Glencore Investment Pty Ltd v Commissioner of Taxation of the Commonwealth of Australia
[2019] FCA 1432
•3 September 2019
FEDERAL COURT OF AUSTRALIA
Glencore Investment Pty Ltd v Commissioner of Taxation of the Commonwealth of Australia [2019] FCA 1432
File numbers: NSD 1679 of 2017
NSD 1900 of 2017
NSD 1956 of 2017Judge: DAVIES J Date of judgment: 3 September 2019 Catchwords: TAXATION – transfer pricing – appeal from objection decisions of Commissioner of Taxation – amended assessments raised pursuant to Div 13 of Income Tax Assessment Act 1936 (Cth) and Subdiv 815-A of Income Tax Assessment Act 1997 (Cth) – related party international dealing – non-arm’s length dealing for the purposes of Div 13 – for the purposes of Subdiv 815-A
conditions operating between two enterprises in their commercial and financial relations differing from those which might be expected to operate between independent enterprises dealing wholly independently – whether consideration paid to applicant by parent company for supply of copper concentrate within arm’s length range (Div 13) – whether profits did not accrue which might have been expected to accrue but for non-arm’s length conditions (Subdiv 815-A) – contract structured as “price sharing” agreement – adjustments made by Commissioner
based on hypothesis of market-related contract – whether permissible to restructure contract as a market-related contract for the purposes of applying transfer pricing provisions – identification of hypothetical transaction for comparative analysis – Chevron Australia Holdings Pty Ltd v Federal Commissioner of Taxation (2017) 251 FCR 40 – 1995 OECD Guidelines “Recognition of the actual transactions undertaken” – no warrant to restructure agreement – price sharing and quotational period terms in comparable transactions between independent parties –
price sharing percentage within an arm’s length range – no discount required for quotational period optionality back pricing term – onus of proof discharged – appeal allowedEVIDENCE – role of expert witnesses
Legislation: Evidence Act 1995 (Cth) s 79
Income Tax Assessment Act 1936 (Cth) ss 136AA, 136AC, 136AD
Income Tax Assessment Act 1997 (Cth) ss 701-1, 815-5, 815-10, 815-15, 815-20, 815-30, 815-40, 995-1
Income Tax (Transitional Provisions) Act 1997 (Cth) ss 815-1, 815-5, 815-15
Taxation Administration Act 1953 (Cth) s 14ZZ
Tax Laws Amendment (Cross-Border Transfer Pricing Act) (No 1) 2012 (Cth)
Cases cited: Cameco Corporation v The Queen (2018 TCC 195)
Channel Pastoral Holdings Pty Ltd v Federal Commissioner of Taxation (2015) 232 FCR 162; [2015] FCAFC 57
Chevron Australia Holdings Pty Ltd v Federal Commissioner of Taxation (No 4) (2015) 102 ATR 13; [2015] FCA 1092
Chevron Australia Holdings Pty Ltd v Federal Commissioner of Taxation (2017) 251 FCR 40; [2017] FCAFC 62
Commissioner of Taxation v SNF (Australia) Pty Ltd (2011) 193 FCR 149; [2011] FCAFC 74
SNF (Australia) Pty Ltd v Commissioner of Taxation (2010) 79 ATR 193; [2010] FCA 635
W R Carpenter Holdings Pty Ltd v Federal Commissioner of Taxation (2008) 237 CLR 198; [2008] HCA 33
Date of hearing: 5-7, 10-14, 17-19 December 2018 Registry: New South Wales Division: General Division National Practice Area: Taxation Category: Catchwords Number of paragraphs: 405 Counsel for the Applicant: Mr J de Wijn QC with Ms T Phillips and Ms C Horan Solicitor for the Applicant: King & Wood Mallesons Counsel for the Respondent: Ms K Stern SC with Ms M Baker and Ms C Pierce Solicitor for the Respondent: Australian Government Solicitor ORDERS
NSD 1679 of 2017
NSD 1900 of 2017
NSD 1956 of 2017BETWEEN: GLENCORE INVESTMENT PTY LTD ABN 67 076 513 034
Applicant
AND: THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA
Respondent
JUDGE:
DAVIES J
DATE OF ORDER:
3 SEPTEMBER 2019
THE COURT ORDERS THAT:
Subject to the parties advising the Court otherwise within seven days, the following orders will be made:
1.The objection decisions be set aside.
2.The objections be allowed.
3.The amended assessments for the income years ended 30 June 2007, 30 June 2008 and 30 June 2009 be set aside.
4.The respondent pay the costs of the applicant, such costs to be taxed in default of agreement.
Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.
REASONS FOR JUDGMENT
INTRODUCTION
[1]
HOW THE COPPER CONCENTRATE WAS PRICED IN THE RELEVANT YEARS
[2]
RELEVANT STATUTORY/TREATY PROVISIONS
[7]
Division 13 of the ITAA 1936
[8]
Subdivision 815-A
[13]
The anti-overlap rule
[27]
THE COMPETING CASES
[28]
CHEVRON
[36]
THE ARM’S LENGTH PRINCIPLE
[48]
THE TAXPAYER’S EVIDENCE
[50]
David Kelly
[51]
Richard Wilson
[54]
Tony Samuel
[58]
THE COMMISSIONER’S WITNESSES
[59]
Leonard Kowal
[63]
David van Homrigh
[64]
JOINT EXPERT REPORTS
[65]
THE COPPER CONCENTRATE MARKET
[67]
Copper concentrate
[68]
The custom concentrate market
[69]
Pricing of copper concentrate
[72]
Copper metal price
[74]
Quotational periods
[75]
TCRCs
[78]
Price participation
[81]
Price sharing agreements
[82]
The spot market
[88]
Other components of a copper concentrate contract
[89]
The payable metal or copper payable in the copper concentrate
[90]
Freight and insurance costs
[91]
Payment terms
[92]
MARKET KNOWLEDGE
[93]
COPPER MARKET LEADING UP TO 2007
[96]
BACKGROUND FACTS ABOUT GLENCORE
[104]
The Group’s activities
[105]
Glencore’s marketing division
[106]
Glencore’s copper concentrate business
[107]
THE CSA MINE
[111]
MINING COSTS
[121]
THE CONTROL EXERCISED BY GIAG OVER THE CSA MINE
[126]
BUDGETS
[133]
FINANCIAL PERFORMANCE OF THE MINE IN 2006
[134]
2007 BUDGET
[137]
JANUARY 2007 MANAGEMENT REPORT
[147]
2007 REVIEW IN THE 2008 BUDGET AND FIVE YEAR PLAN
[149]
PROJECTIONS WITH 23% PRICE SHARING AGREEMENT
[151]
TERMS AND CONDITIONS UPON WHICH COPPER CONCENTRATE WAS SUPPLIED BY CMPL TO GIAG
[162]
MR KELLY’S EVIDENCE ABOUT THE LOGISTICS AND RISKS FOR CMPL IN SELLING ITS COPPER CONCENTRATE IN THE PERIOD 2006 TO 2009, IF INDEPENDENT OF GIAG
[172]
MINING INDUSTRY EXPERT EVIDENCE
[184]
Joint mining industry experts’ report
[185]
Mr Wilson’s evidence
[193]
Price sharing
[195]
Quotational period optionality
[206]
Mr Ingelbinck’s evidence
[215]
Price sharing
[224]
Quotational period optionality with back pricing
[229]
Mr Kowal’s evidence
[237]
Price sharing agreement
[239]
Quotational period optionality with back pricing
[240]
FINANCIAL EXPERTS REPORTS
[243]
OFFTAKE AGREEMENTS
[249]
Contracts with price sharing mechanisms
[253]
Jiangxi Contract
[254]
Redbank Contract
[255]
Red Earth Contract
[259]
Tritton Contract
[261]
PTFI/PASAR Contract
[263]
BMAG-Tintaya Contract
[267]
Other price sharing agreements referred to in the Brook Hunt Report
[272]
Copper concentrate contracts with back pricing optionality
[277]
Barminco Contract
[279]
Peak Gold Contract
[288]
Erdenet Contract
[290]
Montana Contract
[293]
Oxiana Golden Grove Contract
[295]
Oxiana Jaguar Contract
[301]
BMAG-Tintaya Contract
[305]
“COMPARABLE” CONTRACTS
[307]
THE TASK
[309]
PRICE SHARING HYPOTHETICAL
[343]
Price sharing percentage
[346]
Quotational period optionality
[355]
Freight and provisional payments
[371]
CONCLUSION
[382]
THE COMMISSIONER’S CASE
[385]
SINGLE ENTITY RULE
[399]
PENALTIES
[401]
OBSERVATIONS ON THE EXPERTS’ EVIDENCE
[402]
CONCLUSION
[405]
DAVIES J:
INTRODUCTION
The applicant (“the taxpayer”) has appealed pursuant to s 14ZZ(1)(b) of the Taxation Administration Act 1953 (Cth) against objection decisions made by the respondent (“the Commissioner”) disallowing the taxpayer’s objections to amended assessments issued to it for the 2007, 2008 and 2009 income years (“the relevant years”). The taxpayer was assessed as the head of a multiple entry consolidated (“MEC”) group for Australian tax purposes, of which Cobar Management Pty Ltd (“CMPL”) is a member. In the relevant years, CMPL, which managed and operated the CSA mine in Cobar, New South Wales, sold 100% of the copper concentrate produced at the CSA mine to its Swiss parent, Glencore International AG (“GIAG” or “Glencore”). The amended assessments were raised by the Commissioner in the exercise of his powers under Div 13 of the Income Tax Assessment Act 1936 (Cth) (“ITAA 1936”) and Subdiv 815-A of the Income Tax Assessment Act 1997 (Cth) (“ITAA 1997”) on the basis that the consideration paid by GIAG to CMPL for the copper concentrate in the relevant years was less than the consideration that might reasonably be expected to have been paid in an arm’s length dealing between independent parties. The amended assessments included in the taxpayer’s assessable income additional amounts of $49,156,382 (2007), $83,228,784 (2008) and $108,675,756 (2009) referrable to the consideration which the Commissioner considered would constitute an arm’s length consideration for the copper concentrate that CMPL sold to GIAG in each of the relevant years, increasing the tax payable for the 2007 year by $14,746,914.60, for the 2008 year by $13,748,585.40 and for the 2009 year by $43,822,776.60, plus shortfall interest charges were imposed for each of the relevant years in the amounts of $6,043,704.90 (2007), $4,355,479.48 (2008) and $9,959,152.29 (2009).
