JONES DAY PRESENTS®: The Future of Transfer Pricing in Australia: Implications of the Glencore Decision

Read the full transcript below:

Benjamin Lancaster:

The High Court has now refused to grant special leave in the Glencore Transfer Pricing case, so this decision is going to stand for many years as a landmark case in Australia. What the case is about is Australia's old Transfer Pricing rules. They've since been replaced by new rules, but then these new rules are based on the same principles, the arm's length principle. And that's the idea that companies should pay tax as if they earned the profits that they would've earned dealing with their related parties, if they hadn't dealt with those related parties at arm's length.

Benjamin Lancaster:

To give some background on what the facts of the case were, the really critical facts were that an Australian Glencore subsidiary was operating a copper mine and was selling all of its production under a long-term offtake agreement with a related Swiss party. That agreement contained a particular pricing mechanism that was seen in some arm's length contracts. The agreement was then amended in 2007, and that amendment was made to reduce the company's exposure to certain risks, but in doing so, it was forecast to, and in it ultimately did have the effect of reducing the profitability of the Australian company.

Benjamin Lancaster:

So one of the key aspects of this case was that the tax authority was arguing that they were entitled to change the pricing structure in the agreement. And by pricing structure, I mean the pricing formulas, and the factors that the taxpayer took into account to come up with their price. And the court accepted that this is something that is possible, but they accepted it with a big but. And that but is that there is an arm's-length range of pricing structures and the different parties may well take different approaches to come up with their pricing structures. And it can only be that Pricing structure can be amended by a revenue authority where that Pricing structure is ultimately not something an independent party would've done, that is... It's not something that's commercially rational. And if there was evidence of commercial rationality, as there was here, from an industry expert from various third party agreements and from market commentaries, then there's very little that the tax authority can do to change the structure of the transaction.

Benjamin Lancaster:

So looking forward at the new law, it's based on two key concepts. The idea of conditions and commercial and financial relations. And this is something that wasn't in the provisions that Glencore was dealing with. And it does temper to some degree, the ability to carry through the conclusions from Glencore into the new law. That all said, it's a very interesting element because there's two different standards that need to be applied to adjust conditions and commercial and financial relations. For conditions, it's very much a similar test to what we've been applied that can be changed by a tax authority, if they wouldn't be expected to occur this way in arm's length parties. But there's a much higher threshold to change something that amounts to a commercial or financial relation. And that requires it to be something that independent parties would not have done, or it to be something where the substance of what you've got doesn't match the form of your agreement.

Benjamin Lancaster:

So these two exceptions that we have are modeled on the OECD's Transfer Pricing Guidelines, and the guidelines themselves were considered by the court when they found the guidelines to be highly generalized, frustratingly opaque, and lacking the greater clarity and discipline that's usually found in domestic legislation. And the problem we have here now is that these words are almost exactly in our domestic legislation, so there's no doubt going to be dispute to when these certain circumstances that allow you to change your commercial and financial relation will actually apply.

Benjamin Lancaster:

The Glencore decision makes really clear that there's a lot more to Transfer Pricing than simply looking at comparables. And what you need to do is outweighing of all of the evidence that might be relevant to predicting as a factual matter, what arm's length parties would've done in the same circumstances.

Benjamin Lancaster:

Now, in the Glencore case, there was a lot of argument from the tax authority that the agreements that the taxpayer was trying to rely on were not perfectly comparable or sufficiently comparable, looking through an OECD Guidelines type of lens, to be relied on as evidence of what independent parties would've done. But the court wasn't having anything of that kind of approach, and it very much said that you need to weigh them up, and even if they're not perfectly comparable, they may well still be a really valid reference point or example of what arm's length parties might've done in similar circumstances.

Benjamin Lancaster:

And the Glencore decision really shows that it'll be difficult for tax authorities to apply Transfer Pricing rules to attack restructuring or reframing of agreements. And this is because the old agreements, the court said, say absolutely nothing about whether or not the new agreements are arm's length. It would certainly not be a well-advised taxpayer who went blindly into amending agreements that were intended to and expected to reduce the profitability of their Australian subsidiaries. And I think it's certainly very clear that the Australian tax authorities would look to apply our general anti-avoidance rules or our diverted profit tax in that situation.

Benjamin Lancaster:

So when it comes to working out the arm's length consideration, according Glencore was really clear that you must ignore non-arm's length features of the taxpayer, including things like the tax payer's global policies or global attitudes to risk that are being imposed on it because of its membership of a broader global group. And this is really interesting from the perspective of the Chevron decision, where the court found that the taxpayer would've had a parent company guarantee, which it would've provided to a lender to lower its interest rates. And the idea that you can't take into account a non arm's length feature of the tax payer, we think really opens up the question whether or not the conclusions in the Chevron decision are still to be regarded as correct.

Benjamin Lancaster:

It shows that there's a different approach to Transfer Pricing than what a lot of people have thought Transfer Pricing is. And those two main ways that that occurs are, it instructs us that the search for a arm's-length price or an arm's-length set of conditions goes well beyond just looking at the prices in an agreement, and there may well be a range of different ways of coming up with a price that arm's-length parties would've adopted. The second element really is looking at the idea of what evidence you can use. And tax authorities have often been very keen to look at a set of comparable transactions to find rigid comparability criteria, and apply the methods for finding a price that are in the OECD Guidelines.

Benjamin Lancaster:

But what the Glencore decision really highlights is that this is a factual prediction. It needs to be made based on all of the available evidence. So that will include contracts that are highly comparable, but it'll include other things like industry experts and contracts that perhaps only have some value as a reference point, rather than as determinative of what the arm's length conditions might be in a particular set of circumstances.

Benjamin Lancaster:

The Glencore's decision's going to have significant implications for both inbound and outbound investors in Australia. But looking beyond that, because this decision deals with the Transfer Pricing rules and globally recognized principles, it's going to have implications around the world.