The arm’s length standard must continue to underpin commodity transfer pricingBy Avik Bose and Hamish Clark
Recent tax case judgments in commodity-producing countries shine a spotlight on the important commodity transfer pricing challenges that have potential knock-on effects on the trading industry in Singapore.
Any such impact could be significant, given that the commodity trading industry is a key component of Singapore’s wholesale trade sector, which contributes around 17% of the country’s GDP.
Commodity trading tends to involve a complex international supply chain because oil and metals, for example, are rarely produced and consumed in the same country. The extraction entity in one country typically sells to a trading hub in another country. The trading hub then optimises the transaction and ships to the refinery, smelter, or power station, usually in a third country. This complex supply chain often includes a high proportion of related party transactions, meaning that transfer pricing rules apply.
Transfer pricing refers to the price of goods, services, and intangibles sold between related entities within the same business group, with a requirement that such transactions are priced at arm’s length. The arm’s length standard has stood the test of time for many decades as the principle which underpins the pricing between related parties. With commodities, it generally means that the market price of the oil, gas, or mined materials should be applied, also known as the ‘Comparable Uncontrolled Price’ approach.
The OECD’s Transfer Pricing Guidelines, followed by almost all countries, support this approach, as does the Inland Revenue Authority of Singapore, which also provides insightful guidelines on how best to set transfer prices for transactions involving commodity traders.
The recent tax cases in commodity-producing countries demonstrate how some tax authorities wish to challenge the market price approach, and this could have significant implications for commodity traders in Singapore. In particular, the Glencore case in Australia and the Cameco case in Canada are examples of how the respective tax authorities have tried to downplay the important role traders play within the global commodity supply chain.
In the Glencore case, copper was sold from an Australian mine to a Swiss-related party commodity trader through an intragroup agreement. The Australian Tax Office disputed the mining company’s agreement to fix the treatment and refining costs at a percentage of the copper price, which ultimately led to a reduced income in Australia. The taxpayer was able to support their intragroup pricing with evidence, demonstrating that such pricing arrangements are agreed upon by independent market participants.
Similarly, the Canadian Revenue Agency challenged the intragroup pricing of uranium sales to a Swiss related party company in the Cameco case. It was the intention of the Canadian Revenue Agency to use the ‘recharacterisation provisions’ to bring the Swiss trading company’s profits into the Canadian tax net. According to them, intragroup transactions were a ‘sham’, meaning the financial arrangements did not follow the legal form, or had no commercial rationale. In response, the taxpayer argued that the intragroup contracts represented the parties’ true intentions, that the prices were within an arm's length range supported by rigorous analysis, and that the arrangement was commercial, even if there was some tax-oriented purpose behind it.
In both cases, the judgments sided with the taxpayers and indicated that market price is the best representation of commodities prices. In the short term, the outcome of these cases can be viewed positively for Singapore’s trading companies, since they seem to acknowledge the important role the industry plays in ensuring that the right commodity is supplied to the right location, at the right time, and at the most competitive cost.
It is nevertheless evident from the cases that tax authorities in some countries may perceive commodity traders as simply taking a slice of the profits which they deem to belong to the production company. Thus, traders should be prepared to contend with further challenges, particularly in countries with large extractive industries.
There is a lack of understanding of commodity trading companies and the wider industry, which leads to tax authorities failing to appreciate their importance to global supply chains. Global resource production companies must be able to clearly explain the commercial purpose and advantages of having a commodity trading subsidiary within their business group. The trading subsidiary should also be able to make its own business decisions and manage the resultant risks.
The OECD is proposing to introduce a Global Minimum Tax of 15% from 2023 for large multinational enterprises (MNEs) with global consolidated turnover exceeding €750 million. Such MNEs would have to pay top-up tax for the difference between their effective tax rate in each jurisdiction they operate and the 15% minimum rate. This could further impact commodity traders, who are often located in jurisdictions which offer low tax rates or tax incentives. In this regard, the impact of the Global Minimum Tax should be assessed, particularly in the businesses’ financial and operational areas. Commodity traders could then assess the impact, discuss them with relevant stakeholders, and develop appropriate response strategies.
Taxpayers can also mitigate their transfer pricing audit risk by engaging with the tax authorities in a process known as ‘Advanced Pricing Agreements’. Using robust transfer pricing documentation to respond to transfer pricing audit queries from tax authorities remains the most effective method for transfer pricing audit risk management. In the preparation of the transfer pricing documentation, it is necessary to conduct a thorough analysis of the related party transactions according to the relevant rule and guidelines, therefore engaging a transfer pricing specialist is recommended.
Avik Bose and Hamish Clark are transfer pricing partner and director respectively at Deloitte Singapore. The views expressed here are the writers’ own opinions and may not represent those of the firm.