HOW THE COPPER CONCENTRATE WAS PRICED IN THE RELEVANT YEARS
The CSA mine was acquired by the Glencore Group in 1998 and CMPL has been operating and managing the mine since 1999, following recommencement of mining operations. GIAG purchases all the copper concentrate produced at the mine which it then trades, mostly to smelters. The purchases have been under a series of life of mine offtake agreements, the first of which was entered into between GIAG and CMPL in mid-1999 and which has since been amended and replaced from time to time.
Up until February 2007, the offtake agreements were structured as “market-related” agreements. In February 2007, CMPL and GIAG entered into a fundamentally different form of offtake agreement (“the February 2007 Agreement”), known in the copper concentrate industry as a “price sharing agreement”. The contractual terms are considered in greater detail later in these reasons but, for present purposes, it is sufficient to note that the copper concentrate which CMPL sold to GIAG in the relevant years was priced by using, as a reference point, the official London Metal Exchange cash settlement price for copper grade “A” averaged over “the quotational period”. The “quotational period” was, at GIAG’s option, either linked to the month of shipment of the copper concentrate from the loading port of embarkation or the month of arrival of the copper concentrate at the port of disembarkation. Within either alternative, GIAG had the option to elect one of three quotational periods to be declared prior to each shipment from the loading port, at which time GIAG would be aware of the average copper prices in (at least) one of the periods from which it was to make its selection (known in the copper concentrate industry as “quotational period optionality with back pricing”). A deduction was then made from the copper reference price for treatment and copper refining charges (“TCRCs”) which, for the calendar years 2007, 2008 and 2009, were fixed at 23% of the copper reference price (as calculated) for the payable copper content of the copper concentrate. In the copper concentrate industry, the fixing of the TCRC deduction as a percentage of the copper reference price is known as “price sharing”.
The amended assessments that were issued to the taxpayer incorporated two sets of adjustments:
·adjustments to remove the effect of the 23% price sharing mechanism and to replace it with 50% benchmark/50% spot TCRCs which the Commissioner identified as the “rate previously used by CMPL”; and
·adjustments to reflect the impact of a “consistently applied quotational period”.
The adjustments made by the Commissioner reflect the Commissioner’s primary case that the February 2007 Agreement was a non-arm’s length dealing which favoured GIAG to the detriment of CMPL, and that an independent mine producer with CMPL’s characteristics would not have agreed to price sharing at all or to quotational periods with back pricing optionality and, instead, might reasonably have been expected to have sold its production in the relevant years under a life of mine agreement on market-related terms and limited quotational period optionality with no back pricing. The Commissioner contended that as the evidence did not establish that the consideration that CMPL was paid for its copper concentrate in the relevant years was equal to or more than the consideration that might reasonably be expected to have been paid, had the copper concentrate been sold on such terms, the taxpayer had failed to discharge its onus of proof.
For the reasons that follow, I have rejected the Commissioner’s primary case as a misapplication of the provisions of Div 13 and Subdiv 815-A and found on the evidence that the consideration that CMPL was paid for its copper concentrate under the February 2007 Agreement in the relevant years was within an arm’s length range. As the taxpayer discharged its onus of proving that the amended assessments are excessive, the appeal from the Commissioner’s objection decisions should be allowed.
RELEVANT STATUTORY/TREATY PROVISIONS
The Commissioner relied on the provisions of both Div 13 of the ITAA 1936 and Subdiv 815‑A of the ITAA 1997 in making the amended assessments for the relevant years.
Division 13 of the ITAA 1936
Although Div 13 of the ITAA 1936 is now repealed, it was operative in the years in question. Section 136AD of the ITAA 1936 relevantly provided as follows:
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.
…
(4) For the purposes of this section, where, for any reason (including an insufficiency of information available to the Commissioner), it is not possible or not practicable for the Commissioner to ascertain the arm’s length consideration in respect of the supply or acquisition of property, the arm’s length consideration in respect of the supply or acquisition shall be deemed to be such amount as the Commissioner determines.
Relevant definitions were set out in s 136AA of the ITAA 1936, as follows:
(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.
…
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
(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;
(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;
…
(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.
Section 136AC of the ITAA 1936 was in the following terms:
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.
For each of the relevant years, the Commissioner made determinations both under s 136AD(1) and s 136AD(4).
The application of these provisions requires a comparison between the consideration for the property supplied (or acquired) with the arm’s length consideration (as defined) of a comparable hypothetical agreement: Chevron Australia Holdings Pty Ltd v Federal Commissioner of Taxation (2017) 251 FCR 40; [2017] FCAFC 62 (“Chevron”) at [17] per Allsop CJ and [119] per Pagone J. The need to posit a hypothetical agreement is for the purpose of ascertaining the arm’s length consideration, which, fundamentally, is a factual inquiry into what might reasonably be expected to have been paid or received by way of consideration, if the actual agreement had been unaffected by the lack of independence and the lack of arm’s length dealing. That factual inquiry must be based upon, and supported by, probative evidence including, where appropriate, expert opinion in order to identify a reliable substitute consideration for the actual consideration which was given or received: Chevron at [42], [50], [62] (Allsop CJ), [121], [126], [127] (Pagone J).
Subdivision 815-A
Subdivision 815-A of the ITAA 1997 was enacted in 2012 by the Tax Laws Amendment (Cross‑Border Transfer Pricing Act) (No 1) 2012 (Cth) but was made to apply retrospectively to income years starting on or after 1 July 2004: s 815-1 of the Income Tax (Transitional Provisions) Act 1997 (Cth) (“Transitional Act”). Subdivision 815-A was subsequently replaced by Subdivs 815‑B to 815-D for income years commencing on or after 29 June 2013: s 815‑1(2), s 815-15 of the Transitional Act.
The relevant object of Subdiv 815-A is set out in s 815-5(a) as follows:
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;…
Section 815-10(1) empowers the Commissioner to make a determination under s 815-30(1) for the purpose of negating a “transfer pricing benefit”. The determinations which the Commissioner can make under s 815-30(1) include, relevantly, the determination of an amount by which the taxable income of a taxpayer is increased: s 815-30(1)(a). The Commissioner made such a determination for each of the relevant years in question.
Section 815-15 sets out what constitutes a “transfer pricing benefit”. It provides:
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).
By s 815-10(2), s 815-10(1) only applies to an entity if the entity gets the “transfer pricing benefit” at a time when an international agreement containing an associated enterprises article or business profits article applies to the entity. Section 815-10(2) provides:
Transfer pricing benefit may be negated
…
(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.
An “associated enterprises article” is defined by s 995-1 and s 815-15(5) of the ITAA 1997 as:
(a) Article 9 of the United Kingdom convention (within the meaning of the International Tax Agreements Act 1953); or
(b) a corresponding provision of another *international tax agreement.
In the present case there is an applicable international agreement, namely the Agreement between Australia and Switzerland for the Avoidance of Double Taxation with Respect to Taxes on Income, and Protocol [1981] ATS 5 (“the Swiss Agreement”).
Article 9 of the Swiss Agreement is in substantially the same terms as Art 9 of the United Kingdom Convention and, at the relevant time, provided as follows:
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 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.
Section 815-20 of the ITAA 1997 provides that:
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.
The effect of s 815-20(1) of the ITAA 1997 was modified by s 815-5 of the Transitional Act which states that, despite s 815-20, for an income year that starts before 1 July 2012, the documents to which s 815-20 is taken to be referring are:
·the Model Tax Convention on Income and Capital and its Commentaries, as adopted by the Council of the Organisation for Economic Cooperation and Development (“OECD”); and
·the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, in each case as last amended before the start of the income year.
In the present case, thus, the relevant OECD Transfer Pricing Guidelines are the 1995 Guidelines (as updated in 1999) (“the 1995 Guidelines”) and the relevant OECD Model Convention is the Model Convention that was in place before each of the relevant years.
These provisions were also the subject of consideration by the Full Court in Chevron. The “conditions” referred to in Art 9 are those conditions existing between the two enterprises affecting their financial or commercial operations which differ from those which might be expected to operate between independent enterprises dealing wholly independently with one another: Chevron at [82] (Allsop CJ), [153] (Pagone J). Allsop CJ described the word “conditions” in Art 9 as “broad and flexible” and, as Pagone J noted at [153], the relations existing between the enterprises are apt to be conditions that potentially operate upon the dealings between, and which bear upon, the inquiry whether there are such conditions operating between the two enterprises which differ from those that might be expected to operate between independent parties dealing wholly independently with one another.
