108 On the basis of the evidence given in cross examination and express indications made in their affidavits, I accept that any statement of Mr Karoudjian and Mr Schroeter as to the following is hearsay and inadmissible:
(a) the prices charged by various companies (other than Nalco in the case of Mr Schroeter) to which objection has been taken;
(b) any statements which are specifically made on the basis of information supplied by another person;
(c) any conclusionary statements as to comparative markets, the independence of customers, similarity of product or description of market; and
(d) any statements concerning the status of customers, as to whether or not they were end users or distributors of similar products.
109 I also indicate that the 'costing model' presented by Mr Schroeter (which was also objected to by the Commissioner on the basis of relevance) is not relied upon by me in my consideration, and in my view, is irrelevant.
110 I accept both witnesses did have considerable experience and knowledge of the industry, and to a certain extent could give evidence arising from their experience: see eg Notaras v Hugh [2003] NSWSC 167 per Sperling J at [17] to [18] and Jango v Northern Territory of Australia (No 2) [2004] FCA 1004 per Sackville J at [73] to [74]. However, once a witness (not being an expert) indicates that he or she relied upon another person or document as a basis for the evidence given to the Court and such evidence is specific and not arising from the witness's general knowledge, such evidence is hearsay and inadmissible unless the Court exercises its discretion otherwise.
111 However, putting aside the inadmissible evidence of Mr Schroeter and Mr Karoudjian, there is other evidence which would support some of the factual matters raised by them. I have already referred to some of this evidence, but will return to my factual findings later.
112 To the extent that any reliance was sought to be placed upon s 190 of the Evidence Act, I would not exercise my discretion to allow the evidence to be otherwise admitted into evidence, as the evidence is contested and is central to the consideration I must undertake to determine the primary issue in this case. The taxpayer has been aware in the preparation of this proceeding that the burden would be upon it to provide evidence in admissible form to the Court. None of the considerations referred to in s 190 would lead me to exercise my discretion to admit the evidence objected to by the Commissioner.
113 In relation to the objections taken to the evidence of Mr Seve, I accept that he was an expert witness, founded upon his experience in and knowledge of transfer pricing. An expert is entitled to rely upon the information of others, and his own assumptions, as long as these are clearly identified, and the opinion expressed is his or hers: see Paino v Paino [2008] NSWCA 276. Contrary to the submission of the Commissioner, Mr Seve's reliance upon others did not make his report a joint report of many authors (of the type referred to by Stone J in Cooke v Commissioner of Taxation (2002) 51 ATR 223), as he was the sole author of the report and presented it as such to the Court.
114 However, and significantly in this proceeding, Mr Seve could not provide evidence as to the primary facts needed to properly undertake a CUP analysis or provide a comparative analysis. Like an economist, Mr Seve may be able to give evidence about markets and market behaviour generally, but in relation to specific markets and the comparable transactions primary evidence would be required.
115 As such, in this case, Mr Seve cannot give evidence of the factual elements of the CUP analysis which relate to economic comparability, comparability of goods, comparability of point in the chain where goods are sold, comparability of functions of the enterprise, comparability of terms and business strategies.
116 As a matter of procedure, pursuant to s 57 of the Evidence Act, the evidence of opinion could be admitted subject to evidence being admitted at a later stage in the proceeding proving the primary facts assumed by the expert. If by the end of the proceeding a fact upon which a particular opinion is based is not established, then the opinion has no weight.
117 Nevertheless, Mr Seve can provide expert evidence (like an economist) to assist the Court on comparability. However, even with this assistance, the Court has the ultimate task of considering the primary facts, and in this proceeding, determining the ultimate issue concerning arm's length consideration in the context of the interpretation and application of Div 13.
118 In this regard, the comments of the Full Court of this Court in Universal Music Australia Pty Ltd v Australian Competition and Consumer Commission(2003) 131 FCR 529 have equal application to the present case:
[163] In concluding our findings in relation to s46, something should be said about the use of expert economic evidence in cases such as the present. The primary judge referred to the evidence of witnesses called in the cases, to writings on the topic by economists and lawyers, and to the discussion of economic theory in other judgments. The primary task of the Court, however, is to apply the words of the Act to the facts found on the evidence before it. These words involve some economic concepts and the application of the Act to the facts of a particular case may be informed by economic evidence or argument. But it is the language of the Act which defines the task that the legislature has set for the Court. To the extent that the statutory language conflicts with economic theory, the Court is bound to apply the Act.
