economic Cooperation and Development and last amended on 22 July 2010;
    • (b) the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, as approved by that Council and last amended on 22 July 2010;
    • (c) a document, or part of a document, prescribed by the regulations for the purposes of this paragraph.
  • (3) However, a document, or a part of a document, mentioned in paragraph (2)(a) or (b) is not covered by this section if the regulations so prescribe.
  • (4) Regulations made for the purposes of paragraph (2)(c) or subsection (3) may prescribe different documents or parts of documents for different circumstances.

287. It was common ground that the 1995 Guidelines were " covered by " s 815-20, having regard to relevant transitional provisions.

288. The real issue in dispute between the parties was the application of paras (b) and (c) of s 815-15(1), namely whether " an amount of profits which, but for the conditions mentioned in [Art 9], might have been expected to accrue to the entity, has, by reason of those conditions, not so accrued " .

289. The first step, required by para (b), is to identify the " conditions " in Art 9, namely what " conditions operate between the two enterprises in their commercial or financial relations which differ from those which might be expected to operate between independent enterprises dealing wholly independently with one another " .

290. The second step, required by para (c), is to identify whether " but for the conditions " in Art 9 an amount of profits might have been expected to, but did not, accrue to the entity.

291. The focus of the inquiry is on whether conditions operated between enterprises in their commercial or financial relations and, if so, what effect those conditions had. As mentioned above, the primary judge approached the task under Subdiv 815-A on the basis that it was not permissible to determine consideration otherwise than by reference to the agreement in fact entered into unless one of the exceptions in the 1995 Guidelines applied. In my view, this fails to give effect to s 815-15(1)(b) and (c) which focus on whether conditions operating between the entities affected the profits which accrued.

292. Unlike the position with respect to Div 13, the 1995 Guidelines are expressly made relevant by the terms of Subdiv 815-A. If one of the exceptions in [C.1.37] of the 1995 Guidelines applied, it would be consistent with the 1995 Guidelines to determine that the effect of Subdiv 815-A in relation to the entity was that it got a transfer pricing benefit under s 815-15 which could be negated under s 815-10. However, for the reasons which follow, I would not take the step taken by the primary judge and conclude that, in all cases where the two exceptions did not apply strictly according to the terms of those exceptions as identified in the 1995 Guidelines, the relevant transaction must always be taken exactly as found.

293.

ATC 23786

Firstly , Subdiv 815-A must be applied according to its terms and one could not give effect to the 1995 Guidelines if to do so would be inconsistent with the terms of the subdivision or would fail to allow its operation according to its terms. Section 815-15(1)(c) is engaged where " an amount of profits which, but for the conditions mentioned in the article, might have been expected to accrue to the entity, has, by reason of those conditions, not so accrued " . If the conclusion were reached that the provision applied, that conclusion should be given effect even if the facts did not strictly fit within one of the two exceptions contained in [C.1.37] of the 1995 Guidelines.

294. Secondly , in any event, I do not read the 1995 Guidelines as specifying that the two situations identified are the only situations which might be regarded as " exceptional " . As noted above, I do not read the decision of the Full Court in Chevron , or the reasons of Allsop CJ specifically, as authority for such a proposition.

295. The primary judge concluded that the terms of the international agreement (and its form or structure) were ones which might reasonably be expected between independent parties, in the position of CMPL and GIAG, dealing with each other at arm ' s length and that the consideration for the supply of copper concentrate under an agreement so structured was arm ' s length. The application of Subdiv 815-A to those facts required the conclusion that no transfer pricing benefit was obtained. The terms under which the copper concentrate was supplied, being conditions operating between CMPL and GIAG in their commercial or financial relations, were shown not to differ from those which might be expected to operate between independent enterprises dealing wholly independently with one another. GIPL discharged its onus of establishing that independent parties in the position of CMPL and GIAG might have been expected to agree to supply the copper concentrate on the terms it was supplied. It was consistent with the 1995 Guidelines to conclude that the effect of Subdiv 815-A was that no transfer pricing was obtained: s 815-20.

296. In the first sentence of [156], Middleton and Steward JJ state that their conclusions with respect to the operation of Div 13 concerning the " substitution " of a different formula or methodology for ascertaining the arm ' s length consideration apply equally to Subdiv 815-A. Their Honours ' conclusions in relation to Div 13 were, in summary, that the Commissioner may substitute clauses which define price, but not those which do not. In my view:

  • (1) If the terms in the agreement which " define price " are arm ' s length terms, it would ordinarily be unlikely that those terms could be said to be " conditions " operating " between the two enterprises in their commercial or financial relations which differ from those which might be expected to operate between independent enterprises dealing wholly independently with one another " . In those circumstances, it is difficult to see how they could rationally be substituted.
  • (2) If the agreement contains terms which do not define price, and which would not be found in the agreement if it had been between independent enterprises dealing wholly independently with one another, it is difficult to see why those terms could not be substituted under Subdiv 815-A. Such terms may well amount to " conditions " operating " between the two enterprises in their commercial or financial relations which differ from those which might be expected to operate between independent enterprises dealing wholly independently with one another " . If such terms affect the consideration payable or receivable, or profits, it is difficult to see why they should not be " substituted " .

297. In my view, the language of Subdiv 815-A does not contemplate or require a distinction between terms which define price (which Middleton and Steward JJ consider can be substituted) and those which do not (which their Honours consider may not be substituted). In this respect, I note that their Honours ' observation at [155] that " the term ' consideration ' [in Div 13] necessarily directs one to identify those clauses in an international agreement which define the price " does not apply to the language of Subdiv 815-A.

298. That is not to say that it is irrelevant to look at the extent to which a particular clause

ATC 23787

affects consideration or profit. That is plainly and directly relevant. The point of difference is simply that what may or may not be " substituted " for the purpose of applying Subdiv 815-A does not turn on a potentially " unsatisfactory " categorisation of contractual clauses as ones which do or do not define price - see [155] of Middleton and Steward JJ ' s reasons for judgment. Subdiv 815-A, in its application to the present case, turns on the question of whether conditions operated " between the two enterprises in their commercial or financial relations which differ from those which might be expected to operate between independent enterprises dealing wholly independently with one another " - see s 815-10(2); Art 9.

299. As to the final sentence of [156], this implicitly acknowledges the possibility that conditions which do not define price may be substituted, a conclusion with which I agree.

CONCLUSION

300. I agree with the orders proposed by Middleton and Steward JJ.

THE COURT ORDERS THAT:

1. The parties are to confer and, if agreement can be reached, provide the Court with orders for final relief within seven days hereof, or failing that, each party shall file written submissions on the issue of the form of final relief limited to 10 pages in length.

Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011 .


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