Article 9 is the gateway to the application of Subdiv 815-A. That is, s 815-15 only applies if relevant conditions have been identified which 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: s 815‑15(1)(b). If so, the issue then is whether there are 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: s 815-15(1)(c). For that purpose it is necessary to hypothesise what profits “might have been expected to accrue” if the conditions in Art 9 were not present, assessed by reference to a comparable transaction to the actual transaction but one which is between independent enterprises dealing wholly independently with one another. Like Div 13, the hypothesis for the purposes of the application of Subdiv 815-A is an agreement which is not affected by the lack of independence and the lack of arm’s length dealing. The hypothetical thus requires hypothesising circumstances in a dealing where the conditions engaging the application of Art 9 to the enterprise are excluded and the conditions operating between them were as between independent parties dealing wholly independently with each other: Chevron per Pagone J at [156].
Section 815-15(1)(c) requires a comparison of two amounts – the amount of actual profits which accrued to the entity and the amount of profits which might have been expected to have accrued to the entity but for the “conditions”. For s 815-15(1)(c) to operate to permit Australia to impose tax on related party international agreements on a hypothesised arm’s length profit, there must be a causal relationship between the “conditions” referred to in Art 9 and “an amount of profits which…might have been expected to accrue to the entity” but which has not so accrued “by reason of those conditions”: Chevron at [81] (Allsop CJ), [155] (Pagone J). That causal relationship is posited by the “but for” test – namely, that an amount of profits had not accrued which might have been expected to accrue to the taxpayer but for the non-arm’s length conditions mentioned in Art 9. The function of the test prescribed by s 815-15(1)(c) thus is to determine whether the non-arm’s length dealing had the causative effect of reducing the amount of profits that would otherwise have been expected to accrue. If and to the extent that it does, the section operates to bring to account to tax those profits which did not accrue by reason of the non-arm’s length conditions by removing the causative effect of those conditions on the profits which the entity might reasonably be expected to have accrued but for those conditions.
The requirement in s 815-15(1)(c) that the amount be calculated by reference to what “might have been expected” involves a predictive exercise, similar to that required by the provisions of Div 13. Although the word “reasonably” is missing from s 815-15(1)(c), there nonetheless must be a sufficiently reliable evidentiary basis to support the hypothesis of an amount of profits that “might have been expected” to accrue to the taxpayer and for that hypothesis to be supported, the predictive evaluation of an amount of profits that “might have been expected” to accrue to the taxpayer must be one that is more than a mere possibility. In other words, although Subdiv 815-A does not use the word “reasonably”, the standard of reasonableness is founded in the evidentiary basis required to support the hypothesis.
The anti-overlap rule
Section 815-40 of the ITAA 1997 precludes double taxation arising from the simultaneous operation of Div 13 and Subdiv 815-A. Section 815-40 provides:
815-40 No double taxation
(1) The amount of a *transfer pricing benefit that is negated under this Subdivision for an entity is not to be taken into account again under another provision of this Act to increase the entity’s assessable income, reduce the entity’s deductions or reduce a *net capital loss of the entity.
(2) Subsection (1) has effect despite former section 136AB of the Income Tax Assessment Act 1936.
THE COMPETING CASES
It was not in issue for the purposes of Div 13 that CMPL and GIAG did not deal at arm’s length with each other in relation to the supply of copper concentrate on the terms of the February 2007 Agreement. Nor was it in issue for the purposes of Art 9(a) of the Swiss Agreement and consequently Subdiv 815-A that GIAG, an enterprise of Switzerland, participated, directly or indirectly, in the management, control or capital of CMPL, an enterprise of Australia.
The taxpayer’s primary case was that, unlike in Chevron where the terms of the loan diverged from terms which might be expected between independent parties dealing at arm’s length with each other, the terms governing pricing under the contractual arrangements which applied to the 2007, 2008 and 2009 years were terms that existed in contracts for the sale of copper concentrate between independent market participants and were thus terms that might be expected to be found in an agreement between the relevant hypothetical parties. The taxpayer submitted that the task of the Court was to determine:
(a)whether the agreed price sharing percentage of 23% was one that might be expected to be agreed between independent parties in an arm’s length transaction or within the range of price sharing percentages that might be expected to be agreed between independent parties in an arm’s length transaction; and
(b)if so, to what extent it might be expected that there be a discount allowed for quotational period optionality by independent parties in an arm’s length transaction.
On the Commissioner’s case, the hypothetical transaction should not be constrained by the actual terms under which CMPL supplied copper concentrate to GIAG in the relevant years. Those terms, on the Commissioner’s case, were explicable by reference to GIAG’s relational and financial control of CMPL. It was submitted that to constrain the hypothetical transaction to one which adopted price sharing for three years as the mechanism for determining the deductions from price to reflect TCRCs was unrealistic, artificial and contrary to the purpose of the transfer pricing provisions and would result in “a commercially unrealistic outcome…controlled by the taxpayer”.
The Commissioner argued that the evidence did not establish that an independent mine producer with the characteristics of CMPL might be expected to have agreed to price sharing in early 2007 or at any time in the relevant years and the Court should reject the taxpayer’s contention that price sharing was to be taken as the pricing mechanism for three years in order to postulate the statutory hypothesis. It was submitted that, accordingly, this case may not and should not be resolved by determining whether the 23% price sharing was a split which might be expected to have applied in a hypothetical transaction between independent parties for the sale and purchase of copper concentrate. A corollary argument advanced was that the evidence was that long-term contracts for the sale of copper concentrate were often renegotiated at least annually to reflect changing market conditions and the failure to renegotiate terms as to price over a three year period was itself “a consequence of the distortion of commercial reality brought about by the lack of independence between CMPL and GIAG”.
The Commissioner additionally submitted that the evidence did not establish that a hypothetical mine producer with CMPL’s characteristics would have agreed to the quotational period optionality term which appears in the February 2007 Agreement. It was submitted that the only possible impact of that term would be to the detriment of the mine producer and to the benefit of the trader and there would be no reason for the hypothetical mine producer, bearing in mind the market in February 2007 and the reliable production that CMPL had experienced over the years, to agree to such terms.
The Commissioner identified the hypothetical transaction for the purposes of both Div 13 and Subdiv 815-A to be a long‑term contract, originally dated July 1999 and amended and continued from time to time, between independent parties with the characteristics of CMPL and GIAG, for the sale of 100% of the copper concentrate for the life of the mine with terms as to price to be negotiated and amended as between the parties on an annual basis to reflect market conditions, including changing benchmark terms and the commercial needs of the parties.
In response to the Commissioner’s case, the taxpayer argued that there was no basis in fact or in law to assume a wholly different agreement for the sale of copper concentrate to that which the parties in fact agreed. In the alternative it was argued that if it was open to the Court in the circumstances of this case to disregard the actual terms upon which the copper concentrate was supplied in 2007, 2008 and 2009 for the purposes of the hypothesis (which was disputed), the evidence nonetheless demonstrated that an arm’s length seller with CMPL’s characteristics might reasonably have been expected to have entered into a price sharing agreement in similar terms to the February 2007 Agreement.
The competing cases of the parties require determination as to whether the hypothetical agreement for the purposes of the comparative analysis is to be a price sharing contract (as the taxpayer contended) or a market-related contract (as the Commissioner contended). The type of contract is important as the calculation of the TCRCs is an integer in the pricing of the copper concentrate under either type of agreement but the deduction from the copper reference price for TCRCs is calculated very differently under a price sharing contract to the way in which the deduction for TCRCs is calculated under a market-related contract, and so there will be differences in the pricing of copper concentrate depending on which methodology is employed. Thus, the application of the statutory provisions will depend (at least in the first instance) on whether the consideration is to be determined on the hypothesis of an agreement in which the deduction for TCRCs is calculated as a percentage of the referenced copper price or by reference to market-based benchmark/spot terms.
CHEVRON
As both parties submitted that their competing positions were supported by the Full Court decision in Chevron, it is necessary to examine that case in more detail before considering the evidence and the application of Div 13 and Subdiv 815-A.
The facts in Chevron can be stated succinctly. The appellant (“CAHPL”), an Australian company, obtained a loan from its US subsidiary, without giving security or financial or operational covenants, at an interest rate of 9% pursuant to a credit facility agreement. The Commissioner assessed CAHPL pursuant to Div 13 and Subdiv 815-A on the basis that the interest exceeded the arm’s length consideration that might reasonably have been expected in an agreement between independent parties. At first instance (Chevron Australia Holdings Pty Ltd v Federal Commissioner of Taxation (No 4) (2015) 102 ATR 13; [2015] FCA 1092 (“Chevron at first instance”)) CAHPL’s case was that the statutory direction that the arm’s length consideration be compared with its actual consideration required its loan to be priced. In other words, what had to be priced was a loan without security or covenants to be given by a commercial lender to a borrower such as CAHPL with its credit rating and as a standalone entity. The primary judge rejected that contention, holding at [76] that what was required was “to depersonalise the agreement… so as to make it, hypothetically, between independent parties dealing at arm’s length”. In addressing the comparison directed by Div 13, his Honour also rejected the Commissioner’s contention that terms different from those of the actual agreement could be taken into account, holding that Div 13 did not require or authorise the creation of an agreement with terms different from those of the actual agreement. The primary judge found at [87] that the absence of security and operational and financial covenants given by CAHPL for the loan would have affected the interest rate, which was higher in the absence of such security and covenants and, had the loan been made under an agreement between independent parties dealing at arm’s length with each other, the borrower would have given such security and covenants and the interest rate, as a consequence, would have been lower. It was accordingly held that CAHPL had not shown that the arm’s length consideration assessed by the Commissioner was excessive. On appeal, the Full Court affirmed the approach of the primary judge.
