Glencore Transfer Pricing decision - Draft Impact Statement
TBA member James Strong discusses the Commissioner of Taxation's Draft Decision Impact Statement following the High Court's refusal to grant special leave to appeal in Commissioner of Taxation v Glencore Investments Pty Ltd [2021] HCA Trans 098. A PDF copy of this article is available to download below.
The Commissioner of Taxation (Commissioner) has published a Draft Decision Impact Statement (DIS) following the High Court’s refusal to grant special leave to appeal in Commissioner of Taxation v Glencore Investments Pty Ltd [2021] HCA Trans 098.
The special leave application in Glencore
The Commissioner’s grounds for seeking special leave included that the Full Federal Court in Commissioner of Taxation v Glencore Investments Pty Ltd [2020] FCAFC 187 (Glencore) erred in finding that the taxpayer had discharged its burden of proof - without adducing evidence as to which pricing mechanism was likely to have been entered into between independent parties in the position of the taxpayer and its Swiss affiliate had they dealt with each other at arm’s length in relation to the sale and purchase of copper concentrate from the taxpayer’s mine.
Specifically, Senior Counsel for the Commissioner submitted:
“What is completely missing in this case is evidence about the “needs and risk appetites” of the buyer. What that evidence establishes is that, in the marketplace, some buyers and sellers enter into price-sharing agreements and some do not. It turns upon the “needs and risk appetites” of the counterparties and that matter was not addressed.
In our submission, the proposition now that the transfer pricing provisions can be applied by reference solely to what occurs in the marketplace, without reference to the particular circumstances of the taxpayer that would lead it to the conclusion that it would adopt one of a number of choices is a matter that should be revisited.”
The reasons for the Court refusing special leave were given by the Chief Justice, ex tempore, as follows: “The Commissioner seeks to overturn findings of fact upheld by the Full Court below. In our view no question of principle sufficient to warrant a grant of special leave arises. Special leave is refused.” The context for transfer pricing litigation in Australia
Before examining the Commissioner’s reaction to the decision in Glencore, it is necessary to say a little about the transfer pricing litigation landscape.
At its core, transfer pricing litigation involves examination by the Court of the objective facts which establish whether, and to what extent, the actual conditions which operate between the taxpayer and an offshore related party, in connection with their commercial and financial relations, differ from the conditions which might (reasonably) be expected to operate between independent parties dealing wholly independently with one another in comparable circumstances.
This examination takes place in the context of a challenge by the taxpayer to an assessment by the Commissioner. In that context, the burden is on the taxpayer to persuade the Court, through admissible evidence adduced, that the actual conditions which operated might (reasonably) have been expected to operate in the relevant hypothetical circumstances.
The decision in Glencore and Chevron – a tale of two taxpayers
Glencore is the third significant Australian appellate court decision of the past 10 years regarding transfer pricing - the others being the decisions of the Full Federal Court in Chevron Australia Holdings Pty Ltd v Commissioner of Taxation [2017] FCAFC 62 (Chevron) and in Commissioner of Taxation v SNF Australia Pty Ltd [2011] FCAFC 74.
In Chevron, Chevron Texaco Funding Corporation LLC (CTFC), a United States special-purpose subsidiary of the Australian taxpayer, borrowed funds, at an initial interest rate of 1.2%, by issuing USD-denominated, short-term commercial paper into the United States market supported by a guarantee from Chevron Corporation. CTFC used those funds to advance a 5-year, unguaranteed, AUD-denominated loan to its Australian parent (and head company of the Australian tax consolidated group) at an interest rate of 9%. The loan from CTFC enabled the Australian group to repay two borrowings (one of which was interest-free) owed to other members of the Chevron global group outside Australia. The AUD interest payments on the loan were claimed as deductible in Australia against the Australian group’s operating revenue from the North West Shelf gas project. The receipt of that interest, on the other hand, was not subject to income tax in the United States (as CTFC was not treated as a separate entity from its Australian parent under relevant provisions of the United States Internal Revenue Code Regulations), nor was any Australian interest withholding tax payable (as under s 128F of the Income Tax Assessment Act 1936 (ITAA 1936) such payments were exempt from interest withholding tax). To the extent that the 9% interest income derived by CTFC on the AUD loan exceeded the (initial) 1.2% interest expense on CTFC’s USD commercial paper program plus any foreign exchange losses attributable to adverse movements (from CTFC’s perspective) in the AUD/USD exchange rate, that excess was able to be distributed by CTFC to its Australian parent without United States dividend withholding tax (as CTFC was not treated as a US corporation) and without taxation in Australia (as former section 23AJ of the ITAA 1936 treated the distribution from CTFC as a non- assessable non-exempt dividend receipt of the Australian group).
