This is a summary of the decision of the Federal Court of Australia on Commissioner of Taxation v Glencore Investment Pty Ltd  dated 6 November 2020. It can be interesting for international tax and transfer pricing professionals, as it gives valuable details and the pricing of commodities, as well as interpretation of the arm’s length principle generally. For more details about the arm's length principle and commodities transactions, visit our transfer pricing course page.
Glencore business model and transactions under review
Cobar Management Pty Ltd (“CMPL”) is a resident of Australia and is a subsidiary of Glencore Group. CMPL owned and operated an underground copper mine at Cobar in central western New South Wales.
In 2004, CMPL entered into “offtake agreement” with Glencore International A.G. (“GIAG”), resident of Switzerland, for a sale of all cooper concentrate produced by CMPL to GIAG. GIAG was marketing and selling cooper concentrate globally (i.e. acted as a trader). Copper concentrate mined by CMPL was sold to independent smelters in India, China, Japan and the Philippines.
The agreement included several important features:
- It allowed significant quotational period optionality for GIAG. Offtake agreements specify the period, whether a day, days, weeks or months, with which the price or average price of the copper is to be ascertained. In the industry, this is known as the “quotational period.” Some agreements give the buyer options about how to choose the applicable quotational periods and how often such choices can be made (“optionality”).
- The price of copper concentrate was calculated using a formula based on London Metal Exchange copper price minus the cost to a smelter of treating and refining the copper concentrate also referred as TCRCs (and some other, less material, deductions). In other words, the price for copper concentrate is based on the price of the final product (copper) produced from the concentrate, minus the cost of independent manufacturers of copper that they will bear to make that final product. Information about both material elements of the price is available from trustful sources, though both are very volatile and not correlated.
The agreement was significantly amended in 2007:
- The parties abandoned their reliance on benchmark TCRCs. They agreed to adopt a price sharing clause instead, to determine the deduction to be made. For the 2007 to 2009 years, TCRCs were set at 23% of the copper price. The use of price sharing formulas is another way of establishing deductions in copper concentrate sharing formulas, and they are often used in the market. An advantage of this type of formula was that it eliminated a particular type of dangerous volatility arising from the use of benchmark TCRCs, namely an inverse movement in the price of copper and benchmark TCRCs which can occur from time to time.
- Even greater “quotational period” optionality was given to GIAG (on shipment by shipment basis)
previous clause that stipulated the freight allowance (“to be agreed annually”)
was replaced by a fixed US$60 per wet metric ton.
ATO challenged the intra-group pricing between CMPL and GIAG for years 2007-2009 on the following basis:
- Movement from TCRC benchmark to price sharing arrangement made CMPL worse off financially.
- Such a quotational period optionality gives significant benefit to the buyer (GIAG) at the cost of the seller (CMPL) and allows the buyer to always realise a profit.
- The fixed freight allowance of US$60 is based on the cost of freight to India, which is the most expensive (vs China, Japan and the Philippines). Therefore, where copper concentrate was shipped to countries other than India, the freight allowance paid by CMPL to GIAG was overstated.
Positions and key arguments
|Use of price sharing arrangement (23%)||Standard market mechanism, allows moving significant risks to the buyer (GIAG)||Move from TCRC benchmark to price sharing arrangement made CMPL worse off financially; 23% is overstated||Both TCRC benchmark and price sharing is arm’s length, the taxpayer is free to choose based on risk management strategy, ATO was not able to suggest an alternative to 23%. ATO position disregarded|
|Quotational period optionality||Observed in transactions between independent parties, therefore arm’s length||Gives too much flexibility and protects the buyer from the downside risk; should be compensated quid pro quo||Quid pro quo compensation is not calculated by ATO and is not substantiated. ATO position disregarded|
|Fixed freight allowance||Did not provide arguments||US$60 is too high||ATO position supported|
- Court supported taxpayer in all material aspects of the case. Essential points highlighted by the decision:
- ATO was allowed to challenge the pricing methodology and the price sharing percentage, however, it failed to prove that the price sharing arrangement itself is not arm’s length and failed to challenge 23% price sharing percentage. ·
- Reconstruction of the transaction (according to the OECD Guidelines) was not appropriate. ·
- Taxpayers can choose their own risk mitigation strategy and are not required to maximise profitability at any cost.
of forecasts and budgets is useful, but not sufficient (especially in volatile
markets). Use of hindsight should be avoided.
There were several other interesting discussion points, and therefore we recommend reading the case in full.
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