The judgment in Glencore
136 In Glencore, a joint judgment was delivered by Middleton and Steward JJ, and a separate judgment (agreeing in the result) was given by Thawley J.
137 In relation to the associated enterprises article in issue in Glencore (Art 9 of the Swiss Treaty), the taxpayer did not dispute that some conditions operated between the relevant companies (referred to as CMPL and GIAG) which differed from those which might be expected to have operated between independent enterprises dealing wholly independently with one another; it was accepted that GIAG exercised financial and managerial control over CMPL's mine: see at [13] per Middleton and Steward JJ.
138 The relevant version of the Transfer Pricing Guidelines for the purposes of Glencore was the version published by the OECD in 1995: see at [15] per Middleton and Steward JJ. That version was referred to in their Honours' judgment as the "Transfer Pricing Guidelines".
139 At [152]-[153], Middleton and Steward JJ discussed the Transfer Pricing Guidelines (i.e. the 1995 Guidelines) and, in particular, the exceptions referred to in paragraph 1.37 of those Guidelines. As their Honours noted, the Guidelines refer to the need for a revenue authority to apply the "arm's length principle" to the "transaction actually undertaken by the associated enterprises as it has been structured by them". There are two exceptions to this principle which are expressed in paragraph 1.37 of the Guidelines:
The first circumstance arises where the economic substance of the transaction differs from its form.
…
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.
140 Having set out the above quotation, Middleton and Steward JJ made the following observations regarding the Transfer Pricing Guidelines at [153]:
We are hesitant to comment on the language used in these so-called exceptions. The language deployed is very highly generalised and is frustratingly opaque. Further, the discernible object of the Transfer Pricing Guidelines is that they are just that; they are only a guide as to how a revenue authority or a taxpayer might apply the "arm's length principle", or how an OECD member country might enact the "arm's length principle" into domestic law. In that respect, the various statements of abstract principle that may be found in the Transfer Pricing Guidelines may be contrasted with the much greater discipline and rigour in drafting that is usually found in domestic legislation. Of course, Subdiv 815-A obliges the Court to work out whether an entity has got a transfer pricing benefit consistently with these Guidelines, but only to the extent they are relevant. In that respect, where a relevant principle is expressed in nebulous terms, it may not be of much real assistance to the task of applying Subdiv 815-A to particular facts.
141 Their Honours stated, at [154], that in any event it was unnecessary to say anything more about the Transfer Pricing Guidelines because, in their Honours' view, and contrary to the view of the primary judge in that case, the Commissioner "did in fact apply Subdiv 815-A and Div 13 to the transaction actually undertaken by CMPL and GIAG". In their Honours' view, all the Commissioner sought to change was the consideration for the copper concentrate in fact supplied.
142 Their Honours discussed the legal capacity of the Commissioner to substitute a different formula or a different methodology in relation to price for the formula or methodology agreed to by the parties to a transaction. Their Honours first discussed this in the context of Div 13, and then stated that the same conclusion applied to Subdiv 815-A. Their Honours stated at [154]-[157]:
154 … Where parties to an agreement specify a price in dollar terms, or in the terms of another currency, Div 13 gives the Commissioner a clear power to substitute a different price which he considers to be the "arm's length consideration." Upon making his determination under s 136AD, that consideration is then "deemed" to be the relevant consideration received in respect of a given supply. Where parties do not specify an actual price, but rather agree that the consideration payable is to be determined by a formula or some other methodology, the Commissioner, in our view, is also permitted - in the sense of having a legal capacity - to substitute a different formula or a different methodology which he considers will result in the ascertainment of the arm's length consideration. The word "consideration", as Pagone J observed in Chevron at [133], "is not to be construed narrowly and includes that given by the acquiring party so as to move the agreement whether that be in money or in money's worth": Archibald Howie Pty Ltd v Commissioner of Stamp Duties (NSW) (1948) 77 CLR 143 at 152; [1948] 2 ALR 489.We agree. It is at least wide enough to include a pricing formula or some other methodology for the determination of price.
