Australia is a country richly endowed with mineral and
energy resources. Due to its relatively small population and
large mineral wealth, much of the development in this sector
has been directed at exporting mineral commodities. In 2016-17,
the sector constituted almost 7% of total GDP and 68% of total
goods exported. In 2017-18, the total value of energy and
resources (E&R) exports was a record A$226 billion ($162
billion), with iron ore, coal (coking and thermal), liquefied
natural gas (LNG), base metals and gold the primary commodities
exported. Given the sector's size and importance to the
economy, the Australian Taxation Office (ATO) has paid
considerable attention to arrangements adopted by miners in
Australia's export environment
Australia adopts an open trade system for exports (that is,
there are no mandated requirement for onshore processing).
Consequently, a large portion of the exported products for
major commodities is in unprocessed form (apart from limited
beneficiation and blending in the case of iron ore and coal,
and liquefaction for LNG). According to a 2018 energy quarterly
by Australia's Department of Industry, the primary export
markets in 2016-17 were: China (38%), Japan (17%), South Korea
(8%), India (5%) and the European Union's 28 member states
As supply chains have grown with increasing globalisation
and improvements in information technology, many multinational
enterprises (MNEs) in the resources sector have sought to
locate specific elements of their supply chain (such as
marketing and logistics management) within dedicated entities
in the group.
When this process involves marketing and distributing
commodities, a complex value chain is established to ensure
that the right commodity is delivered to the customer in the
right form, at the right place, and at the right time.
It is distinct from the industrial or upstream activity of
commodities firms, and therefore has a different economic model
with different activities and risks that need to be understood
The risk-based framework
One aspect of the ATO's approach to monitor these
arrangements is a risk-based analysis in Practical Compliance
Guidance (PCG) 2017/1, which covers the compliance approach to
transfer pricing (TP) issues related to centralised operating
models involving procurement, marketing, sales and distribution
The ATO started publishing PCGs in 2016 as an aid to
taxpayers. They are meant to:
"Convey… the ATO's assessment of
relative levels of tax compliance risk across a spectrum of
behaviours or arrangements… [and] enable taxpayers to
position themselves within a range of behaviours, activities or
transaction structures that the ATO describes as low risk and
unlikely to require scrutiny".
For the purposes of the guidance, these centralised
operating models have been referred to as 'hubs'. The PCG is a
general statement on the issue, and also includes three
- Schedule 1 covers offshore marketing
- Schedule 2 targets offshore non-core
procurement arrangements; and
- Draft Schedule 3 focuses on offshore
shipping service hubs. Schedules 2 and 3 were published in
Broadly, it may be said that the PCG is directed at MNEs in
the resources sector that have extended their value chain to
locate certain functions, assets and risks (FAR) offshore.
While there are clear commercial reasons to do this, the ATO's
concern was whether the pricing and allocation of total value
chain profit in these arrangements was consistent with the
Despite recent public attention, the use of centralised
operating models is not a new phenomenon. The issue of
marketing hubs was highlighted in the Treasury's Consultation
Paper in 2011, while the 2013-14 federal budget dedicated
A$109.1 ($79 million) to increasing ATO compliance checks on
offshore marketing hubs.
Furthermore, the ATO issued a taxpayer alert on December 10
2015 (TA 2015/5) to bring attention to arrangements involving
offshore procurement hubs (primarily regarding CFC
attributions, but TP matters were also discussed).
Perhaps the most important impetus for the ATO's public
statement was the 2015 Senate inquiry into corporate tax
avoidance and aggressive minimisation, which focused on the
energy and resources sector. The interim report from the Senate
Economic References Committee maintained the spotlight on
marketing hubs, as reflected in Recommendation 1:
"The committee recommends that the Australian
Government work with governments of countries with significant
marketing hub activity to improve the transparency of
information regarding taxation, monetary flows and
inter-related party dealings."
It was recently reported that a major Australian mining
enterprise reached a settlement with the ATO on a TP dispute
relating to its marketing operations in Singapore, and that the
company had subsequently restructured. Whilst the terms of the
settlement were confidential and contained no admission of tax
avoidance, the case highlights the ATO's continued focus on
offshore resources marketing hubs.
With Australia set to become the world's largest annual LNG
exporter in 2019 according to Department of Industry data by
the chief economist (already overtaking Qatar on a monthly
measurement in this position in December 2018, according to
Refinitiv Eikon data), the ATO's approach presents a cautionary
precedent and a troubling question: how are E&R companies
to design and defend their TP arrangements in this changing and
increasingly aggressive tax environment?
Offshore risk zones
The PCG 2017/1 risk assessment framework provides six
different risk zones with colour coding for offshore hubs. They
range from a white zone (the safest risk area) to a red zone
(very high risk).
A hub will be in the white zone if it has entered into
either an advance pricing agreement (APA) or a settlement
agreement with the ATO, or if the ATO has conducted a review of
the hub and provided it with a low-risk rating within the past
Moving up the risk-metric, an offshore marketing hub will be
in the green zone if it has not satisfied the requirements for
a white classification, but hub profits are less than (or equal
to) 100% of the mark-up of hub costs (Schedule 1). Note that
hub costs do not include costs of sales (only operating and
associated costs of the hub, effectively a Berry ratio).
