THE TASK
309 Before addressing the statutory questions by reference to the evidence elicited by the parties, it is useful to set out the task to be undertaken.
310 As earlier stated, in general terms Div 13 applies to substitute an arm's length price for the consideration received for the supply of property or services (or given for the acquisition of such property or services as the case may be) in respect of a taxpayer in a non-arm's length dealing under an international agreement. Similarly, in general terms, the purpose and effect of Subdiv 815-A is to substitute an arm's length profit for the non-arm's length profits which resulted from a non-arm's length dealing under an international agreement. For that purpose, it is necessary to hypothesise a reliably comparable agreement not affected by the lack of independence and the lack of arm's length dealing for the purpose of determining whether the consideration actually given for the copper concentrate that CMPL sold to GIAG in the relevant years was less than the consideration which might reasonably be expected to have been paid if the parties had been independent and acting at arm's length in relation to the supply (Div 13) and, in the case of Subdiv 815-A, whether an amount of profits might have been expected to accrue to CMPL if the transaction it entered into with GIAG had been entered into, had CMPL and GIAG not been related and been dealing with each other at arm's length.
311 The taxpayer contended that the agreement that must be hypothesised is one for the sale of 100% of the copper concentrate from the CSA mine over a period which covers the 2007, 2008 and 2009 years, under an agreement which is structured on a price sharing basis and which provides the purchaser with quotational period optionality including with an element of back pricing. It was submitted that unlike the position in Chevron - where the controlled loan agreement, which was structured without security and covenants, would not have been seen in the market between independent enterprises - the provisions in the February 2007 Agreement were observable in contracts between GIAG itself and enterprises independent of it, and there was nothing to suggest that those counterparties were acting other than in a commercially rational manner.
312 The Commissioner, on the other hand, argued that the 23% price sharing term and the quotational period optionality provisions introduced by the February 2007 Agreement were "simply integers in how the consideration receivable by CMPL from GIAG … was to be calculated". It was submitted that the statutory questions to be addressed are: what might reasonably have been expected to have been agreed between independent parties having relevant attributes of CMPL and GIAG as the price of (the consideration for) the copper concentrate (Div 13); and what financial conditions might have been expected to operate between those parties as to the price of the concentrate (Subdiv 815-A). The Commissioner argued that to resolve the statutory questions under Div 13 and Subdiv 815-A, the Court must therefore determine what terms as to the price of the concentrate - which included freight, TCRCs, price participation and quotational periods - might have been expected to have been agreed between independent parties. It was submitted that the evidence did not support a finding that it might reasonably have been expected that CMPL would have sold its copper concentrate to GIAG in the 2007, 2008 and 2009 years on the same or similar terms to the actual agreement, had CMPL and GIAG been independent and dealt with each other at arm's length in relation to the supply.
313 The taxpayer argued that the Commissioner's approach, rather than pricing the copper concentrate as sold under the actual agreement that was in place between the related parties, required the Court to engage in a speculative task of re-imagining all of the terms of the contract to which independent parties might be expected to have agreed, including by:
(a) converting a contract that applied for the whole of the 2007 to 2009 period, with no facility for annual renegotiation, into one that was renegotiated annually;
(b) replacing the price sharing basis of the actual agreement with a TCRC provision set by reference to the Japanese benchmark; and
(c) replacing the quotational period optionality with back pricing under the actual agreement with a different quotational period provision.
314 I accept the taxpayer's submission. In my opinion, the Commissioner's approach impermissibly restructures the actual contract entered into by the parties into a contract of a different character. The decisions in Chevron, both at first instance and on appeal, make it clear that the hypothetical should be based on the form of the actual transaction entered into between the associated enterprises but on the assumption that the parties are independent and dealing at arm's length, in order to identify a reliable substitute arm's length consideration for the actual consideration given or received. This is consistent with, and confirmed by, the 1995 Guidelines, referred to by Allsop CJ in Chevron at [89], which state at [C.1.36], in a section headed "Recognition of the actual transactions undertaken", that restructuring the controlled transaction under review is generally inappropriate when making the comparison of the conditions in a controlled transaction with conditions in transactions between independent enterprises dealing at arm's length and that the analysis "ordinarily should be based on the transaction actually undertaken by the associated enterprises as it has been structured by them". The 1995 Guidelines also state at [C.1.36] that in the examination of whether a "controlled transaction" satisfies the arm's length principle "in other than exceptional circumstances", the actual transaction should not be disregarded or other transactions substituted, and that:
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.