As observed by Allsop CJ on appeal, consideration was given by the Commissioner to the application of the general anti-avoidance provisions in Part IVA of the ITAA 1936 (Part IVA), however no assessment was raised on that basis. Instead, assessments were raised under the transfer pricing provisions in Division 13 of the ITAA 1936 and the new Subdivision 815-A of the Income Tax Assessment Act 1997 (ITAA 1997). As Pagone J explained on appeal, whereas Part IVA is directed towards cancelling a tax benefit otherwise obtained by the regular application of revenue laws (where the obtaining of that tax benefit was the sole or dominant purpose of a party to the scheme by which it was obtained), the transfer pricing provisions look not to the fiscal motivation of actors, but instead effect a policy that the tax base of a country should not be eroded by means of cross-border transactions with related parties which have the effect of reducing the taxable profit which might reasonably have been expected to arise had an independent parties in the position of the Australian taxpayer and the offshore related party dealt with each other at arm’s length.
The conditions which operated (i.e., the consideration) on the loan from CTFC to the Australian parent included the currency and term of the loan as well as the absence of a Chevron Corporation parental guarantee. The Court accepted evidence that the global Chevron group had a policy (or established practice) of its subsidiary members (including CTFC) obtaining external finance from the market at the “lowest rate possible” and that it was “usual commercial policy” of the group for a guarantee to be provided by Chevron Corporation to support such borrowings.
The Court reasoned that a hypothetical borrower in the position of the taxpayer, as a subsidiary member of a group with that funding policy, might (reasonably) have obtained five-year funding for its Australian operations (in Australian dollars) with the support of a Chevron Corporation parent guarantee. To put this another way, the taxpayer in Chevron was able to satisfy the Court that the relevant hypothetical taxpayer might (reasonably) have obtained a five-year loan denominated in Australian dollars but was unable to discharge its burden of persuading the Court that the loan might (reasonably) have been obtained without a parental guarantee.
In Glencore, the Australian taxpayer and its Swiss related party amended the terms of a long-term, offtake agreement between them for the sale and purchase of copper concentrate from the taxpayer’s mine in Cobar, NSW. Copper concentrate must be treated and smelted into refined copper to be suitable for industrial use. Whereas refined copper is publicly traded on the London Metals Exchange (LME), the market for copper concentrate consists of individual contracts negotiated between miners and their customers (typically smelters or commodity traders). Those contracts typically contain a price mechanism which begins with the quoted LME copper price for a reference period and then makes deductions for notional copper treatment and refining charges (known as TCRC’s), freight plus a margin. In keeping with other base metals, the LME copper price was highly sensitive to market expectations for global growth. The spot market for TCRC’s was also highly volatile and had been known to move in an opposite direction to LME copper price. To manage this risk, it was not uncommon for miners and traders to adopt “price sharing” in the TCRC formula for a portion of the concentrate sold. Under “price sharing”, the TCRC deduction was set at a fixed percentage of the LME copper price. This meant that when LME prices were high, the TCRC’s would increase, thus allowing a greater profit to the trader, conversely, when LME prices decreased, the TCRC would decrease, thus eliminating the risk of an inverse relationship between the TCRC and the price as well as automatically supporting the price obtained by the miner in a falling market.