Allsop CJ stated at [46] that the statutory hypothesis is one directed to a reasonable expectation as to what consideration would be given by the party in the position of the taxpayer. In that case, the task was to identify from the evidence the consideration that might reasonably be expected to have been given or agreed to be given by a party in the position of CAHPL in respect of obtaining a five year loan if the parties to the agreement were independent from each other and dealing at arm’s length, compared to the consideration actually given by the CAHPL. In that case the evidence was that CAHPL was part of a group that had a policy to borrow externally at the lowest cost and a policy that the parent will generally provide a third party guarantee for a subsidiary that is borrowing externally. His Honour said that in those circumstances, the consideration that might reasonably be expected to be given by a company in the position of CAHPL would be an interest rate hypothesised on the giving of a guarantee of CAHPL’s obligations to the lender by a parent such as Chevron.
With respect to Subdiv 815-A, Allsop CJ stated at [82] that the notion of conditions in Art 9 refers to the circumstances or environment that can be seen to operate between the two enterprises in their commercial or financial relations which are different to the circumstances or environment which would operate between independent enterprises. The inquiry then for the purposes of s 815-15(1)(c) is what “amount of profits” might have been expected to accrue, but did not accrue by reason of those conditions. His Honour observed that s 815-15(1)(c) posits “a causal relationship between the ‘conditions’ referred to in Art 9 and ‘an amount of profits which ... might have been expected to accrue to the entity’ but which has not so accrued ‘by reason of those conditions’”. His Honour had regard to the discussion in the 1995 Guidelines as assisting in understanding the nature of that causal inquiry. At [90], Allsop CJ stated that these passages illuminated that the causal test in s 815-15(1)(c) is a “flexible comparative analysis that gives weight, but not irredeemable inflexibility, to the form of the transaction actually entered between the associated enterprises”. His Honour stated that:
A degree of flexibility is required especially if the structure and detail of the transaction has been formulated by reference to the group relationship and a “tax-effective” outcome (even if, as here, one that is not said to be illegitimate). The form of that transaction may, to a degree, be altered if it is necessary to do so to permit the transaction to be analysed through the lens of mutually independent parties.
The Commissioner relied on that passage to contend that the causal inquiry directed by s 815‑15(1)(c) concerning the conditions and profits which might have but did not accrue to the taxpayer should be undertaken flexibly. However, that contention is based on a misreading of his Honour’s reasons at [90]. Paragraph [90] must be read in the context of the discussion starting at [81], and it is worth setting out [81]-[91] in full:
81.Paragraph (c) of s 815-15(1) is central. It posits a causal relationship between the “conditions” referred to in Art 9 and “an amount of profits which ... might have been expected to accrue to the entity” but which has not so accrued “by reason of those conditions”.
82.The notion of conditions in Art 9 refers to the circumstances or environment that can be seen to operate between the two enterprises in their commercial or financial relations which are different to the circumstances or environment which would operate between independent enterprises. The word “conditions” is broad and flexible…
83.That condition or these conditions operated between CAHPL and CFC in their financial relations and was or were manifested in the Credit Facility. The inquiry then for the purposes of s 815-15(1)(c) is what “amount of profits” might have been expected to accrue, but did not by reason of the conditions.
84.The understanding of the nature of that causal inquiry is assisted by the discussion in the OECD 1995 Guidelines (the Guidelines). Paragraph 6 of the Preface to the Guidelines sets out the general approach:
In order to apply the separate entity approach to intra-group transactions, individual group members must be taxed on the basis that they act at arm’s length in their dealings with each other. However, the relationship among members of an MNE group may permit the group members to establish special conditions in their intra-group relations that differ from those that would have been established had the group members been acting as independent enterprises operating in open markets. To ensure the correct application of the separate entity approach, OECD Member countries have adopted the arm’s length principle, under which the effect of special conditions on the levels of profit should be eliminated.
85.The arm’s length principle is set out in Art 9 of the OECD Model Tax Convention on Income and Capital.
86.The Guidelines discuss the arm’s length principle in Ch 1. In the discussion of Art 9, the Guidelines state at [B.1.6]:
By seeking to adjust profits by reference to the conditions which would have obtained between independent enterprises in comparable transactions and comparable circumstances, the arm’s length principle follows the approach of treating the members of an MNE group as operating as separate entities rather than as inseparable parts of a single unified business. Because the separate entity approach treats the members of an MNE group as if they were independent entities, attention is focused on the nature of the dealings between those members.
87.The Guidelines in Section B, in dealing with the statement of the arm’s length principle, discuss at [B.1.10] the practical difficulty in applying the arm’s length principle that may arise from the fact that associated enterprises may engage in transactions that independent enterprises would not engage in. For instance, an independent entity may not be willing to sell or licence some valuable intellectual property or know-how. Some of the discussion is illuminating:
[T]he owner of an intangible may be hesitant to enter into licensing arrangements with independent enterprises for fear of the value of the intangible being degraded. In contrast, the intangible owner may be prepared to offer terms to associated enterprises that are less restrictive because the use of the intangible can be more closely monitored. There is no risk to the overall group’s profit from a transaction of this kind between members of an MNE group. An independent enterprise in such circumstances might exploit the intangible itself or license it to another independent enterprise for a limited period of time (or possibly under an arrangement to adjust the royalty).
88.Section C of the Guidelines concerns guidance for applying the arm’s length principle. The section begins (at [C.1.15]) with a discussion of comparability as follows:
Application of the arm’s length principle is generally based on a comparison of the conditions in a controlled transaction with the conditions in transactions between independent enterprises. In order for such comparisons to be useful, the economically relevant characteristics of the situations being compared must be sufficiently comparable. To be comparable means that none of the differences (if any) between the situations being compared could materially affect the condition being examined in the methodology (eg price or margin), or that reasonably accurate adjustments can be made to eliminate the effect of any such differences. In determining the degree of comparability, including what adjustments are necessary to establish it, an understanding of how unrelated companies evaluate potential transactions is required. Independent enterprises, when evaluating the terms of a potential transaction, will compare the transaction to the other options realistically available to them, and they will only enter into the transaction if they see no alternative that is clearly more attractive.
89.The Guidelines in a section beginning at [C.1.36] discuss the recognition of the actual transaction undertaken. The whole of [C.1.36]-[C.1.38], though long, should be set out:
A tax administration’s examination of a controlled transaction ordinarily should be based on the transaction actually undertaken by the associated enterprises as it has been structured by them, using the methods applied by the taxpayer insofar as these are consistent with the methods described in Chapters II and III. In other exceptional cases, the tax administration should not disregard the actual transactions or substitute other transactions for them. Restructuring of legitimate business transactions would be a wholly arbitrary exercise the inequity of which could be compounded by double taxation created where the other tax administration does not share the same views as to how the transaction should be structured.
However, there are two particular circumstances in which it may, exceptionally, be both appropriate and legitimate for a tax administration to consider disregarding the structure adopted by a taxpayer in entering into a controlled transaction. The first circumstance arises where the economic substance of the transaction differs from its form. In such a case the tax administration may disregard the parties’ characterisation of the transaction and re-characterise it in accordance with its substance. An example of this circumstance would be an investment in which an associated enterprise in the form of an interest-bearing debt when, at arm’s length, having regard to the economic circumstances of the borrowing company, the investment would not be expected to be structured in this way. In this case it might be appropriate for a tax administration to characterise the investment in accordance with its economic substance with the result that the loan may be treated as a subscription of capital. The second circumstance arises where, while the form and substance of the transaction are the same, the arrangements made in relation to the transaction, viewed in their totality, differ from those which would have been adopted by independent enterprises behaving in a commercially rational manner and the actual structure practically impedes the tax administration from determining an appropriate transfer price. An example of this circumstance would be a sale under a long-term contract, for a lump sum payment, of unlimited entitlement to the intellectual property rights arising as a result of future research for the term of the contract (as previously indicated in paragraph 1.10). While in this case it may be proper to respect the transaction as a transfer of commercial property, it would nevertheless be appropriate for a tax administration to conform the terms of that transfer in its entirety (and not simply by reference to pricing) to those that might reasonably have been expected had the transfer of property been the subject of a transaction involving independent enterprises. Thus, in the case described above it might be appropriate for the tax administration, for example, to adjust the conditions of the agreement in a commercially rational manner as a continuing research agreement.
In both sets of circumstances described above, the character of the transaction may derive from the relationship between the parties rather than be determined by normal commercial conditions and may have been structured by the taxpayer to avoid or minimise tax. In such cases, the totality of its terms would be the result of a condition that would not have been made if the parties had been engaged in arm’s length dealings. Article 9 would thus allow an adjustment of conditions to reflect those which the parties would have attained had the transaction been structured in accordance with the economic and commercial reality of parties dealing at arm’s length.
(Emphasis added.)
90.The above discussion illuminates that the causal test in s 815-15(1)(c) based on Art 9 is a flexible comparative analysis that gives weight, but not irredeemable inflexibility, to the form of the transaction actually entered between the associated enterprises. A degree of flexibility is required especially if the structure and detail of the transaction has been formulated by reference to the group relationship and a “tax-effective” outcome (even if, as here, one that is not said to be illegitimate). The form of that transaction may, to a degree, be altered if it is necessary to do so to permit the transaction to be analysed through the lens of mutually independent parties.
91.There is nothing in the Guidelines that requires other than the independent status of the enterprises from each other in the transaction. Thus, to paraphrase the last sentence of [C.1.38], Art 9 (and so s 815-15(1)(c)) would allow an adjustment of conditions to reflect the conditions which the parties would have attained had the transaction been structured in accordance with commercial reality with the parties to the transaction dealing at arm’s length.
(Emphasis in original.)
