On 3 September 2019, the Federal Court (at first instance) found in favour of Glencore in its transfer pricing dispute with the ATO, regarding the pricing of copper concentrate supplied by Glencore’s Australian group to its Swiss parent.
The ATO had argued that the actual agreement between the parties was not consistent with what independent parties would have entered into, such that it was at liberty to substitute a different agreement. The ATO’s substituted agreement would have a different method of determining pricing, which would have resulted in more tax being paid in Australia.
The key reason that Glencore prevailed is that it was able to provide fulsome evidence that there were circumstances seen in the open market where unrelated parties had entered similar arrangements. The judge characterised the ATO’s attempt to substitute a different agreement as speculative.
Although this judgment may on the face of it provide a greater degree of comfort to taxpayers that they can rely on the actual agreements they have in place, there was a fairly extensive body of evidence that Glencore had to provide, in order to prevail. Furthermore, the ATO is likely to appeal to the Full Federal Court. If the ATO is victorious on appeal, it is likely to have further flexibility to disregard agreements that related parties have entered into and then substitute alternative arrangements with more favourable pricing.
What were the key facts?
- A subsidiary in Glencore’s Australian subgroup (“Glencore Australia”) sold 100% of the copper concentrate that it produced, at a mine in Cobar, NSW, to its Swiss-resident parent company (“Glencore Switzerland”).
- Prior to 2007, the pricing of the copper concentrate sold by Glencore Australia to Glencore Switzerland was determined under an “offtake agreement” (i.e. an arrangement between a producer and a buyer to purchase or sell a portion of the producer's yet-to-be-produced product) which was structured as a “market-based” agreement.
- In February 2007, the parties changed this agreement to a “price-sharing” basis which had the following features:
- A set cost for ‘treatment and copper refining charges’ (“TCRC”) set at 23% of the copper reference price shown on the London Metals Exchange (“LME”); and
- The price for the copper concentrate would be priced using, as a reference point, the average price shown for copper over a ‘quotation period’ on the LME – which Glencore Switzerland were given options under the agreement to determine the duration of.
The ATO’s argument
The Commissioner took the view that these terms were not consistent with what two parties, acting on an arms-length basis, would enter into.
The Commissioner amended the assessments of Glencore Australia for 2007 through 2009 to effectively return a taxable income figure that would have been made under the previous agreement. Under the amended assessments issued, Glencore Australia would have been required to pay an additional $92 million in taxes and interest. Glencore Australia then objected against those amended assessments, with the dispute finding its way to the Federal Court before Davies J.
Davies J’s decision
Davies J rejected the ATO’s contentions and found favour of Glencore, agreeing that it had discharged its obligations to demonstrate that the agreements were consistent with what arm’s length parties would have agreed:
“It cannot be said that the entry into a price-sharing contract was irrational, having regard to the benefits of such contracts and the market circumstances,”.
With regards to the ATO’s method of arriving at their amended assessment, Davies J stated that what was done by the ATO required:
"fundamentally rewriting the actual arrangement and engaging in an extensive exercise in commercial judgment which does not accord with, or give effect to, the objective of the arm’s length principle”
It is also noteworthy that this case was decided under the previous “Division 13” transfer pricing regime, which existed prior to the comprehensive re-write of Australia’s transfer pricing regime in 2013. The new regime expressly contains “reconstruction” provisions allowing the Commissioner to disregard the actual transaction, and to hypothesise and substitute what it believes are arm's length dealings. The full extent of this express reconstruction power is yet to be tested before the courts, though the Glencore case may well shed some light on how narrow or broad it should be interpreted.
What happens next?
The ATO is currently considering whether or not to appeal the case, though it is widely anticipated that an appeal will be lodged. As such, taxpayers should not yet take full comfort from this outcome, though it is a timely reminder that transfer pricing rules do permit the ATO to override arrangements between related parties which are not seen in the open market, and it may then seek to recreate what it thought would have occurred on an arm’s length basis. This substituted transaction could well be rather different to what the parties had actually agreed to.
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