155 Our conclusion that the Commissioner has this legal capacity is a necessary consequence of the terms of s 136AD, which permit him to make a determination whereby the taxpayer is relevantly deemed to have received consideration equal to the arm's length consideration. In that respect, the term "consideration" necessarily directs one to identify those clauses in an international agreement which define the price payable for the supply of goods or services. A distinction must therefore be drawn between such a clause or clauses and other clauses found within an international agreement, including those which may indirectly bear upon price. This distinction may be unsatisfactory, particularly in practice, but is nonetheless mandated by the text of Div 13. Whether the Commissioner is authorised under Div 13 to ignore or reframe those other clauses which do not define the price payable must be very seriously doubted. Again, that is because of the language of Div 13. When the Commissioner makes his determinations under s 136AD, the legal consequence is limited to the taxpayer being deemed to have, in this case received, arm's length consideration as defined under s 136AA. Consistently with the usual rule about deeming provisions, the statutory fiction mandated by Div 13 should be construed strictly and only for the purpose which it serves: Federal Commissioner of Taxation v Comber (1986) 10 FCR 88 at 96; 64 ALR 451 at 458 per Fisher J; Financial Synergy Holdings Pty Ltd v Commissioner of Taxation (2016) 243 FCR 250; [2016] FCAFC 31 at [34] per Middleton and Davies JJ. There is thus no power or authority to substitute different terms of a contract where those terms are not seen as defining the consideration received, relevantly, for the supply of goods. Whether a term of a contract is to be characterised as such a term will need to be decided on a case by case basis.
156 In our respectful view, the same conclusion concerning the substitution of a different formula or methodology to ascertain the arm's length consideration applies to Subdiv 815-A. The "conditions" referred to in Art 9 of the Swiss Treaty must include the consideration paid, and where parties have chosen to select a form of consideration which is ascertainable by the use of a formula or some other methodology, the "conditions" referred to in Art 9 of the Swiss Treaty must include that formula or that methodology. In respect of the conditions in an agreement that only indirectly bear upon price, the extent to which the Commissioner can substitute different conditions if he considers that those conditions differ from those which might be expected to operate between independent enterprises dealing wholly independently with one another is a question for another day.
157 In our view, the reasons of Allsop CJ in Chevron support, at least with respect to Div 13, the foregoing conclusion. His Honour observed at [46]: …
(Emphasis added.)
143 At [163], Middleton and Steward JJ stated:
As was made clear in Chevron, Div 13 contemplates a hypothetical transaction entered into by independent parties dealing at arm's length with each other and Subdiv 815-A contemplates hypothetical conditions which might be expected to operate between independent enterprises dealing wholly independently with one another. …
(Emphasis added.)
144 In the next section of their judgment, at [164]-[191] Middleton and Steward JJ considered the issue of the 'personality' of the parties to the hypothetical contract. While this discussion is largely directed to Div 13, reference is also made to Subdiv 815-A. It therefore appears that some, if not all, of the principles expressed in this part of their Honours' judgment are applicable to Subdiv 815-A. At [164]-[165], their Honours outlined the Commissioner's submissions. The Commissioner had submitted that both Div 13 and Subdiv 815-A required the hypothetical parties to the hypothesised copper concentrate transaction to be clothed with the very same attributes that CMPL and GIAG had at the relevant time (February 2007). The Commissioner's submissions were further set out in [165] as follows:
In that respect, the presence of the pre-existing CMPL-GIAG agreement on different terms loomed large in the Commissioner's case. His case was built upon a comparison of the benefits conferred on CMPL by that contract as compared with the reduced cash benefits which were expected to arise by reason of the amendments made in February 2007. Why, it was asked, would a party in the position of CMPL have agreed to such a debilitating change of terms? It simply was not what an independent party dealing at arm's length with a buyer of copper concentrate would ever have agreed to.
145 Their Honours rejected the Commissioner's submissions at [166]:
With respect, we think the Commissioner has asked the wrong question. As a result, whether the CMPL-GIAG agreement fell within that range of hypothetical contracts for the sale of copper concentrate which independent parties dealing at arm's length with each other might reasonably be expected to have entered into, did not feature in the Commissioner's analysis. Because the Commissioner was not asking the correct question, he submitted that there was no range of possible outcomes for this particular mine, but just one outcome, namely retention of the pre-existing terms as they were just before February 2007.
146 Justices Middleton and Steward then discussed the issue of the personality of the parties to the hypothetical contract in detail. Their Honours observed, at [169], that Chevron must be taken to have softened, at least to an extent, the conclusion expressed by the Full Court of this Court in Commissioner of Taxation v SNF (Australia) Pty Ltd (2011) 193 FCR 149 (SNF) at [98]-[99]. At [169]-[171], Middleton and Steward JJ endorsed the observations of Allsop CJ in Chevron at [42]-[44] in relation to Div 13. Having set out those paragraphs, Middleton and Steward JJ observed that they "neither support a test which is the 'utter disembodiment' of the actual parties from the hypothetical transaction, nor a test whereby the hypothetical party stands entirely in the shoes of the taxpayer".
