In a recent landmark case, the Full Federal Court of Australia in FC of T v. SNF (Australia) Pty Ltd (SNFA) - [2011] FCAFC 74, ruled in favour of the tax payer and held against the adjustments sought to be made in respect of the transactions with parent. The Commissioner had considered that the transactions required adjustment, as they were not at arm’s length. SNFA was suffering loss continuously and the Commissioner had considered that the same was on account of higher purchase prices for the supplies effected by the related party. The taxpayer had established that the transactions were at arm’s length, by demonstrating that its overseas supplier (related party) had transacted for the same group of products and had charged prices in such transactions which are higher than what SNFA had paid. The Federal Court found that a global market existed for the products supplied by the related party and supplies to independent third parties are comparable. The Federal Court held that that tax-payer had proved that transactions had been conducted at arm’s length prices and there was no case for the Revenue to resort to its powers under Division 13 (transfer pricing provisions) to ascertain the correct consideration.
The decision analysed various key issues on transfer pricing, which included:
- Whether the comparables submitted by SNFA are comparable transactions
- Interpretation of the phrase “between independent parties dealing at arm’s length”
- Usage of OECD guidelines in interpreting Australian Tax Laws
Comparability
SNFA had established before the trial court that the comparables chosen by it were companies distributing identical products at their respective market. SNF argued that they had attempted to show that the entities occupied similar places in the supply chain and that global nature of the market for industrial chemicals paved way for some distortions in price. SNFA, by adjusting the prices of material to ex-works prices, had substantially complied with the methodology to effect adjustments in consideration for ‘material factors’. The court held that ‘functional comparability’ had been established and no contractual disparities were brought into evidence. On the strength of the evidence presented by it, SNFA was able to show that most of the other comparable transactions had been at same, if not higher prices than those at which it had purchased the material from its related party.
The Commissioner contended that the only comparables sharing the same characteristics as that of the taxpayer (apart from its non-independence from the group), could be considered as lawfully comparable. The Commissioner’s argument was that the comparables did not have the same characteristic as that of SNFA, since ordinary independent parties would not have supported an entity making loss for successive years and continued to run into loss. The Commissioner attributed the motive of trying to pass on losses to the entity in Australia as a reason for this. The ruling, calling for a balanced approach to interpreting the provisions, says that to set the bar of comparison too high expecting crystalline perfection in matching the compared entities would be unrealistic. The correct approach is to determine if the transaction has taken place at arm’s length prices and the onus was on the tax payer to prove the same.
The Federal Court found that two of the three sets of comparables considered by the trial court were appropriate and accordingly rejected the Commissioner’s argument for rejecting the Comparable Uncontrolled Price (CUP) method and adopting Transactional Net Margin Method (TNMM).
Independence
The Commissioner had argued that arm's length consideration should be "the consideration that might reasonably be expected to have been given or agreed to be given in respect of the acquisition if the property had been acquired under an agreement between independent parties dealing at arm's length with each other in relation to the acquisition". Connecting the definition of arm’s length consideration and the operative provision, it was contended that the phrase “between independent parties dealing at arm's length” should include SNFA as one of the parties. However, the Federal Court held that all that the provision requires was a comparison between price which was actually paid by the taxpayer (SNFA) and an arm's length consideration. It also held that, arm's length consideration did not further require that the consideration should not only be at arm's length but that the arm in question should be attached to the taxpayer (SNFA).
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[The authors are Partner and Manager, Lakshmikumaran & Sridharan, India, respectively]