Read in context, it is evident that his Honour at [90] was simply encapsulating shorthand what is set out in the 1995 Guidelines at [C.1.36]-[C.1.38], namely the comparative analysis for the purposes of the causal test should ordinarily 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 where some adjustment to the form of the actual transaction may be necessary in order to undertake a comparative analysis with an agreement unaffected by the lack of independence between the parties and lack of non-arm’s length dealing. His Honour starts at [81] with the observation that s 815-15(1)(c) applies a causative test by positing a causal relationship between the non-arm’s length conditions and profits which might have, but did not, accrue to the taxpayer by reason of the non-arm’s length conditions operating between the parties with respect to the actual transaction. His Honour observes at [84] that the understanding of the nature of that causal inquiry is assisted by the discussion in the 1995 Guidelines. His Honour sets out the relevant paragraphs from the 1995 Guidelines at [88] and [89], and then concludes at [90] that the 1995 Guidelines “illuminate” that the causal test in s 815-15(1)(c) based on Art 9 “is a flexible comparative analysis that gives weight, but not irredeemable inflexibility, to the form of the transaction actually entered between the associated enterprises”. As his Honour noted, some “flexibility” may be required in the case of the two exceptional circumstances set out in the 1995 Guidelines “if it is necessary to do so” so as to permit that transaction to be analysed through the lens of mutually independent parties. It is important to emphasise that his Honour was not saying that the actual transaction may be recast as a different transaction for the purposes of the comparative analysis, other than in the case of the two exceptional circumstances referred to in the 1995 Guidelines.
Pagone J (with whom Allsop CJ and Perram J agreed) held that the focus of the inquiry called for by s 136AD(3) (the cognate provision to s 136AD(4) with respect to acquisitions) and s 136AA(3)(d) is an alternative agreement from the one actually entered into where the alternative agreement was made by the parties upon the assumptions that they were independent and dealing at arm’s length. His Honour stated at [126] that the provisions do not require the construction of an abstract hypothetical agreement between abstract independent parties. Rather the hypothesis is of an agreement which was not affected by the lack of independence and the lack of arm’s length dealing. His Honour stated that the task of ascertaining the arm’s length consideration “is, therefore, fundamentally a factual inquiry into what might reasonably be expected if the actual agreement had been unaffected by the lack of independence and the lack of arm’s length dealing”.
In a passage relied upon by the taxpayer, his Honour stated at [128]:
The need to posit a hypothetical acquisition under an agreement for the purpose of evaluating it by reference to the standard of reasonable expectation requires a consideration of the evidence to determine a reliably comparable agreement to that which was actually entered into. That, as his Honour said at [499] required the hypothetical to remain close to the actual loan. The function of the hypothesis is to identify a reliable substitute consideration for the actual consideration which was given or agreed to be given, and the reliability of the substitute consideration depends upon the hypothetical agreement being sufficiently like the actual agreement.
Later in that paragraph in a passage relied on by the Commissioner, his Honour stated that:
The characteristics of the purchaser must be such as meaningfully to inform an inquiry into whether the consideration actually given under the agreement exceeded the arm’s length consideration under the hypothetical agreement; or, to use the words of the learned trial judge at [80], in the hypothesis the independent parties are to have the characteristics relevant to the pricing of the loan “to enable the hypothesis to work”.
His Honour stated that the actual characteristics of the taxpayer must, therefore, ordinarily serve as the basis in the comparable agreement.
At [129], in another passage relied on by the Commissioner, his Honour stated that the provisions of Div 13 are intended to operate in the context of real world alternative reasonable expectations of agreements between parties and not in artificial constructs. His Honour stated:
The comparable agreement may, therefore, usually assume an acquisition by the taxpayer of the property actually acquired under an agreement having the characteristics of the agreement as entered into but otherwise hypothesised to be between them as independent parties dealing with each other at arm’s length in relation to that acquisition.
His Honour held the borrower may be a company like CAHPL which was a member of a group but where the consideration in respect of the acquisition identified in the hypothetical agreement was not distorted by the lack of independence between the parties or by a lack of arm’s length dealings in relation to that acquisition. At [130] his Honour stated that the ultimate object of the task required by Div 13 is to ensure that what is deemed as the consideration by s 136AD(3) is the reliably predicted amount which the taxpayer might reasonably be expected to give or to have given by way of consideration, rather than a hypothetical consideration without reliable foundation in the facts or reality of the circumstances of the taxpayer in question. At [132] his Honour concluded that the evidence before, and found by, the primary judge “amply supported” the primary judge’s prediction of the reasonable expectation of a borrowing by CAHPL being supported by security.
With respect to Subdiv 815-A, his Honour stated at [156] that the comparison which Art 9 requires to be undertaken is akin to that contemplated by Div 13 and the object is to determine whether conditions actually prevailing between the relevant enterprises differ from those which might be expected to operate if they had been independent and had been dealing wholly independently with each other. His Honour stated that the hypothetical in that exercise is undertaken for the purpose of determining whether the dealing which actually occurred might have been expected to have occurred on different terms, which will generally require that the parties in the hypothetical will have the characteristics and attributes of the actual enterprises in question. In that case, his Honour considered that ultimately the question was that of determining whether profits might have been expected to accrue to CAHPL if the transaction it entered into with the US subsidiary had been entered into where the conditions which operated between CAHPL and the US subsidiary did not operate, that is if they had been dealing with each other at arm’s length in relation to the dealing as independent parties.
Chevron thus makes it clear that the positing of a hypothetical agreement is not for the purposes of pricing a hypothetical supply to a hypothetical buyer (or a hypothetical acquisition from a hypothetical seller) and the provisions do not permit or require the construction of an abstract hypothetical agreement between abstract independent parties. The function of the hypothesis is to identify a reliable substitute consideration for the actual consideration which was given so that the reliability of the substitute consideration depends upon the hypothetical agreement being sufficiently like the actual agreement to be a sufficiently comparable transaction against which to evaluate whether an arm’s length consideration was given under the actual transaction (Div 13) or an amount of profits which might have been expected to accrue did not accrue (Subdiv 815-A).
As Allsop CJ and Pagone J both emphasised, for the hypothetical agreement to be sufficiently comparable to the actual agreement to enable a reliable substitute consideration for that paid or given to be determined, the characteristics and attributes of those parties which inform an inquiry into the pricing of the property supplied or acquired should also be taken into account. In Chevron, both at first instance and on appeal, the Court rejected the taxpayer’s argument that the task was to ascertain whether it might reasonably be expected that CAHPL, as a standalone company, could obtain an unsecured borrowing, with no operational or financial covenants at less than 9% interest. As Pagone J stated at [130], it would distort the application of Div 13 and Subdiv 815-A to posit a hypothetical agreement on the basis that the taxpayer was not a member of a corporate group or as if it were “an orphan” severed from the financial strength of its ultimate parent and corporate group.
Significantly, Chevron is not authority that the provisions of Div 13 and Subdiv 815-A ask what form of agreement might have been negotiated by entities dealing with each other at arm’s length. That approach was rejected by the primary judge in Chevron at first instance at [88] and nothing contrary is said in the Full Court decision. Nor does Chevron provide authority for the proposition put by the Commissioner, namely that the hypothetical transaction, for the purposes of addressing the statutory questions directed by Div 13 and Subdiv 815-A in the present case, is to be identified as a wholly differently structured agreement for the sale of concentrate to the actual agreement which the parties entered into. Not only was there no suggestion by the Commissioner that either of the two exceptional circumstances identified in the 1995 Guidelines have application in the present case, these reasons elucidate later why the approach of the Commissioner to the application of Div 13 and Subdiv 815-A must be rejected.
THE ARM’S LENGTH PRINCIPLE
It is necessary to say something more about Div 13 and Subdiv 815-A. In construing and applying the provisions of Div 13 and Subdiv 815-A it is important to bear in mind the international context in which the internationally accepted arm’s length principle has been adopted as the measure by which countries, and the extent to which countries, may bring to tax within their jurisdiction an appropriate share of tax revenue from the international dealings of multinational enterprises. The transfer pricing provisions give effect to the bilateral international agreements between sovereign countries about how each is permitted to bring to tax international related party transactions. The OECD has adopted the arm’s length principle as the means by which each country, and the extent to which each country, may bring to tax related party international transactions to ensure fairness and equity as between different taxing countries. Australia has adopted that international standard in Div 13 and Subdiv 815-A, the fiscal policy of which is to tax related parties in cross‑border transactions on the basis of the arm’s length principle. The objective of the legislation is to ensure that such parties’ fiscal obligations for domestic tax purposes are based on the arm’s length equivalent dealing of the actual transaction entered into. A construction and application of those provisions that distorts the application of the arm’s length principle in related party international dealings by applying some different measure for determining an arm’s length price than one based on the arm’s length equivalent of the transaction actually entered into, would not give effect to the policy objective.
That is not to say that Div 13 and Subdiv 815-A will apply to all non-arm’s length cross‑border dealings. A non-arm’s length dealing may nonetheless have an arm’s length consideration. As Middleton J noted in SNF (Australia) Pty Ltd v Commissioner of Taxation (2010) 79 ATR 193; [2010] FCA 635 at [39]:
A finding reached for the purposes of s 136AD(3)(b) that any two or more of the parties to an agreement were not dealing at arm’s length with each other will not necessarily be determinative in considering whether the consideration given or agreed to be given for the purposes of s 136AD(3)(c) was not arm’s length consideration. Where it can be concluded that, even though there was an absence of real bargaining, an arm’s length consideration was given or agreed to be given, then s 136AD(3)(c) will not be satisfied and s 136AD will have no application.
Whilst the application of both Divisions is upon the predicate that there was an absence of real bargaining, it does not necessarily follow from an absence of real bargaining, nor must it necessarily follow, that the consideration agreed to be paid was not an arm’s length consideration.
THE TAXPAYER’S EVIDENCE
The taxpayer relied on lay and expert evidence.