147 At [176], Middleton and Steward JJ stated that the extent of depersonalisation in the case before them depended, to use the language of Allsop CJ in Chevron at [45], upon what was appropriate to the task of determining an arm's length consideration. Their Honours then set out seven relevant considerations at [177]-[186]:
177 First, one should commence with the simple and uncontroversial proposition that it is only those attributes or features which can affect the consideration which is receivable which should clothe the hypothetical seller of copper concentrate.
178 Secondly, it is only the objective attributes or features which should be included. In SNF at first instance (SNF (Australia) Pty Ltd v Commissioner of Taxation (2010) 79 ATR 193; [2010] FCA 635) Middleton J observed at [44]:
Just as in a valuation, the focus is not on the subjective or special factors of the parties involved in the transaction (for example whether they were financially sound or not), but is on the transaction itself and the consideration paid. In this sense, the task is not dissimilar to that undertaken in a valuation: see, for example, Boland v Yates Property Corporation Pty Ltd (1999) 167 ALR 575; 74 ALJR 209; [1999] HCA 64 at [82]-[83] and Spencer v Commonwealth (1907) 5 CLR 418; 14 ALR 253.
179 Nothing said by this Court in SNF or in Chevron has led us to doubt the general correctness of this observation which we adopt. It means that one should include all of the objective circumstances of the actual CSA mine, such as the means of production, the levels of production, the costs of production, the size of the mine, its location, and any problems arising from the location (eg water supply issues), and so on. It would include the objective circumstances of the copper concentrate market as at February 2007, including what was being reported by Brook Hunt, and what CMPL had budgeted and forecasted about the market. It would also include being a wholly owned subsidiary of a multinational natural resources group, but that group would not necessarily need to be the Glencore Group.
180 Thirdly, we think that it would be appropriate to exclude any considerations that are the product of CMPL's non-arm's length relationship with GIAG and the broader Glencore Group. In our view, that would include whatever attitude or policy CMPL had formed about the issue of risk when selling to GIAG. Of necessity, any such attitude or risk would have been distorted by CMPL's lack of independence from GIAG. Inferentially, as a separate entity it is unlikely to have considered the issue of risk when selling to GIAG, save for its attempt to comply with Div 13 in the 2007 to 2009 years. It follows that the taxpayer's failure to lead evidence about CMPL's appetite for risk taking is not fatal. Nor is the failure to lead evidence about the Glencore Group's policy about risk taking (if any). Whilst such a policy, if it existed, might have been relevant, it was also, for the reasons given below, open to the taxpayer to discharge its onus on this issue through the opinions of Mr Wilson.
181 Fourthly, and in any event, because the issue of risk taking is so bound up here with the method or formula for determining the consideration payable for the sale of copper concentrate, the taxpayer was entitled to support the appropriateness of the particular formula chosen in February 2007 by reference to what an independent party in the position of CMPL might have done to address risk in the objective circumstances of the copper concentrate market at that time in selling either to an independent trader or smelter. For that purpose, it could legitimately adopt a more conservative approach to risk so long as it was commercially rational to do so, and it is what an independent party dealing at arm's length might reasonably be expected to have done. The Commissioner was entitled to do likewise in support of a different pricing formula. Such a conclusion is consistent with Div. 13 imposing an objective test: WR Carpenter Holdings Pty Ltd v Commissioner of Taxation (2007) 161 FCR 1; 241 ALR 636; [2007] FCAFC 103 at [27].
182 Importantly for this case, in our view it was open to the taxpayer to form its own commercial judgment about how risk was to be assessed as at February 2007 in the hypothetical transaction between independent parties. It was also open for Mr Wilson to form such a commercial judgment arising from the fact that the CSA mine was a high cost venture, so long as that judgment was the expression of what an independent party acting at arm's length might reasonably be expected to have adopted. On behalf of the Commissioner, it was also open for Mr Ingelbinck to perform a similar exercise. It follows that choices which are open to be made about risk may affect the determination of the arm's length consideration. It also follows that there is likely to be more than one price which is an arm's length price. In that respect, a taxpayer is under no obligation to choose a pricing methodology which pursues profitability in Australia at the expense of prudence. There is no obligation to "maximise" profitability at the expense of all else.
183 Fifthly, the possibility of a range of arm's length outcomes, each of which would be sufficient to answer the statutory test, is supported by authority. As this Court said at [125] in SNF:
But that does not mean, more generally, that there is only one arm's length consideration. Often enough, for example, goods will change hands at prices which are different to the market value for perfectly legitimate reasons such as a need to secure long term or large volume arrangements or with traded securities, a premium for control and so on. No doubt, it was for similar reasons that Dr Becker, the Commissioner's own witness, in response to the question '[a]nd you accept that, typically, there's not one arm's length price for a particular product?' answered '[t]hat's correct, yes'.