315 The 1995 Guidelines go on to identify two circumstances in which it may, "exceptionally", be appropriate and legitimate to disregard the structure adopted by the taxpayer in the controlled transaction. The 1995 Guidelines, in [C.1.37], identify these exceptional circumstances as:
(a) 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; and
(b) 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. The 1995 Guidelines give as an example of this circumstance 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, stating that while 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, by adjusting the conditions of the agreement in a commercially rational manner as a continuing research agreement.
316 Paragraph [C.1.38] is important. It states:
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.
(Emphasis added.)
317 This paragraph makes it clear that any restructuring of the actual agreement for the purposes of the comparative analysis is limited to the two exceptional cases outlined in the 1995 Guidelines, each being instances where the form of the transaction adopted by the parties "rather than be determined by normal commercial conditions … may have been structured by the taxpayer to avoid or minimise tax". The 1995 Guidelines explain that, in such cases, the totality of the terms of the agreement would be the result of a condition that would not have been made if the parties had been engaged in arm's length dealings, thereby in those limited circumstances making it both appropriate and legitimate to recast the transaction for the purposes of the hypothesis so as to reflect the economic and commercial reality of the transaction as one between independent parties dealing at arm's length. It should be observed that, in restructuring, the substituted transaction should, nonetheless, still align with what can reliably be hypothesized to be a comparable dealing to the actual dealing in order reliably to determine an arm's length consideration for that dealing. That is made clear by [C.1.37].
318 Paragraph [C.1.41] also illuminates that the two exceptions are not intended to be alternatives to the general rule. It states:
The difference between restructuring the controlled transaction under review which, as stated above, generally is inappropriate, and using alternatively structured transactions as comparable uncontrolled transactions is demonstrated in the following example. Suppose a manufacturer sells goods to a controlled distributor located in another country and the distributor accepts all currency risk associated with these transactions. Suppose further that similar transactions between independent manufacturers and distributors are structured differently in that the manufacturer, and not the distributor, bears all currency risk. In such a case, the tax administration should not disregard the controlled taxpayer's purported assignment of risk unless there is good reason to doubt the economic substance of the controlled distributor's assumption of currency risk. The fact that independent enterprises do not structure their transactions in a particular fashion might be a reason to examine the economic logic of the structure more closely, but it would not be determinative. However, the uncontrolled transactions involving a differently structured allocation of currency risk could be useful in pricing the controlled transaction, perhaps employing the comparable uncontrolled price method if sufficiently accurate adjustments to their prices could be made to reflect the difference in the structure of the transactions.
319 The present case is not a case falling within either of the exceptions referred to in the 1995 Guidelines. The economic substance of what the parties transacted does not differ from the legal rights and obligations created by the February 2007 Agreement and there was no suggestion at all that tax considerations, rather than normal commercial conditions, shaped the terms of the Agreement such that it can be said that the totality of the terms derived from the relationship of the parties and "the actual structure practically impedes the tax administration from determining an appropriate transfer price".
320 To the contrary, the February 2007 Agreement was a form of agreement seen in the market between independent enterprises in the relevant years and, as the experts agreed and as illustrated by the "comparable" contracts, the price sharing methodology adopted by the parties under that Agreement was a recognised, legitimate and accepted way for copper concentrate to be priced and one which other market participants, independent of each other and dealing at arm's length, also adopted at the time in respect of the supply of concentrate by a mine producer to a trader. No adjustment is required to the form of the Agreement to reflect that transaction as one entered into between independent parties dealing at arm's length in order to conduct the comparative analysis and, contrary to the Commissioner's submission, there is nothing in the structuring of the actual February 2007 Agreement that would "skew" the statutory inquiry or "be inconsistent with commercial reality". Significantly, Mr Ingelbinck had no issue with the pricing methodology adopted under the February 2007 Agreement. His issue related to the percentage that was chosen. Similarly, Mr Ingelbinck's disagreement with the quotational period clause was not so much with the quotational period options provided to GIAG but related to "the value of those [quotational periods]" and whether sufficient value was provided to CMPL for the back pricing component of it. Nor was there evidence to suggest that a price sharing agreement would never be adopted by an independent mine producer like CMPL and an independent trader like GIAG dealing wholly independently with each other.
321 The price sharing term was not simply an "integer" in the pricing of the copper concentrate, as the Commissioner contended, but a different market mechanism altogether by which to price copper concentrate. As the experts agreed, a price sharing contract and a market-related contract are fundamentally different types of contracts as the copper concentrate is priced materially differently under a price sharing agreement to how it is priced under a market-related contract. Whereas under a market-related contract the TCRCs are set by reference to a benchmark set annually and/or spot terms, with no correlation to the prevailing copper prices, under a price sharing agreement the TCRCs are fixed as a percentage of the metal exchange copper price for the duration of the contract so that the TCRC deduction and the metal exchange copper price are directly correlated to one another. Thus, there will be differences in the pricing of copper concentrate and the price payable, depending on the pricing structure used.