119 Therefore, I regard the evidence of Mr Seve as expert evidence admissible under s 79 of the Evidence Act, but only to be given weight to the extent admissible evidence is otherwise before the Court as to the necessary primary facts. On this basis, the evidence is not unfairly prejudicial to the Commissioner for the purposes of s 135 of the Evidence Act. Mr Seve has set out the information he had relied upon, his assumptions, and the instructions he was given to prepare his reports. The taxpayer does not rely upon Mr Seve's evidence to prove the primary facts, and no order was required to be given pursuant to s 136 of the Evidence Act.
120 I turn then to the evidence of Dr Becker and the objections of the taxpayer.
121 The Commissioner relied upon the evidence of Dr Becker in the form of three reports and various tables annexed to those reports. The second of those reports supplemented Dr Becker's first report and the third report responded to the report prepared by Mr Seve.
122 Dr Becker commented on comparability, but an important aspect of his evidence was his reliance on the TNMM.
123 What was to be determined by the TNMM was that for every $100 of sales the taxpayer in fact obtained a net selling price of $71.43. Dr Becker then determined how much of that $71.43 an independent party would give to a manufacturer to acquire the products. He resolved this question by determining a 'benchmark operating profit' on $100 of sales, and then subtracting from that $71.43.
124 The benchmark operating profit was determined by Dr Becker by reference to the operating profits of the other functionally comparable distributors. Under that methodology for determining price, unlike in the case of a CUP analysis, he did not compare specific transactions or groups of transactions, with other truly comparable transactions. Instead, Dr Becker sought to identify with a single economically significant category or genus of enterprises other businesses by reference to their functionality and risk profile. The object was then to determine the average, or mean, of profits made by those businesses. Precise comparability was not required by the method, so long as the enterprises being considered exhibit those same economically significant elements that contribute to profitability.
125 It was submitted that in this way, profits earned by enterprises that operate in different jurisdictions and carry on different types of business may be taken into account so long as they exhibit, in each case, substantially the same economic function and risk profile.
126 To achieve the analysis, Dr Becker first searched for independent Australian distributors of polyacrylamides trading between 1997 and 2003, and found 4 independent Australian limited risk distributors, and 7 independent companies in countries with relatively strong economies that distribute products broadly similar to polyacrylamides. Dr Becker took the median point within the range of operating profits, 1.7%, as the appropriate benchmark. This translated to a cost of sale for the taxpayer of $69.74. That is, in order for the taxpayer to make an operating profit of 1.7%, it could pay no more than $69.74 for the products. Dr Becker noted that in order to achieve a profit of 1.7% the taxpayer would have paid a total of $12.3 million less for the polyacrylamides over the whole relevant period than it did in fact pay.
127 The Commissioner submitted that in the context of this proceeding, the TNMM provided a rational basis for determining the profits that might have been expected to accrue to the taxpayer had it dealt with the suppliers at arm's length. TNMM involved a comparison of the net profit margin that the taxpayer realised from the sale of polyacrylamides with the net profit margin realised by the independent companies, which Dr Becker identified as functionally comparable.
128 The Commissioner submitted, consistent with Dr Becker's opinion, that if the taxpayer was independent and dealing wholly independently it would not have returned losses, over the years in dispute, but rather an average operating profit margin of 1.7%.
129 In my view, undertaking the TNMM does not provide a proper basis for determining what consideration it was reasonable to expect that an independent purchaser would pay for the products. The TNMM does not address the issue as is required by Div 13 of the ITAA, as interpreted earlier in these reasons. I reject the use and applicability of the TNMM as contended for by the Commissioner in the context of applying Div 13.
130 Further, one of the very real problems with the TNMM undertaken by Dr Becker is that the analysis focuses on a seven year period, and the need to make a profit of 1.7%. There is no method to divide that period into a relevant year, or to relate the analysis to the requirements of Div 13, focusing on arm's length consideration in relation to the acquisition of particular goods.
131 Another problem with profit based methodologies was referred to by Downes J in Roche (2008) 70 ATR 703:
[185] One of the problems of profit based methodology is that, when applied to transfer pricing, it inevitably attributes any loss to the pricing. Where operating expenses are higher these may place some of the emphasis of the cause of the loss on the wrong area. After all, it is certainly true that there are companies which make losses for reasons other than the prices for which they acquire their stock. The Australian operations of multinational companies are not necessarily excluded from this.
132 The taxpayer also challenged Dr Becker's capacity to give expert evidence due to his lack of specialised knowledge. I am satisfied having regard to matters attested to by Dr Becker that he was suitably qualified to provide an expert opinion on the TNMM profitability analysis and to make economic assessments of the taxpayer's financial statements. He was not qualified to give evidence in valuing the products or describing the markets of such products other than in the same way as Mr Seve. That is, based upon primary facts. Dr Becker can assist the Court on methodology and the elements of comparability, although, as I have said, it is a question of fact for this Court to determine the arm's length consideration based upon the evidence.