(1) David Kelly
The lay evidence was given by David Kelly. Mr Kelly is a chartered accountant by training who has been involved with the CSA mine in four capacities:
·prior to 2006, Mr Kelly worked as an auditor at Deloitte and audited the accounts of the CSA mine;
·from 2006 to 2009, he was employed by GIAG as the CSA mine’s asset manager;
·from 5 November 2007 and until 9 October 2017, he was a director of CMPL (and the two GIAG subsidiaries which owned the CSA mine);
·since 2009, Mr Kelly has traded commodities for GIAG, including the copper concentrate produced at the CSA mine and sold by CMPL to GIAG.
Mr Kelly swore four affidavits in these proceedings in which he gave evidence about a range of matters, including: the copper market and pricing and terms of sale of copper concentrate; the Glencore Group and Glencore’s business; GIAG’s acquisition and ownership structure of the CSA mine; his involvement with the CSA mine as the CSA mine’s asset manager between 2006 and 2009, as a trader from 2009 onwards and as a director of CMPL from 5 November 2007 until 9 October 2017; the operations of the CSA mine during the relevant period; the mine’s financial performance in 2006; the challenges the mine faced from 2006 to 2009; the logistics and risks for CMPL in selling its copper concentrate in the period 2006 to 2009, if it had been independent of GIAG and sought to sell its copper concentrate directly to smelters; and the offtake agreements under which CMPL supplied copper concentrate to GIAG over the period 1999 to 2009. He also exhibited to his affidavit examples of other offtake agreements for the sale of copper concentrate containing price sharing and quotational period back pricing optionality terms.
The Commissioner urged the Court to treat Mr Kelly’s evidence with considerable caution, submitting he was not an independent witness, he had overstated parts of his evidence, his evidence included matters about which he did not have personal knowledge or relevant experience to give evidence on, and his recollection of events in 2006 to 2007 was shown to be sketchy and unreliable. Some of those criticisms were shown to have foundation but, ultimately, the matters that must be decided do not turn on the contentious parts of Mr Kelly’s affidavit evidence, as these reasons will elucidate.
(2) Richard Wilson
Mr Wilson is an expert in market analysis of the global copper concentrate industry. Until 2011, he was the author, and since 2011 has been the editor, of the Brook Hunt Report, an annual publication examining the global markets for copper concentrate. Mr Wilson was also the co‑developer of the C1, C2 and C3 mine costing analysis (to which reference will be made later in these reasons). Mr Wilson prepared three reports for these proceedings.
Mr Wilson’s first report addressed the following questions:
(a)whether the conditions (individually or together) that operate under the 1999 Offtake agreement as amended from time to time and including as amended by the Third Replacement Concentrate Agreement (together with its Addendums and Amendment) as they applied in the 2007 to 2009 calendar years differ from those that might be expected to operate between a producer/seller of copper concentrate in the position of [CMPL] and a purchaser independent of CMPL having regard to the circumstances of CMPL in the period 1999 to February 2007; and
(b)if they do,
(i) how such conditions differ; and
(ii)what profits (if any) may have been expected to accrue to CMPL by reason of such differences?
Mr Wilson’s second report contained his response to, and comments on, the expert reports of the Commissioner’s mining industry experts, Mr Leonard Kowal and Mr Marc Ingelbinck.
Mr Wilson’s third report contained his response to supplementary reports of Mr Kowal and Mr Ingelbinck.
(3) Tony Samuel
Mr Samuel is a forensic accounting expert. He prepared one report which responded to the expert report of the Commissioner’s financial analysis expert, Mr David van Homrigh.
THE COMMISSIONER’S WITNESSES
The Commissioner called the following expert witnesses:
(1) Marc Ingelbinck
Mr Ingelbinck is a mining industry expert. He formerly traded commodities for Cargill, Inc, before commencing a management position at Magma Copper in which capacity he traded the company’s copper cathode, copper rod and sulphuric acid output, sourced third party copper concentrate feed and managed the company’s price risk management programs. Later he was vice president, marketing and trading for BHP’s base metals customer sector group with overall responsibility for all concentrate marketing within the group. Mr Ingelbinck prepared two reports for these proceedings.
In his first report, Mr Ingelbinck addressed the following questions:
(1)For the [relevant years], do the conditions that were operating between CMPL and GIAG in their commercial and financial relations, differ from the conditions which might have been expected to operate between an Independent Producer/Seller and Independent Buyer dealing wholly independently with one another? If so:
(a) how and to what do such conditions differ; and
(b)what profits (if any) by reason of these conditions might reasonably have been expected to have accrued to CMPL but for those conditions?
(2)For [the relevant years], is the consideration received or receivable by CMPL for the sale of Cobar copper concentrate to GIAG different from the consideration that might reasonably have been expected to have been received or receivable for the sale of Cobar copper concentrate by an Independent Producer/Seller to an Independent Buyer dealing wholly independently with one another? If so:
(a) how and to what extent; and
(b)what consideration might reasonably have been expected to have been received or receivable by an Independent Producer/Seller but for that difference?
(3)Please answer the above questions in the alternative and assuming that the Independent Producer/Seller was the operator of the Cobar Mine in the period 1 January 1999 to 31 December 2009 and:
(a)operated in a commercial context as a wholly owned subsidiary of a multinational global resources company in the same or similar circumstances to that of CMPL and GIAG; or
(b)for the period between 1 January 2007 and 31 December 2009 operated as a stand‑alone producer/seller of Cobar copper concentrate.
Mr Ingelbinck was subsequently asked to prepare a supplementary report addressing the following questions:
1.Whether my opinions as set out in my report would change or be affected in any way having read two affidavits of David Hinder Kelly and, if so, how and explain why.
In particular, having regard solely to the circumstances of CMPL in the period 1999 to February 2007, identify whether my opinions as set out in my report would change or be affected in any way, and, if so, explain why.
2.Having considered Mr Wilson’s reports:
(a) whether my opinions as set out in my report, would:
(i) change or be affected in any way and if so, how and explain why;
(ii)in particular, having regard solely to the circumstances of CMPL in the period 1999 to February 2007, identify whether my opinion as set out in my report would change or be affected in any way, and if so, how and explain why; and
(b) identify those statements in the second Wilson report that I agree with and those I disagree with. For any statement that I disagree with, provide reason(s) for that disagreement.
(2) Leonard Kowal
Mr Kowal is another mining industry expert with 35 years of experience with Inco Ltd, then the largest producer of nickel in the world, and, at the time of trial, an additional 12 years of experience providing consultant services to a wide array of metal producers. During his time with Inco Ltd, he was involved in negotiating various contracts and also marketing. Mr Kowal prepared two reports which addressed the same Questions 1 and 2 as Mr Ingelbinck was asked to address.
(3) David van Homrigh
Mr van Homrigh is a financial analysis expert. He was asked to analyse and provide advice on the financial affairs of CMPL for the period 18 December 1998 to 31 December 2009 and, in particular, the period from 1 January 2007 to 31 December 2009. In relation to the period from 1 January 2007 to 31 December 2009, Mr van Homrigh was asked to respond to the following questions:
1.Whether or not CMPL and/or the Cobar mine was profitable.
2.To what extent there was an uncertainty as to the profitability of future copper concentrate mining operations at the Cobar mine.
3.Whether or not CMPL required bank or other financing in order to operate the Cobar Mine and the nature of any such financing sought or provided.
4.The nature, and benefits to CMPL, of financial arrangements which were in fact in place as between CMPL and/or the Cobar Mine and the Joint Venture Participants and/or GIAG or any third party.
JOINT EXPERT REPORTS
Joint expert reports were prepared by:
(a)the mining industry experts – Mr Wilson, Mr Ingelbinck and Mr Kowal; and
(b)the financial experts – Mr van Homrigh and Mr Samuel.
Only the mining industry experts were cross examined on their reports.
THE COPPER CONCENTRATE MARKET
It is helpful to start with the evidence about the copper concentrate industry for context. Evidence explaining the copper concentrate market was given by the three mining industry experts as well as by Mr Kelly and, in the broad detail, they all gave largely consistent evidence. A summary of that evidence follows.
Copper concentrate
Copper concentrate is produced at copper mines from the processing of sulphide and oxide ore. To produce pure copper from the ores, the copper concentrate must then go through further processing and refining, which is done at smelters. Copper concentrates are highly variable in composition in respect of the grades of their key elements (copper, iron, sulphur and various precious metals such as gold and silver) and the presence and levels of impurities. The variations arise due to differences in copper mineralogy present in an orebody. The copper content of copper concentrate varies from around 10% to around 50% depending upon the orebody and the processing techniques used to derive it. Each smelter has different requirements as to the copper concentrate that it purchases, which relate to its ability to treat the concentrate in light of the payable metals and impurities the concentrate contains.
The custom concentrate market
The production and smelting of copper concentrates within a corporate group is described as integrated production. Where copper concentrates are sold to independent third parties, this is known as the custom concentrate market. The participants in this market are miners, smelters and traders. Miners are sellers of copper concentrates and smelters are buyers. Traders (also known as merchants) act as intermediaries and both buy and sell copper concentrates. Copper concentrate can be sold under long‑term arrangements with a smelter or a trader (which accounts for around 80% of custom concentrate trading) or on the spot market (approximately 20% of all custom concentrate trading). The contractual arrangements which govern these sales are known in the industry as offtake agreements.
Mr Ingelbinck in his first report commented at para 12:
The relationship between non-integrated mines and custom smelters is largely a symbiotic one. A copper concentrate producer who does not have a home to monetise its production has a serious problem. So does a custom smelter who does not have sufficient primary raw material supply to run its operation. This is reflected in the fact that in my experience the vast majority of copper concentrate purchase/sales agreements are structured on a long-term basis which provides the seller with a guaranteed home for its output, the buyer with security of raw material feed and allows both parties to avoid a greater degree of volatility in commercial terms which tends to prevail in the spot market.
