The Australian Tax Office (ATO) amended assessments under Australian transfer pricing law on the basis that the consideration paid by GIAG to CMPL was less than an arm's length amount. Ultimately the Court found in favour of the taxpayer and held that the consideration paid was within the arm's length range. The Court tackled some important points of principle in reaching this decision.
Summary of facts
CMPL sold 100% of the copper produced at its Australian mine to its parent GIAG. The copper was purchased under a series of “offtake agreements", the first of which was entered into in 1999. In 2007, CMPL and GIAG entered into a “price-sharing agreement" which was materially different to the previous agreements between the parties.
The new agreement priced copper by reference to the London Metal Exchange cash settlement price for copper averaged over the 'quotational period'. GIAG had the choice of three quotational periods with one of those periods being known at the time it made its selection providing a measure of pricing certainty (known as 'quotational period optionality with back pricing'). A deduction was made from the reference price which was fixed at 23% for the three years of the agreement (known as 'price sharing').
The ATO sought to adjust the agreement between the parties in the following ways (a) to replace the 23% price sharing mechanism with the rate which the ATO identified as previously being used by CMPL under its prior agreements; and (b) to reflect a consistently applied quotational period. This was put forward on the basis that independent parties would not have agreed to price sharing at all or to quotational periods with back pricing optionality.
CMPL advanced the positon that the agreement, which must be hypothesised in order to determine whether the consideration or profits which accrued were arm's length, reflected the actual agreement entered into by the parties. CMPL regarded the relevant questions for the Court as being whether (a) the agreed price sharing percentage of 23% was one that might be expected to be agreed between independent parties; and (b) if so, to what extent it might be expected that there be a discount in the agreement for quotational period optionality.
What arrangement should be tested?
The Court rejected the ATO's approach seeking to reconstruct the actual agreement between the parties. The Court referenced the OECD Transfer Pricing Guidelines which only permit reconstruction in two specific circumstances:
- Where the legal form of the arrangement differs to its economic substance; or
- Where the form and substance of the arrangement are the same, however, the arrangements in their totality, differ from those which would have been adopted by independent enterprises.
The Court held that neither of these conditions applied to the relevant arrangement. Therefore, the task was for the Court to determine an arm's length consideration for the actual agreement entered into.
Comparable contracts – close is good enough
As part of the evidence the Court considered, CMPL put forward a number of examples of contracts between independent parties in the copper industry.
The Court did not accept the ATO's position that, on the basis that CMPL did not establish that any of the contract examples were directly comparable transactions, the Court could not use them to determine what might have been included in such a contract. In rejecting that position, the Court stated that if the ATO's position was correct then the onus on the taxpayer in such disputes would be so high that they could never succeed.
The contracts produced by the taxpayer were thought to have probative value and demonstrated that price sharing and quotational period optionality provisions (a) were actually agreed to in the copper market during the relevant tax years and (b) are therefore conditions which “form part of a pricing structure that might be expected to have operated between a producer/seller of copper in the position of CMPL.
An arm's length amount?
The Court was satisfied on the evidence presented by the parties that (a) the price sharing percentage of 23% was within the range of percentages between arm's length parties and (b) without the (impermissible) use of hindsight the parties would not have been able to value the benefit conferred by the back pricing and as such was not satisfied that a discount might have been expected for its benefit.
Accordingly, the Court found in favour of the taxpayer and that the taxpayer established that the consideration paid to CMPL by GIAG was within an arm's length range.
The case was decided under the Australian transfer pricing rules before the implementation of certain Base Erosion and Profit Shifting (BEPS) amendments to the regime. However, there are important points of principle arising from the case that should continue to have influence.
The Court's reluctance to interfere with the actual arrangement entered into between the parties, the practical approach to the level of comparability of third party arrangements and the acceptance of a tolerable arm's length range of pricing, are each points that should survive in the amended regime.
Those points are likely to have significance in the interpretation of the arm's length principle in New Zealand on the basis that the principle is an internationally recognised concept of general application and that judicial guidance on its application is limited.
If you have any questions about the matters raised in this article, please get in touch with the contacts listed or your usual Bell Gully advisor.