COLOMBIA vs CARBONES EL TESORO S.A. (Glencore)

 

COUNCIL OF STATE

 

CONTENTIOUS-ADMINISTRATIVE CHAMBER

 

FOURTH SECTION

 

Adviser rapporteur: MYRIAM STELLA GUTIERREZ ARGÜELLO

 

Bogotá D.C., sixteen (16) September two thousand twenty-one (2021)

 

Case number: 08001-23-31-000-2011-01033-01(22352)

 

Plaintiff: CARBONES EL TESORO S.A.

 

Defendant: DIRECCIÓN DE IMPUESTOS Y ADUANAS NACIONALES - DIAN (National Tax and Customs Directorate)

 

JUDGMENT

 

The appeal lodged by the plaintiff against the judgment of 27 March 2015, handed down by the Administrative Court of Atlántico, Decongestion Subsection, the operative part of which is as follows:

 

"FIRST: Declare the objection raised by the defendant's legal representative not proven, in accordance with what is set out in the grounds of this judgment.

 

SECOND: Deny the claims in the application, in accordance with the reasons set out in the grounds of this decision.

 

THIRD: Reimburse the plaintiff, if any, the costs of the proceedings.

 

FOURTH: No order as to costs (Art. 171 C.C.A., amended by Article 55 of Law 446 of 1998)".

 

(...)

BACKGROUND TO THE ADMINISTRATIVE PROCEEDINGS

 

On 25 April 2008, Carbones El Tesoro S.A., filed an income tax return for the taxable year 2007. Subsequently, on 13 July 2008, it filed its individual transfer pricing information return (DIPT) for the same tax year.

 

On August 25, 2010, the DIAN issued Special Demand No. 022382010000221, which was notified on August 30, 2010 (fls. 109 to 137) and on November 26, 2010, the plaintiff responded to the special demand (fls. 138 to 163).

 

On 29 April 2011, the Settlement Management Division of the Barranquilla Regional Tax Directorate issued the Official Review Settlement 022412011000132 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.

 

PROCEDURAL BACKGROUND

 

Complaint

 

In an action for annulment and reestablishment of rights provided for in article 85 of the Contentious Administrative Code (CCA, Decree 01 of 1984), the plaintiff filed the following claims (fl. 2):

 

A.         To declare the total nullity of the Official Revision Settlement No. 022412011000132 of 29 April 2011, issued by the Settlement Management Division of the Barranquilla Regional Tax Directorate of the U.E.A. National Tax and Customs Directorate - DIAN.

 

B.         As a consequence of the above, declare the finality of the income tax return of CARBONES EL TESORO S.A. for the taxable year 2007, as well as the inadmissibility of the penalty for inaccuracy.

 

C.         That as a consequence of the declaration of nullity, the company CARBONES EL TESORO S.A. be reinstated in its rights, declaring that it is in full compliance with its income tax obligations for the taxable year 2007.

 

D.         Declare that CARBONES EL TESORO S.A. is not liable for the costs incurred by the Directorate of National Taxes and Customs in relation to the administrative proceedings, nor for the costs of these proceedings.

 

In the complaint, articles 13, 29, 83 and 363 of the Constitution, 35 of the Contentious Administrative Code, 102, 178 and 260 of the Code of Civil Procedure, 121, 260-1, 260-2, 647 and 647-1 of the Tax Statute and article 7(B) of Decree 4349 of 2004 were indicated as violated. The concept of the infringement is summarised as follows (pages 6 to 51):

 

The plaintiff raised the disregard of the purpose and aim of the transfer pricing regime, due to the fact that the Administration speculated about how the taxpayer's operation should work without offering any legal or commercial basis.  He argued that the defendant exceeded its powers by modifying the structure of the business, which is contrary to the very nature of the transfer pricing regime, which seeks to ensure that once the operation is defined, it is governed by market ranges. To support the above, he explained the characteristics of the coal sale transaction with its foreign affiliate, its shareholder composition, and the violation of the transfer pricing regime by the Administration, by suggesting that the remuneration of its foreign affiliate should be received via dividends when the transaction is based on a supply contract.

 

He argued that the principle of autonomy of will enshrined in article 1602 of the CC and article 121 of the ET were not respected, because the Administration concluded that its foreign affiliate acts as a commercial agent, according to its own analysis of functions and assumption of risks, and determined that it should receive a 5% commission on the price proposed by the affiliate in the sale of coal in accordance with article 121 (a) of the ET and Resolution No. 2296 of 22 March 1976. In this regard, he stated that the aforementioned rules established a tax benefit for those payments to commission agents, consisting of the deductibility of these payments without the need to demonstrate that withholding tax had been paid, so it is a rule that facilitates access to a tax benefit, but it is not a market range and has no application in the transfer pricing regime. Similarly, it argued that the 5% commission was not agreed by the parties, so it is not possible for the Administration to "pretend to impose a commercial value that must be assumed for any commercial relationship, because by assuming this it does not take into account the principle of free will".