133 I now turn to the evidence of Mr Pich. No objections were taken to his evidence, although the Commissioner whilst not attacking the credit of Mr Pich, submitted in many respects that his evidence should not be accepted by the Court.
134 I say at the outset that subject to one qualification I accept the evidence of Mr Pich. As I say, his credit was not attacked, and I consider the evidence he gave logical and in conformity with commercial reality, once one accepts (as I have) that the taxpayer was being supported at all times by its parent in pursuit of Mr Pich's world wide objective.
135 The one qualification relates to evidence given in re-examination. In re-examination Mr Pich did make a reference to losses made by SNF France, based upon calculations made some two or three weeks prior to giving evidence. Those calculations were not produced to the Court, nor were they called for by the Commissioner. No reference was made to these losses in Mr Pich's sworn affidavit. There was some lack of clarity in the exact amount and period of the losses, and I am not prepared to accept the figures given by Mr Pich. However, I am prepared to accept, although I regard it as irrelevant to the main task, that losses were made in the relevant period by SNF France which Mr Pich regarded as creating a 'catastrophic situation' in France. I do not see any inconsistency in this oral evidence with any of the documentation before the Court.
136 There were other important aspects of Mr Pich's evidence, going to the issue of arm's length consideration and the question of 'market', an issue of contention in this case. The taxpayer contends that there was a global market for the products, which the Commissioner submitted the taxpayer has not proved.
137 In my view, there is sufficient evidence to demonstrate that there was a global market, at least for the purposes of considering the issue of an arm's length consideration in the context of Div 13. This is not a proceeding which requires the exactness of market definition in the same way as may be required in considering competition issues: see generally Corones SG, Competition Law in Australia (4th ed, 2007) pp.139 et seq. Even in that area of discourse, the extent to which the market needs defining will depend upon the circumstances of the case.
138 Mr Pich, on the question of global market, gave the following evidence:
My objective for SNF France was, and remains, that it should be the world's pre-eminent manufacturer of acrylamide and its derivatives for the water-soluble polymer market, and to hold 50% market share of the flocculant market globally.
SNF France and its subsidiaries (collectively, the 'SNF Group') have become a leading producer of flocculants for water treatment and are actively present on four continents. The main manufacturing locations of the group are in France (SNF France), the United States of America (SNF Inc in Riceboro and Perlington), South Korea (Eyang Chemical Co Ltd) and China (SNF (China) Flocculant Co Ltd). The market share of SNF Group globally at this time is approximately 38%.
…
The prices for purchases by SNF Australia from members of the SNF Group were set by SNF France, always having regard to the global market for the products.
139 Mr Pich further indicated that global pricing arrangements were in place, although in the relevant period, not in Australia. This was because negotiations did not occur in Australia, as there were no personnel to undertake such negotiations. The negotiations for price were conducted outside Australia. However, this is of no moment. Whilst the evidence is unclear as to how the global price lists were referenced in terms of the pricing in different countries or geographic regions, what is clear on the evidence is the actual prices paid by the taxpayer and the customers. It does not matter what the basis of setting a global price list was, or whether different considerations applied to global pricing around the world, if, as in this proceeding, the evidence shows consistency of range in the prices of the transactions sought to be relied upon as truly comparable. It is the price paid that is critical, assuming it is a price paid in a truly comparable transaction.
140 All the evidence and surrounding circumstances point to a global market. If a company wished to purchase polyacrylamides from a SNF manufacturer, it would look to France, China or USA. This is not to be confused with the market in which the taxpayer or distributor sells. When analysing the evidence, the relevant evidence is not the prices and terms of the distributor's (including the taxpayer's) own sales. The Commissioner failed to make this distinction in looking at the evidence. In one instance for example, the Commissioner relied upon evidence of Mr Pich where he discussed establishing SNF Australia with a different cost structure from other subsidiaries within the SNF Group because of factors specific to the Australian market to demonstrate that the market in Australia was different from other markets in which the taxpayer was said to rely as comparable to Australia (see par 93(c) of the "Respondent's Revised Outline of Submissions"). However, Mr Pich was clearly not talking of the market relating to the acquisition of the products, but was giving evidence about the taxpayer's sales in Australia and the competitive environment in Australia (see paragraph 23 of Mr Pich's affidavit and Transcript p 133 line 41 and p 134 line 14).
141 Mr Pich also gave evidence that he would not have authorised the sale of products to an independent purchaser at the lower prices charged to the taxpayer during the relevant period. It was submitted that given that the suppliers were already losing money on their sales to the taxpayer, one could not reasonably expect that the suppliers would charge the existing low prices to an independent party. This to me seems correct.