The existing offtake agreement between the taxpayer and the Swiss trader used a 50/50 split between an annual Japanese benchmark price for the TCRC’s and the use of negotiated spot prices. The amendments to the offtake agreement included moving to 100% “price sharing”, with the TCRC deduction fixed at 23% of the LME copper price for a three-year period 2007-2009 (with no minimum or ‘floor’ price for the TCRC’s). Additionally, the Swiss trader was to be granted increased flexibility to choose the period within which the reference LME price would be set. This was known as “quotation period optionality” and was generally seen as a benefit to the trader. As a further benefit, one of the reference periods the Swiss trader could chose would be a period for which prices were already known (so called ‘back pricing’). At the time of the amendments, the LME copper price was trading at unprecedented record highs, although there was evidence that the price was forecast to fall. The Cobar mine was a high-cost mine (in the top 10% in terms of cash costs globally) and was therefore especially vulnerable to adverse movements in the price obtained for the copper concentrate. The effect of the amendments was to immediately increase the TCRC deduction and therefore decrease the concentrate price received by the Australian miner, in exchange for the prospect of lower TCRC deductions (with no minimum set), and therefore potentially higher relative concentrate prices for the miner in the future, should the LME price fall significantly over the ensuing three-year period.
There was a price to be paid for the Australian miner obtaining this 3-year reduced downside risk. The 2007 Japanese benchmark TCRC price had already been set at US 15.4c/lb for 30% concentrate. This translated to roughly 6.5% of the budgeted copper price in the taxpayer’s 2007 budget for the Cobar mine. For the 2008 and 2009 year, the taxpayer’s budget estimated relative TCRC Japanese benchmark prices of around 9.6% and 9.4% of the forecast copper price respectively. The Commissioner formed the view that agreeing to grant a TCRC allowance to a low-taxed Swiss affiliate equal to 23% of the LME copper price for the next 3 years, when the budgeted forecast TCRC’s over that time were between 6.5% and 9.6%, was not “commercially rational” from the perspective of the Australian taxpayer. The Commissioner’s experts gave evidence that the move to “price sharing with quotational period optionality” (including one period of ‘back pricing’) benefitted the Swiss trader at the expense of the Australian miner and, whilst they conceded an Australian miner might theoretically have entered into such a contract with an independent party, in their view, it was not one which it ought to have entered into in this case. The taxpayer’s expert expressed the contrary view that “price sharing” was a rational and sensible mechanism for a high-cost miner to adopt to protect the profitability of the mine in the event of a collapse in the historically high LME copper price without a corresponding fall in benchmark TCRC prices. He quoted from an industry report which stated that the “normal range” of price sharing observed in the market was for TCRC’s to be set at between 21%-26% of the copper price.
The Commissioner sought to persuade the Court that the Glencore global group had a general policy of “maximising the profit of an asset” (such as the Cobar mine) and of the Glencore group. The Commissioner argued, by analogy with Chevron, that an independent party in the position of the Australian miner, who was a subsidiary of a group with that “profit maximising policy”, would not (reasonably) accept the significantly reduced price in exchange for the reduced risk which the newly agreed terms represented. The Court expressed doubt as to nature of this “so-called policy” and, in any event, did not accept that it would have had the effect of denying an independent party, in the position of the Australian miner, the opportunity to enter into an off-take agreement with100% price sharing, should it so wish. In the circumstances, the Court accepted that the taxpayer had discharged its burden of establishing that a hypothetical seller in the position of the taxpayer, operating a high-cost mine, might (reasonably) have entered into an offtake agreement on terms which reduced the short-term price otherwise available in the market (including through an element of ‘back pricing’), in exchange for a reduction in the taxpayer’s risk of obtaining lower prices over the longer term if the LME reference price were to fall significantly over the next three years.
The taxpayer in Glencore discharged its burden by establishing to the satisfaction of the Court what the hypothetical taxpayer might (reasonably) have done in comparable circumstances. This was far less onerous for the taxpayer than establishing what a hypothetical taxpayer would have done, or even was most likely to have done, given a choice between benchmark pricing and "price sharing".
The depersonalised taxpayer
One aspect of controversy in the decisions in Chevron and Glencore is to what extent a hypothetical person in the position of the taxpayer, in comparable circumstances, is deemed to possess the taxpayer’s attributes as a member of the actual global group - including being affected by the policies (or general practices) of that group.
More specifically, to what extent must the taxpayer adduce evidence that the policies and practices of the global group of which the taxpayer is a member do not have the effect of excluding a particular set of conditions which otherwise might (reasonably) have been entered into by the hypothetical taxpayer in the relevant circumstances?
