The dispute brought by the Australian tax authority cornered around the conditions of the intra-group arrangements for the sale of copper concentrate in the years 2007-2009.
Cobar Management Pty Ltd (“CMPL”), an Australian affiliate of Glencore Group, mined copper concentrate since 1999 and sold all of its production to Glencore International AG (“GIAG”), a Swiss affiliate. Copper concentrate is generally converted to copper via smelting and refining. Under Glencore’s business model, GIAG bought copper concentrate and re-sold it to third party smelters.
Based on an intra-group agreement dated 1999, GIAG, acting as a distributor, used to receive a 4% commission rate on copper sales from CMPL, the Australian mining counterparty. Based on the agreement shipping and smelting activities were outsourced to third parties. The costs for the said outsourced activities were ultimately borne solely by CMPL.
In 2007, the intra-group arrangement was altered in such a way that GIAG bore the outsourcing activities’ costs. Pricing of the copper concentrate was based on the London Metal Exchange price for refined copper, less certain discounts representing the required treatment and refining costs for conversion of the copper. Consequently, the transfer pricing policy was amended to a price sharing agreement where GIAG’s discount was increased to 23% comprising the above treatment and refining costs.
Consequently, the Australian tax authority challenged the 2007 intercompany agreement and considered that the Group’s intra-group transactions should be governed by the 1999 version. Concretely, the subject of the dispute was the pricing of the applicable “discounts”, contractual terms regarding freight costs and “quotational period optionality”.
The evidence before the Court showed that there was considerable volatility both in terms of the treatment and refining costs as well as the benchmarks applied. In addition, during the relevant period copper price was exceptionally volatile. In the course of the proceedings, it was agreed that CMPL was a high cost mine for which functionality uncertainty was inherent. The decision to set the treatment and refining costs at the fixed rate of 23% of London Metal Exchange was an option for CMPL to mitigate the risks it was facing during this volatile period. The court ruled that taxpayers are under no obligation to choose a pricing methodology that pursues profitability in Australia at the expense of prudence. There is no obligation to “maximise” profitability at the expense of all else. Consequently, the Court accepted that the rate of 23% for the treatment and refining costs deductions was within the arm’s length range.
In the course of proceedings, it was confirmed that the 2007 contract altered the terms insofar as the quotational period optionality clause was amended to bestow GIAG with the possibility to choose an option on a shipment-by-shipment basis in contrast to annual basis (1999 agreement).
The Australian tax authorities argument in that respect was that the prior agreement (1999) already contained the quotational period optionality. Thus, they argued that in accepting the quotational period optionality, arm’s length sellers would have expected to receive a quid pro quo. Nevertheless, the Australian tax authorities provided no evidence as to what would such a quid pro quo constitute, or how it should be quantified.
Under the intra-group agreement, the parties agreed a freight allowance based on standard shipping terms from Australian to India. Yet, based on the evidence provided by the Australian tax authorities, out of 18 shipments that have taken place during the year, only one had been to India. Noteworthy is the fact that the freight rate to India was materially higher than to other destinations and no support to justify that was provided by the taxpayer. Consequently, the submission with respect to excessive freight allowance was accepted by the Court.
Glencore’s transfer pricing case gives taxpayers a certain degree of comfort that they may rely on their contractual arrangements put in place, provided that they are commercially rational and witnessed in open market reality.
In addition, in case of a tax dispute the taxpayers do not need to demonstrate that their transfer pricing methodology deployed is more in line with the arm's length' principle than the one proposed by the tax authorities. Taxpayers should be able to demonstrate that their transfer pricing methodology is in line with a rationale and commercially acceptable arm’s length outcome based on reliable prediction as to what can be reasonable behavior among independent economic operators.