142 Mr Pich also gave evidence going to the explanation for losses incurred by the taxpayer, to which I will return when dealing with that topic.
143 All that the taxpayer needs to put before the Court is sufficient evidence to demonstrate true comparability. Oral testimony, if in admissible form, can be sufficient, even if not fully supported by documentary material. For instance, I am satisfied that there is a global market on the evidence I have referred to, although one could readily anticipate that a great deal more evidence could be placed before the Court to demonstrate this fact.
144 On the available evidence, I make the following observations and findings as to the comparable transactions:
(a) The actual prices paid by the taxpayer for the acquisition of the products were lower than the large majority of prices paid by the purchasers in the comparable transactions over a similar period of time;
(b) The taxpayer sold the large majority of products to end-users, although there were exceptional instances where this did not occur;
(c) The products subject of the comparable transactions relied upon by the taxpayer were the same or similar to the products acquired by the taxpayer;
(d) The essential terms of the comparable transactions were the same or similar to those of the taxpayer including the size of the orders, the terms of payment and delivery, and taking into account currency conversions and isolated rebates; and
(e) Each of the customers and other purchasers were independent, and were trading in an industry similar to the taxpayer and were distributors of product in their respective market places.
145 I make these findings on the bases of the admissible data produced by the witnesses called by the taxpayer, the documentation tendered by the taxpayer relating to the customers and purchasers, and affidavits of Mr Pich, Mr Schroeter, Mr Karoudjian and Mr Schlag to the extent not objected to by the Commissioner. It will be apparent that the matters sought to be proved by the evidence objected to by the Commissioner have been proved by other evidence not otherwise objected to.
146 This evidence relied upon by the taxpayer establishes the true comparable nature of the transactions relied upon. As I have already indicated, the focus is on the market in which the products are acquired by the taxpayer, and any 'unique features' of the market in which the taxpayer sells, is of no importance. In relative terms, the comparable transactions that occurred in Australia were not great. I accept that on their own the transactions relied upon that took place in Australia would not support the CUP analysis undertaken by the taxpayer. However, particularly in view of the fact there is a global market, putting together all the comparable transactions relied upon by the taxpayer; the burden placed upon the taxpayer is satisfied.
147 I accept that no comprehensive evidence was led to explain how prices were set or negotiated by each of the suppliers, or who set the prices. Further, there was no evidence in relation to:
(i) the nature, size, business and operations of the comparable entities in their respective overseas markets;
(ii) the profits made by the so-called comparable entities on sales of polyacrylamides in their respective overseas markets;
(iii) what profit or return was made by each of the suppliers on its sales of polyacrylamides to the taxpayer.
148 I do not consider, in determining the arm's length consideration in the circumstances of this proceeding, that such evidence was necessary.
149 In the present case there was a free market for the products. It was a global market with many participants. The arm's length price as determined by that free market was, on the evidence, almost always in excess of the prices paid by the taxpayer. The data showed that the subsidiaries of the customers commonly paid the same prices regardless of their geographical location.
150 There was also a sufficient volume of sales to independent third parties for almost every comparable product purchased by the taxpayer from its associated companies to enable the Court to reach a view of comparability on the balance of probabilities.
151 In light of the evidence and the approach I have taken in considering the comparable transactions, the Commissioner's attempt to cast doubt on the price comparison undertaken by the taxpayer on several bases, including the location of the market, functional comparability of the purchaser and the level of the market, fails.
152 I have already indicated that the relevant market is a global market. This finding overcomes the submissions of the Commissioner which related to the comparability of foreign markets and the Australian market. The comparability is to be viewed in the global context.
153 In terms of functional comparability, the evidence is that the customers and other purchasers the subject of the analysis were not end users of the products but, like the taxpayer, on-sold such products.
154 Regarding the level of the market the subject of the analysis, the Commissioner argued that the taxpayer did not show that the independent purchasers of the products operated at the same level in the market as the taxpayer did. The analysis of the taxpayer was based on comparing the prices paid to the suppliers by independent parties with the price paid to those same suppliers by the taxpayer. The result of this analysis was that the taxpayer paid the same amount if not less than the independent purchasers paid for the products. I do not consider it matters for the purposes of applying Div 13 and having regard to the other findings found in this proceeding, that the similarity in the level of the market be established as contended for by the Commissioner.
155 In any event, it appears to me that the taxpayer, the customers and other purchasers were at the same level of the distribution chain. Each purchased from the suppliers, and no difference in price could be said to be attributable to being at a different level in the distribution chain.
156 For the above reasons, the taxpayer has satisfied the burden upon it to satisfy the Court that the consideration the taxpayer paid for the products was the arm's length consideration. The taxpayer has displaced the figure determined by the Commissioner in his determinations under s 136AD(4).