In Chevron, it was accepted, as an objective fact, that the “usual commercial policy” of the global group of which the hypothetical taxpayer was deemed to be a member, was that the parent company would support external borrowings by subsidiary members with a guarantee.
In Glencore, no examination was undertaken as to the “usual commercial policy” of the global Glencore group viz a viz de-risking the profitability of its high-cost, base metal production assets by entering into “price sharing” agreements with third parties and thereby forgoing a significant portion of upside profit potential from those assets. Had such a specific policy existed, it may well have been relevant. This raises the possibility that a taxpayer might make a forensic decision not to introduce such evidence.
The Commissioner’s unsuccessful argument before the High Court was that the taxpayer did not lead evidence to show what risk posture a hypothetical subsidiary of the Glencore group (or a group possessing the equivalent risk posture to that of Glencore) was likely to have adopted in comparable circumstances. If the taxpayer is not obliged to lead evidence of the existence of a group policy which, if applied, would materially affect the commercial decisions of the hypothetical taxpayer, the impetus will be on the Commissioner to try to obtain such evidence. Unlike information which exists in Australia, offshore information remains outside the reach of the Commissioner’s compulsory information gathering powers. If the taxpayer declines to provide adequate responses to the relevant offshore information notice, the Commissioner may be left to rely on more cumbersome and less satisfactory information exchange protocols in Australia’s double taxation treaty network.
Decision Impact Statement
In the DIS, the Commissioner:
- noted the High Court’s observation that in challenging the decision of the Full Federal Court he sought to overturn a relevant finding of fact; - stated that he does not accept that the reasons of the majority in Glencore (at [187]) represent a change in the application of the relevant legal principles applied in Chevron regarding the degree of ‘depersonalisation’ of the hypothetical taxpayer; - noted that the ‘totality of the available evidence’ must be carefully examined in order to best establish what conditions that might (reasonably) have been expected to operate in the hypothetical construct in any given case; - noted that this might include evidence about all of the relevant objective circumstances of the actual parties in the actual market at the relevant time, relevant group policies, how the taxpayer and its group might have contemporaneously dealt with third parties for the same or similar transactions, the prevailing contemporaneous practices in the relevant industry and what other independent entities in the same or similar contemporaneous circumstances as the parties might (reasonably) have been expected to have done; - noted that it may not be sufficient for a taxpayer to rely solely on expert opinion of what independent parties in the same industry might (reasonably) have done, depending on the totality of the evidence available – referencing the comments of the majority in Glencore (at [180] and [191]) that evidence about Glencore’s policies or risk appetite might have also been relevant had it been before the Court; - emphasised that third party agreements between industry participants that were not “truly comparable” cannot be relied on as determinative of the statutory test in transfer pricing cases; - highlighted that Glencore was not a case about ‘reconstruction’ - as the alternative pricing mechanisms in the offtake agreement all formed part of the consideration for the supply for the purposes of Division 13 and/or the conditions that operated for the purposes of Subdivision 815- A. - noted that there were textual differences between the statutory language of Division 13/Subdivision 815-A and that of Subdivision 815-B ITAA 1997 including that:
(a) section 815-215 within Subdivision 815-B defines the "arm’s length conditions” with specific reference to independent parties dealing wholly dependently with one another in ‘comparable circumstances’ (and included a non-exhaustive list of factors to which regard must be had in identifying those ‘comparable circumstances’; and
(b) section 815-130 within Subdivision 815-B establishes a framework of a ‘basic rule’ and three ‘exceptions’ for how the arm’s length conditions are to be identified and in which particular circumstances those conditions are to be based on the ‘actual commercial or financial relations’ (and by inference, in which circumstances the ‘actual commercial or financial relations’ can be reconstructed or replaced by the Commissioner in determining the arm's length conditions).
Given the complexity of the factual and legal issues involved, combined with the new law in the form of Subdivision 815-B, it seems that a fourth instalment in the transfer pricing litigation saga is only a matter of time. Many people consider that Episode IV is often the best of a particular series, so we await the next instalment with more than the usual sense of anticipation.
By James Strong, Barrister
Liability limited by a scheme approved under Professional Standards Legislation
Tax Bar Association - Glencore Special Leave and ATO decision impact statement
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