Judgment summary
This was an appeal by the Commissioner of Taxation against a decision of the primary judge who had allowed the taxpayer's objections to assessments issued for the 1998 to 2004 income years under Division 13 of Part III of the Income Tax Assessment Act 1936 (Cth) [3]-[5]. The taxpayer, SNF (Australia) Pty Ltd, was the Australian distributor within the SNF Group, a French based multinational manufacturer and distributor of polyacrylamides, ultimately owned by Monsieur Rene Pich [1].
The Commissioner had determined that the prices the taxpayer paid to its related suppliers in France, the United States and China exceeded arm's length consideration under s 136AD(3), increasing the taxpayer's assessable income for the relevant years, with tax involved exceeding $2 million [3].
The trial judge found that the taxpayer had generally paid less than independent third party purchasers for the same or similar products and allowed the taxpayer's appeals in full [5]. The Commissioner appealed on three broad grounds: errors of fact concerning the comparability of transactions relied on by the taxpayer; error in accepting the evidence of M. Pich that the French supplier had made losses on sales to the taxpayer; and an error of law as to the proper construction of "arm's length consideration" in s 136AA(3)(d) [9].
The Full Court found some errors in the trial judge's treatment of the comparables evidence but, having reviewed the material itself, reached the same ultimate conclusion as the trial judge [10], [70]. It rejected the Commissioner's legal argument that the only lawful comparables were purchasers sharing the taxpayer's own loss-making characteristics [10]. The appeal was dismissed with costs [134].
Background
The SNF Group manufactured and distributed polyacrylamides, industrial chemicals used mainly for water treatment in mining, pulp and paper milling and sewage treatment industries [1]. The group's ultimate holding company, SNF Société Anonyme, was almost entirely owned by Monsieur Rene Pich [1]. The group comprised manufacturing suppliers and distributors, with intra-group prices set centrally by those at the helm of SNF France [1].
The taxpayer was the Australian distributor in the group, purchasing polyacrylamides from related suppliers in France, the United States and China [3]. The Commissioner determined that the prices paid by the taxpayer to these suppliers exceeded arm's length consideration and substantially increased the taxpayer's assessable income for the 1998 to 2004 years [3]. The taxpayer objected without success and appealed to the Federal Court [3]. The amounts of tax involved exceeded $2 million, with the total tax, penalty and interest set out in Appendix 2 to the judgment totalling $2,028,793.98 [3].
It was not disputed that the taxpayer had persistently made losses during the relevant period, which the trial judge found would have forced an independent operator from the market [6]. The trial judge found these losses were caused by a combination of factors, including unreasonably low sales per salesperson, competition in the Australian market, excessive stock levels and poor management, and not by the prices paid to suppliers [7].
Core dispute
The central legal question was whether s 136AD(3) of the Income Tax Assessment Act 1936 (Cth) had been engaged, which turned on whether the prices paid by the taxpayer to its related suppliers exceeded the "arm's length consideration" as defined in s 136AA(3)(d) [3]-[4]. The taxpayer bore the onus of proving that the prices it paid did not exceed arm's length consideration, under s 14ZZO of the Taxation Administration Act 1953 (Cth) [4].
The taxpayer sought to discharge this onus by showing it had paid less than independent third party purchasers paid for the same or similar products, relying on three sets of comparable transactions and expert evidence from Mr Seve applying a comparable uncontrolled price (CUP) methodology [4], [12]-[13]. The Commissioner's expert, Dr Becker, considered no suitable comparable transactions were available and instead applied the Transactional Net Margin Method (TNMM), concluding the prices paid did not represent arm's length consideration [4].
On appeal the Commissioner argued that the trial judge erred in his findings of fact about the comparability of the transactions relied on, erred in accepting M. Pich's evidence that the French supplier made losses selling to the taxpayer, and erred in law by not confining lawful comparables to purchasers who, like the taxpayer, had a history of persistent losses [9].
Court findings
The Full Court held that the trial judge's process of reasoning about the comparable transactions disclosed some errors, enlivening the Court's obligation to review the material and reach its own conclusions [10], [69]. On review, the Court found the first set of comparables (five identified distributor companies) and the third set (Mr Seve's product-specific analysis of twenty products) were appropriate and supported the conclusion that the taxpayer paid less than arm's length purchasers for the same or similar products [70]. The second set of comparables (Australian and New Zealand purchasers) was not properly relied upon because functional comparability, in particular their status as distributors, had not been established for most of them [52].
The Court rejected the Commissioner's challenge to the trial judge's acceptance of M. Pich's evidence that the French supplier had made losses selling to the taxpayer, finding no basis to interfere with the trial judge's assessment of credit [78]-[91].
On the construction issue, the Court held that "arm's length consideration" in s 136AA(3)(d) does not require the hypothetical comparator to share all of the taxpayer's characteristics other than independence, such as a history of persistent losses; the words require only that the parties to the comparable transaction be independent of each other [97]-[99]. The Court also held that the OECD Transfer Pricing Guidelines were not admissible aids to construing the relevant double taxation treaties in the absence of evidence of state practice adopting them, though even if considered they supported making adjustments for differences rather than requiring identical comparators [116]-[121]. The Court found the existence of a global market for polyacrylamides was supported by the evidence [37], [70]. It also held that a taxpayer need not prove a single specific arm's length price; it suffices to show that the price paid was less than an arm's length price [128]-[129]. The Commissioner's ground concerning the trial judge's finding on the causes of the taxpayer's losses was not pressed [130].
Outcome
The appeal was dismissed with costs [134].
Tp method highlighted
The taxpayer's case relied on the comparable uncontrolled price (CUP) method, using three sets of comparable transactions: a first set of five identified distributor companies prepared by Mr Karoudjian [14]; a second set of Australian and New Zealand companies [50]; and a third set of 21 companies analysed by Mr Seve by reference to specific products ("code arts") using five OECD comparability factors, namely characteristics of the property, functions performed, contractual terms, economic circumstances of the markets, and business strategies of the parties [29], [53].
The Commissioner's expert, Dr Becker, considered no suitable comparables were available and instead applied the Transactional Net Margin Method (TNMM), concluding the prices paid by the taxpayer did not represent arm's length consideration [4]. The Full Court accepted that the first and third sets of comparables were appropriately established, finding the premise for using the TNMM, namely the unavailability of comparables, was not made good [70]-[71].
Major issues / areas of contention
- Whether s 136AD(3) of the Income Tax Assessment Act 1936 (Cth) was engaged, that is, whether the taxpayer paid more than arm's length consideration for polyacrylamides purchased from related suppliers
- Whether the comparable uncontrolled price (CUP) method or the Transactional Net Margin Method (TNMM) was the appropriate methodology given the availability of comparable transactions
- Whether the three sets of comparable transactions relied on by the taxpayer were truly comparable, including functional comparability as distributors
- Whether the trial judge erred in accepting evidence from M. Pich that the French supplier made losses selling to the taxpayer
- Whether the proper construction of "arm's length consideration" in s 136AA(3)(d) required comparators to share the taxpayer's own loss-making history
- Whether the OECD Transfer Pricing Guidelines and the OECD Model Tax Convention were admissible aids to interpreting the relevant double taxation treaties and the domestic transfer pricing provisions
- Whether the existence of a global market for polyacrylamides was established by the evidence
- Whether a taxpayer must prove a single specific arm's length price to discharge its onus under s 14ZZO of the Taxation Administration Act 1953 (Cth)
- The admissibility and evidentiary weight of hearsay statements concerning the status of comparable purchasers as distributors or end-users