184 Sixthly, what controls the range of acceptable arm's length outcomes is the concept of what might reasonably be expected. As Pagone J observed in Chevron, that concept calls for evidence which supports a "sufficiently reliable" prediction which can be seen as reasonable. As his Honour said at [127]:
The standard of reasonable expectation found in the words "might reasonably be expected" in s 136AA(3)(d) calls for a prediction based upon evidence. In Federal Commissioner of Taxation v Peabody (1994) 181 CLR 359; 123 ALR 451 the High Court said at CLR 385; ALR 461:
A reasonable expectation requires more than a possibility. It involves a prediction as to events which would have taken place if the relevant scheme had not been entered into or carried out and the prediction must be sufficiently reliable for it to be regarded as reasonable.
The prediction contemplated by Division 13, like that contemplated by s 177C of the 1936 Act, involves an evaluative prediction of events and transactions that did not take place but the prediction must be based upon evidence and, where appropriate, upon admissible, probative and reliable expert opinion: see Commissioner of Taxation v Futuris Corporation Ltd (2012) 205 FCR 274; [2012] FCAFC 32 at [79]-[81]; see also Peabody v Federal Commissioner of Taxation (1993) 40 FCR 531; 112 ALR 247 at 256 (Hill J).
185 The Commissioner in his written submissions appeared to contend that the hypothetical mandated by Div 13 required a taxpayer to prove what independent parties would have agreed to be the arm's length consideration, rather than what independent parties might reasonably be expected to have paid or received. He relied on certain sentences in Chevron which appeared, on one view, to adopt a "would" test, but clarified during the hearing before us that he accepted that Div 13 mandates a "might" test. We respectfully agree with this clarification. We do not think that those sentences in Chevron were intending to convey a test at odds with the language of s 136AA(3)(c) and (d) of the 1936 Act. The statutory test relevantly requires the hypothetical price to be ascertained by reference to what might reasonably be expected to have been received or paid if the property had been supplied under an agreement entered into between independent parties dealing at arm's length with each other. In our view, Art 9 of the Swiss Treaty mandates a relevantly analogous inquiry. It refers to what might be expected and not to what would be expected.
186 Finally, in applying the foregoing a degree of flexibility and pragmatism is required. Whilst the onus remains on the taxpayer to discharge its onus of proof of demonstrating excessiveness in the amended assessments, one should not apply Div 13, or indeed Subdiv 815-A, narrowly. Predicting how independent parties dealing at arm's length with each other would price a wholly controlled transaction is a difficult and complex issue. That is especially so when one integer which here directly affects the consideration payable is the formation of a commercial judgment about risk taking. The Court should acknowledge, and take into account, the practical difficulties faced by both the taxpayer and the Commissioner in finding evidence that grounds what is sufficiently reliable, or which demonstrates that something is insufficiently reliable. The answer is not always to be found in overly lengthy and complex expert reports. Common sense is required.
(Emphasis added.)
148 In relation to the issue of personality under Subdiv 815-A, Middleton and Steward JJ stated at [189] that Subdiv 815-A "applies in an analogous way to Div 13" and that "[b]oth must be applied flexibly". Their Honours cited with approval the observations of Allsop CJ in Chevron at [90]. Their Honours also cited with approval a passage from [156] of the reasons of Pagone J in Chevron.
149 Turning to the judgment of Thawley J in Glencore, his Honour agreed with the orders proposed by Middleton and Steward JJ, but expressed his own reasons in relation to the operation of Div 13 of the ITAA 1936 and Subdiv 815-A of the ITAA 1997. His Honour addressed Div 13 and Subdiv 815-A separately, in light of the significant differences in the statutory language and structure: see [248].
150 His Honour addressed Div 13 at [249]-[272].
151 At [273]-[281], Thawley J considered the 1995 Guidelines. At [280]-[281], his Honour referred to the two exceptions appearing in paragraph 1.37 of the 1995 Guidelines (set out at [139] above). At [278], Thawley J stated that, contrary to the primary judge in that case, he did not read the reasons of Allsop CJ in Chevron as stating or implying that the identification of the arm's length consideration must be based on the actual transaction as structured by the parties, save in the case of the two exceptional circumstances referred to in the 1995 Guidelines. At [280], Thawley J stated that Allsop CJ "was not applying the exceptions referred to in the 1995 Guidelines". Justice Thawley stated at [280]:
Rather, the Chief Justice's reference to the two exceptions was merely to support the conclusion otherwise reached by his Honour from the text of Subdiv 815-A that the inquiry under s 815-15(1)(c) was one which required a "comparative analysis that gives weight, but not irredeemable inflexibility, to the form of the transaction actually entered between the associated enterprises": Chevron at [90].
