At issue is the selection of the most appropriate transfer pricing method for sale of coal mined by Carbones El Tesoro S.A. in Colombia to its related party abroad, Glencore International AG. Carbones El Tesoro S.A. had determined the transfer price by application of the TNMM method.
The tax authorities found that the most appropriate method for pricing the transactions was the CUP method. To that end, the tax authorities applied a database (McCloskey price list) in which the price, was determined by referring to a good similar to that traded (thermal coal) and to the Btus (British Thermal Unit) thereof.
On 29 April 2011, the Settlement Management Division of the Barranquilla Regional Tax Directorate issued an assessment by which it modified the income tax return for the taxable year 2007, in the sense of disregarding as a net loss for the year the amount of $30. 509.961.000 and imposed a penalty for inaccuracy of $16.597.418.784, based on the questioning of the method that the taxpayer chose to establish the profit margin in the coal supply operation with its economic partner abroad.
Carbones El Tesoro S.A. filed an appeal with the Administrative Court
Judgement of the Administrative Court
The Court decided in favour of Carbones El Tesoro S.A. and set aside the assessment of the tax authorities.
“4.4 In accordance with the above, and in accordance with the information provided by the plaintiff in the supporting documentation, the Chamber finds that the plaintiff set out in detail the economic reality of its operation of exploitation, production and sale of coal to its related party abroad, including the business and commercial structure, and the activities that each of the parties involved carried out. From this, it can be seen that the plaintiff operated as a producer with limited risks insofar as the risks assumed were limited to those related to its functions of exploitation, production and transport from the mine to delivery at the port, so that all those risks related to the functions of negotiating the price with the final customer, invoicing, collection, commercialisation, marketing, marketing, sales and distribution of the coal to the final customer were limited to those related to its functions of exploitation, production and transport from the mine to delivery at the port, collection, commercialisation, marketing, logistics and transport – including the contracting of vessels and the respective insurances – from the port of the vessel in Santa Marta to the delivery to the final client, were assumed by the foreign affiliate, since it was the one with the necessary infrastructure and expertise for such work, as indicated in the supporting documentation.
4.5. Considering the supporting documentation submitted by the applicant, the Board notes that the applicant presented the criteria used to eliminate possible comparables on the basis of the functions performed. To this end, it eliminated companies whose function in addition to coal mining was to carry out other activities such as electricity generation and/or distribution, or gas exploration and/or production, companies whose mining activity corresponded to products other than coal, companies that leased coal mines, or that were active in the oil industry without segmenting their financial statements by activity, companies that were in Chapter 11, and companies that did not have sufficient descriptive information on the business (…). This demonstrates that the plaintiff undertook a functional level analysis to support that, under the TNMM method, the information available and used presented a high level of comparability that was more suited to its particular situation. In the same vein, in its functional analysis, the complainant presented aspects related to the company’s management, production planning, mine contracting services, coal mining operations and the way it transported coal. He further stated that his responsibility was to plan the production of the El Tesoro mine, coordinate the receipt of coal purchased from local suppliers and transport it to Santa Marta, where it was loaded onto vessels contracted by his company. In addition, it included information about the market and sales, where it stated that it had not carried out any marketing, sales or distribution activities in relation to the exported products, given that 100% of the sales were made to its related party abroad, the latter being the one who decided the sales strategy. It added that the distribution and logistics of the delivery from the port in Santa Marta was the responsibility of its related party and the risks related to the coal were transferred to it once the coal was loaded onto the vessels (…).
4.6. On the other hand, as stated in legal basis 3, the CUP method compares the price of goods or services agreed between independent parties in comparable transactions. Its use implies that the economic characteristics of the transactions being compared must be analysed to determine a high degree of comparability. Thus, the CUP method is not the most appropriate when the conditions of the good are not sufficiently similar, or when the functions, including the risks assumed by the parties, cannot be adjusted in the particular case. When using commodity price lists (in a recognised and transparent commodity market), relevant circumstances such as the nature of the commodity, volume discounts, timing of transactions, terms of insurance, terms of delivery, and currency, among others, must be considered. In this case, the agreements and contracts that fix the terms of these factors are contrasted with those of third parties, in order to verify whether they coincide with those that would have been agreed in comparable circumstances. Under these premises, the Court finds that the defendant, through the use of the CUP method, applied a database in which the price, even though it referred to a good similar to the one traded – thermal coal – and to the Btus of this, was not sufficient to prove that the prices set in said database were for transactions in which the parties assumed similar functions, risks and negotiation terms as those of the transaction analysed. Nor is there any analysis of the appropriateness or otherwise of reasonable technical economic adjustments in the application of that method, such as differences in contractual terms, the level of the distribution chain, the geographic market, the date, the associated intangible property, exchange rate risks, realistic buyer alternatives, among others, which could eliminate the differences between the transactions compared, and make the CUP method the most appropriate. All the factors referred to in the previous paragraph had a direct bearing on the price determined in the thermal coal sales transaction between the related parties, since, otherwise, the McCloskey price list would end up setting a price equivalent to that which would have been obtained in sales to final customers, without taking into account that the allocation of functions and risks must attribute a value to the functions performed by Glencore in the controlled transaction. This is because the analysis must be carried out with respect to the price of sale to an entity that then resells the coal to the final customer, which assumes significant risks, not only of invoicing, collection and maintenance of the customer with a low portfolio risk as the defendant claims. Indeed, the Chamber notes that the Defendant assumes the allocation of risks in the coal sales transaction, but in applying the McCloskey price list does not set out the reasons why it considers that the price set therein is the one that effectively reflects the risk allocation raised, and whether it is identified with the conditions fixed between CET and its related party, but merely states that, since it is the plaintiff who bears most of the risks, it should receive a higher remuneration, and that, since the sale price is lower than the price quoted on a public market, the price indicated in the McCloskey database should be used. Furthermore, the Board notes that the defendant did not set out in detail the reasons why it considered that the method selected by the applicant (TNMM) was not the most appropriate for the controlled transaction, but merely stated that this method would be applicable if the market conditions did not match the situation of the product sold, if there were no public prices that could be applied to the product sold, and if the product sold differed significantly from the publicly traded product.
4.7. In these terms, the Chamber considers that the applicant was not obliged to use the CUP method because it demonstrated the reasons why the TNMM method was more appropriate according to the characteristics of the transaction analysed, and the defendant did not refute the reasons for applying the TNMM method, nor did it question the information in this respect contained in the supporting documentation to support the selected method. For the reasons set out above, given that the plaintiff demonstrated compliance with the criteria for choosing the method required by the applicable regulations and compliance with the arm’s length principle, the Chamber considers that the official assessment of the income tax presented for the taxable year 2007 is not admissible.”
Col vs CARBONES EL TESORO S.A.(22352) ORG