For Schedule 2 (offshore non-core procurement hubs), the
low-risk zone is reached if the hub's profits are less than (or
equal to) 25% of the mark-up of hub costs (again, based on a
Berry ratio approach).
For Schedule 3 (offshore shipping service hubs), the
low-risk zone is hub profits less than or equal to 25% mark-up
of relevant hub costs (Berry ratio-based), or if hub costs are
below A$2 million ($1.4 million). In addition, the hub must be
both a marketing and shipping hub, and hub profits must be less
than or equal to 100% mark up of relevant hub costs.
For all three schedules, if the low-risk thresholds are
exceeded, the hub will still remain in the green zone, as long
as all hub profits are fully attributed back to Australia under
Australia's controlled foreign corporation (CFC) rules.
If the low-risk thresholds are exceeded and the hub profits
are not fully attributed back to Australia, the taxpayer will
fall within one of the other four colour-coded risk zones. Each
zone is calibrated solely by the amount of tax potentially at
risk, comparing the actual hub results to the relevant green
zone profit. In PCG 2017/1, the tax impact is calculated using
the following formula (for each separate schedule).
- Schedule 1 offshore marketing hubs: Tax
impact = [hub profit minus 100% mark-up above costs] x
non-attributed income ratio x Australian company tax
- Schedule 2 offshore non-core procurement
hubs: Tax impact = [hub profit minus 25% mark-up above costs]
x non-attributed income ratio x Australian company tax rate;
- Schedule 3 offshore shipping services
hubs: Tax impact = [hub profit minus 25% mark-up above costs]
x non-attributed income ratio x Australian company tax
The tax impact will then determine the level of risk and
priority of application of the ATO's compliance resources to
the hub, with the blue zone at the lower end of the scale and
the red zone at the highest priority for review.
However, even if the taxpayer is in the intermediate yellow
or amber zones, it will be moved automatically into the red
zone if it does not have TP documentation that meets the
requirements set out in Taxation Ruling 2014/8. According to
PCG 2017/1, the existence of these documents is considered
"critical to the assessment of risk related to hubs that are
outside the green zone".
The level of detail expected in TP documentation is
extensive, and includes primary evidence of legal arrangements,
financial outcomes, job descriptions, key performance
indicators and cost/benefit analysis. This places a high
compliance burden on taxpayers, and thereby increases their
chances of inadvertently falling into the red zone.
However, falling into the ATO's high-risk zone does not
necessarily mean that the arrangements or pricing are
inappropriate, but it does mean that the ATO is likely to apply
additional compliance scrutiny. In addition, falling into the
ATO's low-risk zones does not necessarily make pricing outcomes
low risk in the hub's host country, and may in fact make them a
higher risk from the local tax authority's perspective.
Taxpayers must self-report the outcomes of their analysis to
the ATO via the international dealings schedule or the
reportable tax positions schedule (if applicable).
Underlying assumptions and profit measurement
The underlying assumption in the PCG is that offshore hubs
are in effect service provider entities to their affiliate
Australian miners. This is evident in the selection of the
Berry ratio as the low-risk benchmark indicator. While the PCG
acknowledges that hubs may have different risk profiles and
therefore may achieve different results, no consideration is
given to any form of profit measurement other than the Berry
While some hubs may indeed be characterised as service
providers based on a functional analysis, other hubs will be
more properly characterised as marketers/distributors,
resellers or full traders of commodities, or as shipping
brokers in the case of shipping activities. The Berry ratio
calibration of risk means that hubs are virtually always
categorised as high risk under the PCG's framework, the
consequences of which include increased use of ATO compliance
resources and more limited opportunities for the taxpayer to
enter the APA programme.
The OECD's TP guidelines indicate that the resale price
method (RPM) may be an appropriate TP method for re-sellers of
goods when suitable independent benchmarks are
available.13 There is significant market-based
evidence in the form of executed agreements on commercial
databases that shows commodity sales agents and re-sellers
typically charge a percentage of the final price as their
commission/margin (broadly, a resale price margin).
The agreements between third parties are available for
multiple commodities. PCG 2017/1 notes that taxpayers have
tried to rely on such commission rates used by third parties to
establish a CUP in support of their own position (that is,
using the market-based agreements as CUPs for the resale margin
to be applied). The ATO states that its concern in relying on
this data has been the absence of supporting information to
establish comparability and the market indicators relied
However, PCG 2017/1 then indicates that the low-risk
benchmarks it applies have been determined by the ATO having
regard to all available information, including data collected
as part of ATO compliance activities. However, because the
indicators are provided for the purpose of risk assessment
(rather than determining arm's-length methods or outcomes) and
include commercially sensitive data, the ATO will not release
the supporting data.