322 There is thus no warrant to restructure the February 2007 Agreement from a price sharing contract to a market-related contract for the purposes of determining the causative effect of the non-arm's length dealing on the profits that CMPL accrued, and I reject the Commissioner's contention that the appropriate hypothetical for the purposes of this exercise is a market-related contract. Substituting market-related TCRCs for TCRCs calculated as a fixed percentage of copper prices would produce a hypothetical transaction based upon different commercial considerations and a different commercial structure to that which was actually entered into. It involves and requires fundamentally rewriting the actual arrangement and engaging in an extensive exercise in commercial judgment which does not accord with, or give effect to, the objective of the arm's length principle.
323 There are further reasons to reject the Commissioner's primary case.
324 In predicating an agreement on benchmark terms, the Commissioner argued that the onus of proof on the taxpayer required the taxpayer to establish that a mine producer with CMPL's characteristics might be expected to have agreed to price sharing in early 2007 and that the evidence did not establish that, if CMPL had sold all of its production of copper concentrate under an agreement on terms unconditioned by its relationship with GIAG, it would have sold its copper concentrate on the same or similar terms to the terms on which it did sell the copper concentrate in the relevant years. In putting that argument, the Commissioner has incorrectly elided the two statutory questions directed by the provisions. The first question is whether there has been a non-arm's length dealing between enterprises in an international dealing (Div 13) or, in the case of Subdiv 815-A, whether the conditions which operated between the enterprises in international dealings differed from those which might be expected to have operated between "independent enterprises". That question is directed at establishing the precondition to permit an adjustment, for fiscal purposes, of the actual consideration received or paid (as the case may be) by an entity to an amount which is an arm's length equivalent. The second question is whether the consideration received for that dealing was less than or greater than an arm's length amount (as the case may be) (Div 13) or, in the case of Subdiv 815-A, whether there was a causal relationship between the non-arm's length conditions and profits not accruing to the taxpayer. The second question is a different inquiry to the first question. The statutory task directed by the second question is to determine an arm's length consideration for the actual transaction entered into and the need to posit a hypothetical agreement is for the purpose of evaluating an arm's length amount for the actual transaction. For that purpose, the hypothesized independent dealing is a comparable agreement to the actual transaction but where the consideration is not distorted by the parties' lack of independence and lack of arm's length dealing: Chevron at [4] (Allsop CJ), [129] (Pagone J). The Commissioner's submission that to answer the second question in this case first requires resolving what terms independent parties might reasonably be expected to have agreed on conflates the preconditions for the second question to arise with the exercise of determining a non-arm's length consideration.
325 In Cameco Corporation v The Queen (2018 TCC 195) ("Cameco"), the Tax Court of Canada recently rejected an approach similar to that taken by the Commissioner in this case. Justice Owen noted at [751] that:
…the task under the traditional transfer pricing rules is to ascertain the price that would have been paid in the same circumstances if the parties had been dealing at arm's length. The traditional transfer pricing rules must not be used to recast the arrangements actually made among the participants in the transaction or series, except to the limited extent necessary to properly price the transaction or series by reference to objective benchmarks.
At [714], his Honour said that in asking whether the transactions would have been entered into by persons dealing at arm's length the Canadian transfer pricing provisions are "not asking the Court to speculate as to what arm's length persons might or might not have done in the circumstances".
326 The opinions of Mr Ingelbinck and Mr Kowal in response to Questions 1(b) and 2(b) asked of them similarly elided the two statutory questions by using benchmark terms as the starting point for their consideration, based on their view that had CMPL been dealing at arm's length with GIAG it would have sold the copper concentrate on terms different to a price sharing agreement. As a consequence of this elision, their opinions in response to Questions 1(b) and 2(b) have little utility because Questions 1(b) and 2(b) did not direct the experts to address the correct statutory questions.
327 There is another issue with the opinions expressed by Mr Ingelbinck and Mr Kowal. Both Mr Ingelbinck and Mr Kowal opined that an independent seller of copper concentrate in the position of CMPL would have obtained more profits under a contract based upon benchmark TCRCs than CMPL in fact obtained, and that the 23% price sharing provision was thus "beneficial to GIAG" and led to a "revenue deficiency" for CMPL. It was on this basis that each reached the ultimate conclusion that it was unreasonable for CMPL to have agreed to sell its copper concentrate to GIAG pursuant to a 23% price sharing contract. However, this type of analysis involved precisely the same kind of hindsight reasoning which was rejected in Cameco at [757]-[758] because "[i]t is looking at what was the outcome of the transaction".