Long-term offtake agreements can provide for ongoing sales over a fixed number of years or for the “life of the mine”, and may be for specified quantities of concentrate or for the whole of a particular mine’s production. The experts were agreed that the advantage to a miner of an entire production offtake agreement is that the miner is guaranteed that all of its production will be sold as and when it is ready to be shipped, which effectively transfers risk to the buyer.
Pricing of copper concentrate
Due to the highly variable nature of copper concentrate, there is no terminal market for copper concentrate where it can be traded at a precise known price. In contrast, the price of refined copper is typically set by reference to the price quoted on a metal exchange such as the London Metal Exchange. In Mr Ingelbinck’s words, “recognising this” the industry has adopted a pricing structure for its contracts which follows a reasonably well-established framework. However, each contract is individually negotiated and have varying terms that affect the price of the copper concentrate. As Mr Wilson stated, the detail and pricing of the individual contracts will vary greatly depending on the needs and risk appetites of the seller and buyer and whether the contracts are for spot sales or medium/long-term contracts.
The evidence was to the effect that copper concentrate sold under offtake agreements will generally be priced by reference to:
(a)the price of copper metal on a metal exchange, such as the London Metal Exchange, averaged over a given period of time (known in the industry as the “quotational period”);
(b)the deductions to be made from the reference price for the TCRCs; and
(c)other adjustments for the payable copper content in the copper concentrate (noting that smelting processes will usually not recover 100% of the copper content in concentrate) and penalties for deleterious elements.
Copper metal price
I do not accept these submissions.
First, the use of a FOB freight provision whereby the buyer arranges for freight, and is provided with a mutually agreed freight allowance which is deducted against the amount paid to the seller, was a standard term in contracts for the supply of copper concentrate in the relevant years.
Secondly, the Commissioner’s complaint impermissibly relies on hindsight analysis – that is, that few shipments were made to India for 2009 and the rates for shipping to China, Japan, and Korea in that year were less than the actual rate charged.
Thirdly, it does not follow from the simple fact that GIAG received a higher freight allowance in 2009 than if it had chosen the freight rates for China, Japan, or Korea that it might be expected that independent parties would not have agreed such terms. As Mr Kelly explained in cross examination, there are a number of different factors which might affect freight rates agreed between the parties.
The Commissioner did not contend that the provisional payment clause, which provided for a 100% provisional payment, was a condition which differed from what might be expected to have been agreed between independent parties. However, it was submitted that the timing of the payment was an “unusual feature” in that it provided for CMPL to be paid for material produced but not shipped in a given month. Although it was accepted that this clause had potential benefits for CMPL, it was submitted that the benefit to CMPL of earlier payment was really “just a nominal benefit” bearing in mind the balances in the current account facility held by GIAG for CMPL. Further, it was Mr Ingelbinck’s evidence that the provision also had benefits for GIAG arising from its ability:
(a)to withhold material from the market temporarily should GIAG wish to avoid being forced to sell in a sloppy concentrate market;
(b)to operate profitably if the material has been priced and there is a contango market: that is, it is anticipated the price will increase in the future;
(c)to build up larger lots to secure more beneficial freight rates; and
(d)to do some or all of the above.
Accordingly, it was submitted, the provisional payment mechanism was not sufficiently favourable to CMPL to compensate for accepting the unfavourable price sharing and quotational period terms. Further, it was submitted, the taxpayer had not proved that CMPL did receive any benefit of a value that offset, or reduced in any way, the detrimental contractual terms.
I reject the submission that the taxpayer needed to prove that CMPL did receive a benefit from the provisional payment mechanism which was more than nominal, first because it was the common evidence of the experts that it was advantageous to CMPL to be paid on production, rather than having to wait until shipment of the concentrate to be paid, not just from a cash flow perspective, but also from a risk perspective and, second, because the benefits conferred by the timing advantage are simply to be weighed as part of the holistic bargain that might be expected to have been agreed by independent parties acting at arm’s length.
CONCLUSION
Accordingly I find that the taxpayer has established that the prices that CMPL was paid by GIAG for the copper concentrate it supplied to GIAG under the February 2007 Agreement were within an arm’s length range and accordingly the taxpayer has discharged the onus of proof on it.
The Div 13 determinations were premised on the claim that the consideration received by CMPL for the copper concentrate that it supplied to GIAG in the relevant years was less than the “arm’s length consideration” (in the defined sense) which might reasonably be expected to have been received by a producer/seller of copper concentrate in CMPL’s position selling to an independent buyer in GIAG’s position under an agreement between independent parties dealing at arm’s length with each other. As I have concluded that the consideration paid by GIAG to CMPL for the concentrate fell within the range of consideration that might reasonably be expected to be paid, the amended assessments are therefore not supported by Div 13 and are excessive.
So too, for the purposes of Subdiv 815-A, CMPL did not get a transfer pricing benefit within the meaning of s 815-15(1) of the ITAA 1997 because, for the purposes of s 815-15(1)(c), there was no amount of profits which, but for the conditions mentioned in Art 9 of the Swiss Agreement might have been expected to accrue to CMPL but which, by reason of those conditions, did not so accrue. The amended assessments are therefore not supported by Subdiv 815-A and are excessive.
THE COMMISSIONER’S CASE
In case it is necessary, I should deal with the Commissioner’s case that the evidence did not establish that independent parties in the position of CMPL and GIAG might have been expected to enter into an agreement on price sharing terms or with the range of quotational period options contained in the February 2007 Agreement. The analysis that follows assumes, contrary to how I have found, that the predicate of an agreement on price sharing terms must first be established on the evidence.
For the following reasons advanced in the taxpayer’s written submissions, I am satisfied on the evidence that it might reasonably be expected that an independent mine producer in the position of CMPL might be expected to enter into a price sharing agreement in early 2007.
First, the unchallenged evidence was that the CSA mine was a high cost mine and a high cost mine, susceptible to a reduction in the margins between its revenues and operating costs, might be expected to have been interested in removing the uncertainty of large movements in benchmark TCRCs and spot TCRCs by fixing a margin of the copper price that ensured that it would remain in operation, especially so during a period of extreme market volatility. The Commissioner’s case ignored the fundamental differences between contracts on benchmark terms and contracts on price sharing terms.
Secondly, an independent seller as at the beginning of 2007 would have known that benchmark TCRCs had been historically volatile, ranging from around 10% of the London Metal Exchange copper price to 30% of the London Metal Exchange copper price. While by the beginning of 2007 the benchmark TCRC for 2007 had been set, the benchmark TCRCs for 2008 and 2009 were unknown. Further, although the 2008 and 2009 benchmark TCRCs had been forecasted by Brook Hunt, such forecasts had proven historically to be highly unreliable. Thus, whilst CMPL’s own budgeted profit forecast for 2007 (which was prepared on a conservative position on the basis of benchmark terms) forecast significant profits, there was no assurance that the forecast TCRC/copper price ratio reflected in its budget or in Brook Hunt’s Reports for 2008 and 2009 would, in fact, eventuate.
Thirdly, while price participation had been set to zero in the benchmark TCRC for 2007, and it was the common view of the experts that price participation would not be reintroduced in 2008 or 2009, the 2006 Brook Hunt Report made clear that there was uncertainty as to whether it would be reintroduced in later years. Mr Ingelbinck agreed that, in early 2007, “no-one in the industry knew whether it would be reintroduced”. Mr Ingelbinck also agreed that in 2006, price participation was a material aspect of the cost that a mine subject to a benchmark TCRC contract incurred, with 2006 price participation representing almost 50% of the total TCRCPP and that a price sharing agreement ruled out the risk of price participation being introduced into the equation.
Fourthly, spot TCRCs had been even more volatile in the years preceding 2007, ranging from zero c/lb up to around 45c/lb. Brook Hunt did not try to forecast spot TCRCs, which Mr Wilson said are “virtually impossible to predict” and Mr Ingelbinck agreed were “more difficult to predict than are benchmark TCRCs” and that “neither of them [spot or benchmark TCRCs] are entirely predictable in the first place”. The spot TCRCs for the 2007 to 2009 period were thus unknown and were not forecast nor able to be forecast. Further, given that the relationship between spot TCRCs and benchmark TCRCs had been historically volatile, the benchmark 2007 TCRC gave no indication of what spot TCRCs over the ensuing years might be. Mr Ingelbinck agreed that, as at the beginning of 2007, “what was not known and could not be predicted [was] where spot TCRCs would be”.
Fifthly, as at the beginning of 2007, the London Metal Exchange copper price was extremely volatile and difficult to predict. Having reached all-time highs at the end of 2006 after a rapid escalation, market sentiment was that the price would fall, but it was not possible to predict when, at what speed, or to what levels. Although pricing forecasts were available, in prior years such forecasts had proved to be materially inaccurate. Mr Ingelbinck’s evidence was that the rise in copper prices in 2006 was “a somewhat unheard of event and caused all kinds of re‑evaluations amongst industry participants as to what made sense and how to structure these agreements …people were confused”.