While it is acknowledged that the PCG approach is for ATO
risk assessment purposes only, the lack of transparency on the
basis for the benchmarks seems at odds with the OECD's TP
guidelines (paragraph 3.36), where it warns against the use of
secret comparable information by tax administrations. The
imprecision of the Berry ratio approach, combined with the
opacity of the analysis, provides little certainty for
taxpayers with offshore hubs.
Commodity trading hub considerations
Commodity trading hubs are typically established to be
active in the market, build relationships with key clients by
understanding their unique needs, manage commodity movements to
ensure timely delivery, and oversee all activities to ensure
risk levels do not exceed limits. This allows risk exposures of
commodity trading to remain isolated and controlled, ensuring
swift processing of time-sensitive commodity transactions.
These hubs control the group's risk exposure by utilising
skilled teams to isolate and manage counterparty credit risk
and commodity price movement risk, and to optimise logistical
The primary role of the marketing hub is to achieve the
highest possible price for the commodities sold, as well as
achieving efficiencies through centralisation. In this regard,
the term commodity is slightly misleading as it implies a
knowable market price at a point in time based on published
prices or indices.
However, this is not always correct in the case of mineral
commodities such as coal, iron ore and LNG. For example, the
published prices for thermal coal are based on certain minimum
specifications, so when certain coal supplies exceed
specifications, there is an opportunity to achieve higher
prices by understanding the customer requirements and meeting
these through better quality coal.
Alternatively, the marketer can understand the customer
specifications and use this knowledge to direct the coal
blending activities in Australia in a way that enables
different quality coal to be blended to achieve a better
overall price across the board. For long-term LNG contracts, a
marketer may achieve a better slope against the oil index price
by understanding customers' technical requirements.
Merely targeting a profit outcome linked to operating costs
does not capture any of the value or profitability that may
accrue to the MNE from the above activities, and is likely to
create an incentive for the hub to increase its costs without
regard to improving the commodity selling price (as it has no
exposure to the upside of better prices).
As a counterpoint to the approach adopted for non-resident
hubs in PCG 2017/1, it is useful to consider the differences
apparent in draft PCG 2018/D8, released in November 2018. The
draft focuses on inbound distribution arrangements and
Australian resident resellers.
Given the functional similarities to offshore
marketers/distributors, readers may be forgiven for expecting
that these entities would also be risk-assessed by the ATO
based on a return on their operating expenses.
However, that is not the case, and the draft PCG assesses
risk based on an EBIT/sales ratio, or operating
margin.15 This is an asymmetrical approach and, in
most cases, will mean a lower level of profitability in
outbound distribution hubs.
In addition, the ATO has set profit markers for inbound
distributors to remain in the low-risk zone that are relatively
high (ranging from above 4% to above 10%) compared with recent
market-based benchmark observations.
The 'one size fits all' risk assessment approach adopted in
PCG 2017/1 means that many offshore, extended value chain
operations of Australian resources-based MNEs are likely to be
considered by the ATO to represent a high tax risk to the
Australian tax base. Taxpayers in this sector should:
- Carefully consider their pricing
methodology with offshore associates;
- Review the robustness of the analysis and
documentation they have to support the pricing; and
- Prepare to engage with the ATO to explain
their position if they have not already done so.
© 2019. For information, contact Deloitte Touche
Tohmatsu Limited.This communication contains
general information only, and none of Deloitte Touche Tohmatsu
Limited, its member firms or their related entities
(collectively, the "Deloitte network") is, by means of this
communication, rendering professional advice or services.
Before making any decision or taking any action that may affect
your finances or your business, you should consult a qualified
professional adviser. No entity in the Deloitte network shall
be responsible for any loss whatsoever sustained by any person
who relies on this communication.
Tel: +61 (0)7 3308 7275
John Bland is a principal with Deloitte Australia.
He has over 20 years' experience as a specialist
transfer pricing practitioner, including 13 years as a
John is based in Queensland, a major mining and
resources state where John has assisted many clients in
this sector on TP issues. He has experience across a
wide range of mined and extracted resources
commodities, and has advised clients on the relevant TP
issues at all points of the energy and resources value
chain, including pre-exploration feasibility,
financing, extraction, beneficiation, marketing,
shipping and logistics, trading and sales.
John has assisted clients on complex matters
including profit split methodologies for
upstream/downstream pricing and has successfully
concluded a number of advance pricing arrangements in
the E&R sector.
T: +61 7 3308 7245
Milla Ivanova is a transfer pricing analyst based in
Deloitte Australia's Brisbane office. Along with her
work in TP, Milla is writing a thesis in the area of
international tax law, focusing on the Multilateral
Instrument and its impact on Australia and its largest
trading partners. In 2017, Milla published a paper on
the Australian Taxation Office's approach to
centralised operating models in the energy and
resources industry, specifically liquefied natural gas.
In 2018, she published a paper on the Multilateral
Instrument, focusing on the permanent establishment
concept and arbitration in light of Australia's
unilateral tax reforms. Milla's interests lie in TP in
the energy and resources sector, as well as policy and
international tax reform.