328 In that case, the Canadian taxpayer, Cameco Corporation, had entered into long-term contracts to sell uranium to its Swiss trading subsidiary. After the supply contracts were executed, the price of uranium rose significantly. The result was that profits from the Canadian-sourced uranium were realised largely in Switzerland rather than in Canada. The Canadian Revenue Agency ("CRA") re-assessed Cameco, attributing additional profits to it in respect of the sale of its uranium, relying on the Canadian transfer pricing provisions, amongst other provisions.
329 The reasons in Cameco record that, unlike copper concentrate, uranium is not listed on a metals exchange but is bought and sold under spot or long-term contracts, which apply different kinds of pricing mechanisms. These consisted of: fixed pricing models (eg $15/Ib); base escalated pricing ("BPC") models (which specify a base price that is escalated over time according to a specified formula which typically accounts for inflation); market-related pricing mechanisms (which specify a price that is determined by reference to one or more indicators of the market price of uranium, as published by leading companies in the industry); and hybrid pricing (which uses a combination of base escalated and market-related pricing mechanisms): at [25]-[32]. The supply contracts between Cameco and its Swiss subsidiary included ones which used the BPC pricing model.
330 Owen J found that the BPC transactions provided the taxpayer with an appropriate level of compensation. His Honour reasoned that they were long-term contracts, the duration of which was within the range of other long-term contracts reported for that period, and that they were for volumes of uranium that were not excessive when compared to arm's-length wholesale contracts made during the same period. Owen J further observed at [731]-[737] that commodity producers would sell production under BPC contracts to secure a guaranteed revenue stream for that production even if the (market-related) price was expected to move higher, on the basis that there is a "well-established concept in finance, known as the 'Certainty Equivalent', which clearly suggests that rational actors will accept a lower guaranteed amount in lieu of a higher expected, but risker, cash flow".
331 His Honour found that the transfer pricing analysis of the CRA's experts had been, to a significant degree, based on hindsight. The CRA's experts had used the taxpayer's actual results on the sales of uranium to third parties in the years in issue, under market-based pricing mechanisms, to determine the margin that would be achieved at arm's length by a seller of uranium under BPC contracts. It was held that it was not possible to use contracts with market-based price mechanisms as reliable arm's length comparables for determining the relevant margin on BPC contracts because the future price in fact obtained under the market-based contracts depended on the future price of uranium, which was uncertain at the time the BPC contracts were made. The Court's reasoning was as follows:
[810] … [I]f market-based contracts are used to determine the arm's length margin in a future year, the analysis is in essence using hindsight to determine the margin because the future price is the result of the choice made at the inception of the contract.
[811] To understand this point, it is helpful to first recite an opinion of Doctors Shapiro and Sarin [who were the taxpayer's experts]:
Without the benefit of hindsight, no contracting option is unequivocally better than another, and none is prima facie irrational. Whether a supplier or consumer ends up better off under a base-escalated contract, a pure market-price contract, or a market-price contract with a ceiling, depends on the future price of uranium. Only in hindsight can one know whether a particular type of contract was the right one for a buyer or seller to enter into, and on an ex-ante basis, any choice could be reasonable depending on counterparty preferences and other market circumstances.
[812] The actual price of uranium in a future year under a market-price-based contract reflects the result of the originally neutral choice made when the arm's length persons agreed to the price mechanism in the contract. In the case of a commodity with a potentially volatile price, the future result will almost invariably favour one pricing choice over another, different pricing choice even if the initial choices each reflected arm's length terms and conditions. Accordingly, to measure the price under a non-arm's length [BPC] contract against the result under a market-based contract is in effect to use hindsight - ie the result of the original choice-since the result could not be known at the time the contract was executed. This skews the calculation of the margin by the "result" component of the choice of price mechanism, contrary to the 1995 Guidelines.
332 Equally so, applying the reasoning in Cameco to the present case, it is irrelevant to compare the extent to which the results achieved under the price sharing contract entered differed from those that would have been achieved under an alternative agreement based upon benchmark TCRCs and to do so with the benefit of hindsight.
333 It follows that I also reject the other construct of the Commissioner's case, namely, that to discharge its onus of proof, the taxpayer had to prove that had CMPL sold its copper concentrate on terms unconditioned by its relationship with GIAG, it might reasonably be expected that it would have sold its copper concentrate on price sharing terms.