Sixthly, not only had benchmark TCRCs, spot TCRCs and London Metal Exchange copper prices been historically volatile and subject to “significant changes”, but their relationship to one another had also been subject to significant volatility, there being no correlation between them. In the period 2000 to 2006, the value of TCRCs and price participation as a percentage of CSA’s copper revenues ranged from 11.6% to 26.8%, with a median of 20.7%. Further, at the end of 2005, the budgeted 2006 TCRCs were approximately 31% of the budgeted copper sales revenues for 2006. At the end of 2006, the budgeted 2007 TCRCs were 12% of the budgeted copper sales revenues for 2007. However, this was simply a function of the all-time high copper prices, and to be achieved required the denominator of the equation to remain large. Under a price sharing agreement, the volatility associated with the lack of correlation between London Metal Exchange copper prices and benchmark/spot TCRCs was avoided. Further, Mr Ingelbinck agreed that different participants in the market could have taken different views about the importance of avoiding such volatility, and that this would ultimately be a commercial decision.
Seventhly, the evidence showed that based on its own costs budgets and Brook Hunt’s price forecasts as at 2006, CMPL would have been viable and would have expected to generate a profit margin of at least 25% and up to 40% (depending on the costs figures chosen) in each of the relevant years under a 23% price sharing contract. Mr Wilson thought that the margins “looked pretty healthy” for a high cost mine as at 2007 and that the margins were “pretty much in line with what [he would expect to see]”.
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.
The Commissioner, on the other hand, argued that the adoption of a price sharing agreement in replacement of benchmark terms would have compromised the financial viability of the mine, if the concern of the producer was one of increasing operating costs as at the end of 2006. It was submitted that “indeed Mr Wilson accepted that if there was a concern as to escalating operating costs ([which] Mr Kelly said there was) agreeing to the 23% price sharing and the escalation of figures that involved was a decision that would put the financial viability at risk”. There are two responses. First, the Commissioner’s contention that the adoption of a price sharing agreement in replacement of benchmark terms put the viability of the mine at risk moving forward if fuel or other costs increased was shown to be incorrect. Secondly, Mr Wilson’s answer must considered in context. It is clear from the line of questions put to Mr Wilson that he disagreed with the premise upon which the question was put, namely that there was, in fact, a concern that there might be escalating costs in the 2007 period. In Mr Wilson’s view, cost escalation should have peaked. It is also incorrect that Mr Kelly gave evidence that “there was a concern at the mine as to escalating operating costs”. What Mr Kelly in fact said in the transcript references footnoted was that “operating costs had actually, in fact, been going up” in 2006 and he referred to CMPL as having “increasing operating costs” in 2006. The 2007 Budget did refer to CMPL having increasing operating costs in 2006 and recorded that cost control would be an important focus of the business in 2007 but there was nothing expressed in the Budget about a concern as to increasing operating costs in 2007.
The Commissioner urged the Court to draw a Jones v Dunkel inference from the “glaring” absence of evidence that anyone at CMPL considered that it would be in CMPL’s interests for it to amend its pricing terms so as to provide for price sharing, rather than the pre-existing benchmark style terms. It was submitted that had anyone at CMPL considered that in February 2007 it was in CMPL’s interests to enter into a price sharing agreement, the Court would readily expect the taxpayer to have led such evidence. That contention is rejected as subjective motive is completely irrelevant to the application of Div 13 and Subdiv 815-A, even on the Commissioner’s case with respect to how the statutory provisions operate. Accordingly, I draw no such inference.
The Commissioner submitted that similarly the Court would reject the contention that a hypothetical mine producer with CMPL’s characteristics would have agreed to six quotational period options with back pricing and shipment by shipment declarations in February 2007. It was submitted that the only possible impact of such an agreement would be to the detriment of the mine producer, and to the benefit of the trader. It was submitted that there would be no reason for the hypothetical mine producer, bearing in mind the market in February 2007 and the reliable production the mine had experienced over the years, to agree to such terms. It was also submitted that given Mr Wilson’s evidence that the quotational period that will be agreed between a mine and a trader will come “down to the holistic negotiation of the contract between the buyer and the seller” and there is no fixed framework for what the quotational period should be and that there was no evidence of the negotiation of the February 2007 Agreement, there was no basis for the Court to conclude that it might reasonably be expected that a hypothetical mine producer in the position of CMPL might reasonably have been expected to agree the unfavourable terms as to quotational periods agreed in the February 2007 Agreement. This last submission has no support in the legislation or any authority and is also rejected. As Chevron makes clear at [131] (Pagone J), what might reasonably be expected to be given or agreed to be given under a hypothetical agreement if the parties had been independent and were dealing at arm’s length is an objective determination.
Accordingly, if it were necessary to decide, I would be satisfied that the taxpayer had established the predicate of a 23% price sharing agreement with the quotational period clause found in the February 2007 Agreement.
SINGLE ENTITY RULE
An additional argument advanced by the taxpayer was that Div 13 did not apply to it because the relevant international agreement was between GIAG and CMPL and, although in accordance with the single entity rule in s 701-1 of the ITAA 1997 CMPL is taken to be part of the taxpayer, being the head company of the taxpayer’s MEC group, for the purposes of working out amounts of income tax liability and losses of the taxpayer, 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 taxpayer relied on the following passage in Channel Pastoral Holdings Pty Ltd v Federal Commissioner of Taxation (2015) 232 FCR 162; [2015] FCAFC 57 at [119]:
It is convenient to speak of Div 701 as the “single entity rule” applying to the members of a consolidated group, as the heading to s 701-1 indicates, but it is important not to confuse whatever might be understood by such a label or description with what the section actually provides. The effect of Div 701 has been described as creating a statutory fiction but it may be more helpful, and more accurate, to describe its effect as a statutory direction concerned with the calculation of a composite liability. The statutory direction in s 701-1(1) is not 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. The statutory direction, rather, contemplates the continued existence of a subsidiary of a consolidated group but directs that for the limited purposes of determining “liability” or “losses” of the members of the group, the subsidiary is to be treated as [part] of the head company… The single entity rule is a statutory direction which removes the need, which had previously existed under the former grouping provisions, for separate returns and assessments, but the rule does not create a general statutory fiction that the individual parts of the consolidated group do not continue to have an existence or that their individual existence is not specifically relevant in the working out of the liability ultimately falling upon the head company.
(Emphasis added in the taxpayer’s submissions.)
That passage does not support the proposition advanced. To the contrary, as made clear in that passage, the single entity rule operates as a “statutory direction” that, for the limited purposes of determining “liability” or “losses” of the members of the group, the subsidiary is to be treated as part of the head company, rather than as a separate entity, and for that purpose, the actions and transactions of the subsidiary member are treated as having been undertaken by the head company. 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. For the purposes of the application of Div 13 the relevant “taxpayer” is still CMPL and so too for the purposes of Subdiv 815-A, the relevant “entity” is CMPL. There is no inconsistency between these provisions and the single entity rule.
PENALTIES
In view of my conclusion, the question as to whether the refusal of the Commissioner to remit all or part of the shortfall interest charge imposed on the taxpayer does not arise for consideration.
OBSERVATIONS ON THE EXPERTS’ EVIDENCE
Ultimately, the outcome in this case did not turn on preferring the evidence of one expert over another expert on matters where conflicting opinions were expressed by the experts. However, had the case required the Court to determine whose evidence to accept where the experts did express differences of opinion, the following oft-repeated observations about the role of the expert would have become material in assessing the evidence.
The reports of each of the mining industry experts included expressions of opinions on matters outside their specialist knowledge and, in some instances, without the witness having any foundation for the view expressed. Experts, however, perform a particular role. The role of the expert is to provide independent assistance to the Court by providing an objective and impartial opinion on matters within the specialist knowledge of the expert: s 79 of the Evidence Act 1995 (Cth) (“Evidence Act”). It is not the role of the expert to be an advocate for the party calling them nor to express views or speculate on matters about which the expert does not have specialist knowledge. An expert should make it clear when a matter falls outside his or her expertise. Experts need to exercise particular caution to avoid making assertions of fact which have no foundation, otherwise they are seen to be advocating a case rather than providing objective and impartial assistance. Unfounded or speculative reasoning may also undermine or diminish the persuasiveness and cogency of the opinions expressed by the expert on matters on which she or she is qualified to give an opinion, eroding confidence in the accuracy, reliability and objectivity of such opinions. In the present case, each of the experts, obviously keen to supply with the Court with reasoning supporting the position of the party on whose behalf they gave evidence, strayed from time to time into becoming advocates for the party by proffering opinions and making comments on matters which they were not qualified to give. Experts should be mindful of their role to assist the Court and take care to comply with the Code of Conduct in expressing their views.
There is another reason for doubt to be expressed about the reliability of Mr Kowal’s evidence. There is significant uncertainty as to the extent to which Mr Kowal himself authored his reports. He was engaged by Charles River & Associates in 2016 to assist with advice it was providing to the Commissioner in connection with the audit of Glencore. Mr Kowal said that “Charles Rivers was the contractor to the AGS, and Charles Rivers asked me to help them in certain aspects of the preparation of the report”. Mr Kowal’s report was described by him as a “report made by Charles River & Associates that [he] had input into”. Although Mr Kowal stated that “by far the majority [of his report] is mine” he frankly conceded that components of his report were prepared by Charles River & Associates and it remains wholly unclear which parts of his reports were prepared by him and which parts were not. In the circumstances I cannot conclude that the expressions of opinion in his report are based “wholly or substantially” on specialist knowledge possessed by Mr Kowal based on his training, study or experience as required by s 79 of the Evidence Act.
CONCLUSION
In view of my conclusions, the objection decisions should be set aside and the amended assessments for the 2007, 2008 and 2009 income years set aside. Subject to argument by the parties, there should be an order that the Commissioner pay the taxpayer’s costs of the proceedings.
I certify that the preceding four hundred and five (405) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Davies. Associate:
Dated: 3 September 2019
Key Legal Topics
Areas of Law
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Taxation Law
Legal Concepts
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Transfer Pricing
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Arm's Length Principle
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Compensatory Damages
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Expert Evidence
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