152 Justice Thawley considered Subdiv 815-A at [282]-[299]. After setting out the key relevant provisions, Thawley J noted at [288] that the real issue in dispute between the parties was the application of paragraphs (b) and (c) of s 815-15(1). His Honour outlined the steps involved and the focus of inquiry at [289]-[291]:
289 The first step, required by para (b), is to identify the "conditions" in Art 9, namely what "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".
290 The second step, required by para (c), is to identify whether "but for the conditions" in Art 9 an amount of profits might have been expected to, but did not, accrue to the entity.
291 The focus of the inquiry is on whether conditions operated between enterprises in their commercial or financial relations and, if so, what effect those conditions had. As mentioned above, the primary judge approached the task under Subdiv 815-A on the basis that it was not permissible to determine consideration otherwise than by reference to the agreement in fact entered into unless one of the exceptions in the 1995 Guidelines applied. In my view, this fails to give effect to s 815-15(1)(b) and (c) which focus on whether conditions operating between the entities affected the profits which accrued.
153 At [292], Thawley J stated that, if one of the exceptions in paragraph 1.37 of the 1995 Guidelines applied, it would be consistent with the 1995 Guidelines to determine that the effect of Subdiv 815-A in relation to the entity was that it got a transfer pricing benefit under s 815-15 that could be negated under s 815-10. Importantly, Thawley J then stated at [292]:
… However, for the reasons which follow, I would not take the step taken by the primary judge and conclude that, in all cases where the two exceptions did not apply strictly according to the terms of those exceptions as identified in the 1995 Guidelines, the relevant transaction must always be taken exactly as found.
154 Justice Thawley set out his reasons for that view at [293]-[294]:
293 Firstly, Subdiv 815-A must be applied according to its terms and one could not give effect to the 1995 Guidelines if to do so would be inconsistent with the terms of the subdivision or would fail to allow its operation according to its terms. Section 815-15(1)(c) is engaged where "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". If the conclusion were reached that the provision applied, that conclusion should be given effect even if the facts did not strictly fit within one of the two exceptions contained in [C.1.37] of the 1995 Guidelines.
294 Secondly, in any event, I do not read the 1995 Guidelines as specifying that the two situations identified are the only situations which might be regarded as "exceptional". As noted above, I do not read the decision of the Full Court in Chevron, or the reasons of Allsop CJ specifically, as authority for such a proposition.
155 Justice Thawley also stated at [296]-[299]:
296 In the first sentence of [156], Middleton and Steward JJ state that their conclusions with respect to the operation of Div 13 concerning the "substitution" of a different formula or methodology for ascertaining the arm's length consideration apply equally to Subdiv 815-A. Their Honours' conclusions in relation to Div 13 were, in summary, that the Commissioner may substitute clauses which define price, but not those which do not. In my view:
(1) If the terms in the agreement which "define price" are arm's length terms, it would ordinarily be unlikely that those terms could be said to be "conditions" operating "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". In those circumstances, it is difficult to see how they could rationally be substituted.
(2) If the agreement contains terms which do not define price, and which would not be found in the agreement if it had been between independent enterprises dealing wholly independently with one another, it is difficult to see why those terms could not be substituted under Subdiv 815-A. Such terms may well amount to "conditions" operating "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". If such terms affect the consideration payable or receivable, or profits, it is difficult to see why they should not be "substituted".
297 In my view, the language of Subdiv 815-A does not contemplate or require a distinction between terms which define price (which Middleton and Steward JJ consider can be substituted) and those which do not (which their Honours consider may not be substituted). In this respect, I note that their Honours' observation at [155] that "the term 'consideration' [in Div 13] necessarily directs one to identify those clauses in an international agreement which define the price" does not apply to the language of Subdiv 815-A.
298 That is not to say that it is irrelevant to look at the extent to which a particular clause affects consideration or profit. That is plainly and directly relevant. The point of difference is simply that what may or may not be "substituted" for the purpose of applying Subdiv 815-A does not turn on a potentially "unsatisfactory" categorisation of contractual clauses as ones which do or do not define price - see [155] of Middleton and Steward JJ's reasons for judgment. Subdiv 815-A, in its application to the present case, turns on the question of whether conditions operated "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" - see s 815-10(2); Art 9.
299 As to the final sentence of [156], this implicitly acknowledges the possibility that conditions which do not define price may be substituted, a conclusion with which I agree.
(Emphasis added.)