Case note

Who counts as a comparable, and what a taxpayer has to prove

Commissioner of Taxation v SNF (Australia) Pty Ltd (2011) 193 FCR 149; [2011] FCAFC 74

The Commissioner argued that the only transactions a taxpayer may compare its own dealings with are those involving a business like itself. The Full Court rejected that, holding that "arm's length" describes the relationship between two parties and says nothing about who either of them is, and that a taxpayer need not identify a single correct price.

Court

Full Court of the Federal Court of Australia

Bench

Ryan, Jessup and Perram JJ, in a single judgment of the Court

Decided

1 June 2011

Outcome

Appeal dismissed with costs. The taxpayer won

The facts

The SNF group was a French multinational making and distributing industrial chemicals used mainly to clean water. The Australian company was one of the group's distributors. It bought the chemicals from group manufacturers in France, the United States and China at prices set by the parent, in a structure the Court described as one where the processes of commerce were alive within the group but the negotiating function was clipped by the overriding will of the ultimate parent: [1], [3].

The Commissioner determined that the prices paid exceeded an arm's length consideration and increased the Australian company's assessable income for the years 1998 to 2004. Tax, penalty and interest exceeded $2 million: [3].

Three facts shaped the argument. The Australian company had made persistent losses, and the trial judge found those losses would have driven an independent operator from the market, but found they were caused by low sales per salesperson, competition, excessive stock and poor management rather than by any transfer of profits: [6]. The French supplier was itself selling to Australia below cost over the period: [73], [78] to [80]. And the group suppliers sold the same products to genuinely independent distributors elsewhere in the world, which is what made the case winnable: [31].

What was in dispute

The Commissioner's central contention was one of construction. The definition speaks of the consideration that might reasonably be expected "between independent parties dealing at arm's length", and he argued that one of those parties had to be the taxpayer, so that the only lawful comparables were businesses sharing the taxpayer's own characteristics apart from its group membership.

If that were right, the taxpayer's evidence collapsed, because its comparables were large international chemical distributors buying in other markets, not businesses resembling a loss-making Australian subsidiary.

What the Court decided

The appeal was dismissed with costs in a single judgment of the Court. The construction contention failed, and the Court's summary of why is unusually direct.

The Commissioner’s contention that the only comparables which could lawfully be examined under s 136AD(3) were those sharing the same characteristics as the taxpayer (apart from its non-independence from the group) also fails for this is not, to put the matter bluntly, what s 136AD(3) says.

The Court at [10].

The reasoning is worth following because it is about ordinary language. To say that a transaction is at arm's length is to say something about how two parties stand in relation to each other. It is a relative statement, and a relative statement carries no information about either party's absolute position. The Court's illustration was that a requirement that two businesses be more than 20 kilometres apart says nothing about where either of them is: [98]. Nothing in the operative provision being directed at the taxpayer required the definition to be overlaid with a further requirement that the arm in question be attached to the taxpayer: [99].

The reading was also impractical. If no business shares all of a taxpayer's price-relevant features, and only such a business will do, then a taxpayer bearing the onus can never succeed, because the bar is set at an unattainable height: [102]. The OECD Guidelines the Commissioner relied on in fact point the other way, treating material differences as something to be adjusted for rather than as disqualifying: [103] to [106].

On the evidence, the Court held the taxpayer had proved a single global market for these chemicals, and drew a distinction that answers a common objection: proving a single market is not proving a single price. Price dispersion within a market shows competitive advantage and disadvantage within it rather than the absence of a market, as variations between similar houses in one suburb would: [41] to [43].

The Court also restated, applying W R Carpenter, that motive is irrelevant. The Commissioner's suggestion that the arrangement was designed to make losses in Australia and profits in France was of no legal consequence, because the arm's length inquiry does not include any investigation of purpose: [7].

Finally, and importantly for any taxpayer carrying the onus, the Court held that it is enough to show that the prices paid were at or below an arm's length price, and that a taxpayer taking the second course need not establish any particular figure as the arm's length price: [128].

Why the decision matters

The decision is the foundation of the modern Australian approach to comparables. It establishes that the search is for transactions that are comparable, with adjustments made for differences that matter, rather than for a mirror image of the taxpayer. That is what makes benchmarking possible at all: an exact analogue of a particular group subsidiary rarely exists.

It is equally important for what it says about the burden. A taxpayer does not have to prove the right answer. It is enough to prove that what it actually paid was no more than an arm's length price would have been. In a field where the Commissioner's figure and the taxpayer's figure are both estimates, that distinction decides cases.

The treaty holding needs care and is frequently misstated. Three different questions were answered three different ways. The treaties are to be interpreted in accordance with Article 31 of the Vienna Convention: yes. The commentary on Article 9 of the OECD Model Convention forms part of the context: yes, though on these facts it threw no light on the issue. The OECD Transfer Pricing Guidelines may be used to construe the treaties: no.

The reason for the last answer is narrow, and the Court was explicit about it. The Guidelines could be used only if they reflected the subsequent agreement or practice of the particular States, and there was no evidence of that. The Court said in terms that its conclusion should not foreclose a future attempt to prove it: [117]. The holding is therefore about the evidence in that case, not about the standing of the Guidelines generally, and it says nothing about the current domestic provisions, which direct attention to the Guidelines by their own terms.

Where it stands

The decision stands. It has not been overruled or doubted. It was expressly affirmed by the Full Court in Commissioner of Taxation v Glencore Investment Pty Ltd (2020) 281 FCR 219 at [179], cited by the High Court in Addy v Commissioner of Taxation (2021) 273 CLR 613, and treated as governing in Singapore Telecom Australia Investments Pty Ltd v Commissioner of Taxation (2024) 302 FCR 192 at [134]. No application for special leave is recorded in the material read.

One qualification travels with it. In Chevron Australia Holdings Pty Ltd v Commissioner of Taxation (2017) 251 FCR 40 at [43] the Full Court read parts of this judgment as confined to the argument the Commissioner had run, declining to treat it as requiring the complete detachment of both parties from their actual circumstances. The Full Court in Glencore later observed that Chevron must be taken to have softened the earlier statement.

Division 13 has been replaced, first by Subdivision 815-A and then by Subdivision 815-B of the Income Tax Assessment Act 1997 (Cth). The construction of the repealed words does not carry across directly. What has carried across is the approach: comparability with adjustment rather than identity, and the proposition that a taxpayer need not land on a single figure. The treaty holding about the Guidelines is the part most likely to have been displaced by the current provisions and should be checked against them before it is relied on.

A case note by Boettcher Law. It is general information about Australian law and a summary of a published decision, and it is not legal advice on any particular arrangement. Paragraph references are to the reasons of the Full Court.