334 The Commissioner's case started with the proposition that the evidence showed that the pricing of copper concentrate is established through a process of negotiation between buyer and seller in the context of a "framework" contract between buyer and seller covering a whole range of terms and conditions including TCRCs, price participation, quotational periods and penalties, but that the main aspects of the contract subject to negotiation are the TCRCs and price participation. That proposition was uncontroversial and is accepted.
335 The Commissioner next submitted that the terms of the hypothetical transaction for the purposes of both Div 13 and Subdiv 815-A must, therefore, include a long-term, or framework, agreement between the hypothetical buyer and the hypothetical seller, as made in 1999, amended and continued over time, and where it might reasonably be expected that there would be annual negotiation of contract terms going to price (including TCRCs, quotational periods, and freight allowances) to reflect market conditions, which negotiations would take place by reference to annual benchmark terms and to market conditions as reported in publications such as Brook Hunt.
336 It was then contended that the February 2007 Agreement was "therefore to be understood as a means adopted by related parties, influenced by the lack of independence between those parties and the conditions operating between them, of setting the price payable for concentrate within the context of such a long-term framework agreement which permitted amendment in writing from time to time and contemplated annual negotiation of price". It was submitted that "[i]t would skew the statutory inquiry and be inconsistent with commercial reality to approach the statutory tasks as if the contractual relationship between the parties was determined solely by [the February 2007 Agreement], and to constrain the transaction to require that it be one which fixed price for three years by a price sharing arrangement" and "[a]ccordingly, the starting point for that analysis is not what would have been agreed 'under a price sharing contract of at least three years' duration which applied for the 2007 to 2009 years'".
337 The extension of the argument was that price sharing was not commercially rational if the aim of the mine producer was to make as much profit as possible. It was submitted that neither Mr Ingelbinck nor Mr Kowal considered that an independent party in the position of CMPL would have agreed to switch to price sharing, that Mr Wilson agreed that it would not be commercially rational to do so if the aim was to make as much profit as possible and Mr Kelly's evidence was that making as much profit as possible "was precisely" GIAG's aim in managing its mining assets. It was submitted that:
The Court would readily conclude that any other multinational commodities group, and any other orphan independent mine, would similarly have had the aim of maximising profitability, and that price sharing would not have been commercially rational in the circumstances. Mr Wilson's evidence was that on the available market information at the end of 2006, it was highly likely that CMPL (and it would follow any independent mine producer with its characteristics) would be worse off financially by agreeing to the price sharing agreement for three years rather than remaining on the terms as between CMPL and GIAG at the start of 2007.
338 I have already addressed why that argument wrongly elides the question of whether the preconditions exist for the exercise of power under Div 13 and Subdiv 815-A with the task of evaluating an arm's length consideration for the actual dealing. There are three other points to make about these submissions.
339 The first point is that neither Div 13 nor Subdiv 815-A directs an inquiry into the commercial prudence of the non-arm's length contract or transaction entered into. The inquiry directed is a comparative analysis of the consideration given under the actual agreement with a comparable "real world" arm's length consideration. Nothing different is said in the 1995 Guidelines. Where at [C.1.37] reference is made to adjustment of the conditions of the agreement "in a commercially rational manner", it is in the context of the second exceptional circumstance where the structure of the transaction is not explained "by normal commercial conditions" but may have been structured to avoid or minimise tax so that some adjustment to the transaction may be required to bring a "commercial reality" to the independent dealing hypothesis.
340 Secondly, in construing and applying the provisions of Div 13 and Subdiv 815-A, it is essential in giving effect to the policy objectives of those provisions not to intrude into the analysis concepts more appropriately found in other provisions, such as Part IVA of the ITAA 1936. The arm's length principle does not introduce, or involve, any investigation or consideration of purpose or motive: W R Carpenter Holdings Pty Ltd v Federal Commissioner of Taxation (2008) 237 CLR 198; [2008] HCA 33 at [38]. Nor does the assessment of an arm's length consideration involve an inquiry into what profits might reasonably be expected to have been obtained on a differently structured transaction, nor is the question whether, had the transaction been structured differently, it might reasonably be expected that greater profits would have accrued.
341 Thirdly, even if it be relevant to consider the commercial prudence of that which was transacted, hindsight could not be used to second-guess the commercial judgment made at the time as to the pricing methodology to adopt.
342 However, in case I am wrong in my analysis, later in these reasons I also address the Commissioner's argument that the evidence did not establish that independent parties in the position of CMPL and GIAG might have been expected to enter into such an agreement.