 

It argued that the administration did not refute the validity of the method of transactional profit margins (TU) used, nor did it object to the supporting documentation for the year 2007. In this regard, it argued that, under the free determination granted by article 260-2 of the ET (in force for the year 2007), it applied the TNMM method because it was more reliable to assess the profitability of the company according to the sample obtained from independent companies with comparable business activities, and presented the suitability of the method based on what was reported in the supporting documentation.

 

It stated that Management did not take into account the comparability criteria set out in Article 260-3 of the ET, the rules on the selection of the method, nor did it explain the reasons for considering the comparable uncontrolled price (CP) method more appropriate for the transaction. This is because the CUP method does not reflect the reality of the transaction, nor the terms of negotiation used by the company. In this regard, it stated that neither the Colombian legal system nor the OECD guidelines indicate any of the methods established in article 260-2 of the ET as the only and priority method.

 

He alleged the violation of the right to equality enshrined in article 13 of the Constitution, due to the fact that the Administration ignored the coal sales price certified by the Ministry of Mines and Energy for similar companies applicable in 2007, which led it to infer that the plaintiff should assign a price that was not in accordance with the real transaction developed with the economic partner; thus applying an excessive and unrealistic price.

 

He argued that the official liquidation suffered from false motivation, since it is not true that he assumed all the risks of the transaction, as stated in the supporting documentation, so he should not obtain a higher profitability. Furthermore, it argued that the supporting documentation demonstrated that its profit margin was within the interquartile range determined in its comparability analysis.

 

He asserted the violation of the right to due process, inasmuch as the Administration did not give reasons for the act being challenged, by not presenting the reasons of fact and law to support that the taxpayer made an error in choosing the TNMM method, and did not even read the response to the special requirement, but simply replicated the same arguments in the official review liquidation.

 

It argued the violation of the principle of good faith (article 83 C.N.), since it complied with its transfer pricing obligations and the Administration did not take into account the correct performance of the plaintiff with respect to the year 2007, and did not value the supporting documentation provided and inferred the bad faith of the plaintiff in determining the commission applicable to its related party from abroad in the coal supply operation.

 

He stated that the defendant did not comply with the rules of the sanctioning process, given that it should have initiated an audit of the supporting documentation and the DIPT, before questioning the determination of the income tax.

 

He explained the improper evidentiary assessment of the Administration in rejecting the reported loss, based on prices consulted in international coal databases, which do not correspond to those outlined in its supporting documentation. He questioned that the Respondent used as evidence the prices taken from the McCloskey database, as well as e-mails exchanged with this entity, analysed and freely translated into Spanish, in an imprecise manner, in violation of the requirements of article 260 of the CPC on the use of documents in a foreign language.

 

Additionally, it argued that the Administration intends to demonstrate that the selected method is inaccurate; but for this purpose it uses a database that takes into account spot prices, while the plaintiff conducts its negotiations with its related party abroad using forward prices.

 

Finally, with regard to the penalty for inaccuracy due to the decrease in losses, it stated that it was inadmissible because it did not engage in any punishable conduct. Furthermore, it alleged a difference of criteria with regard to the applicable law, since the adoption of a method different from that indicated by the defendant could not give rise to a penalty, insofar as the tax rules do not establish a single method, to such an extent that they left it to the taxpayer's discretion to determine it.

 

Opposition to the claim

 

The defendant contested the claims of the plaintiff, as follows (fls. 188 to 208):

 

It raised a plea of insufficiency of the claim, because the plaintiff did not appeal the official review liquidation in a timely manner, which led to the rejection of the appeal for reconsideration as untimely, and therefore, there was no exhaustion of governmental channels.

 

Regarding the disregard of the purpose and aim of the transfer pricing regime, it stated that it did not exceed its powers insofar as it amended the income tax return based on the information provided by the taxpayer, which led to the conclusion of the omission of income, which when added generated the reduction of the loss and the consequent penalty for inaccuracy.

 

He stated that, both in the special requirement and in the official liquidation, he presented the arguments by which he questioned the method used and concluded that it was not the most appropriate. Furthermore, it claimed that it has the competence to disregard the method used by the taxpayer and to determine the most appropriate one in order to comply with the purpose of the transfer pricing regime.

 

Regarding the application of the comparability criteria and the violation of the right to equality, it indicated that it applied the regulations as set out in the contested acts, and that these contain all the information related to the evidence collected and the analyses carried out.

 

Regarding the false motivation of the administrative act, he indicated that in the evidence and analysis it was possible to conclude that the company assumes all the risks of the operation, that therefore the foreign affiliate only acts as an intermediary, where it assumes the risks inherent to that activity, and that in addition, by virtue of the total control that it exercises over the shareholder, derived from the shareholding relationship, there should be no such intermediation in the coal operation to the end customer, because the affiliate obtains its profit via dividends. In fact, it argued that the company should obtain a higher return, but this is not reflected in the chosen method. It argued that the TNMM method applies only when market conditions are not in line with the situation of the product sold, and if there are no public prices that can be applied to the product sold or if the product sold is significantly different from the publicly quoted price, which is not the case for the applicant, as there are public reference prices for thermal coal. 

 

Similarly, it stated that since world trade in coal is driven by price lists issued by public databases with a standard quality of the product, in a given port and taking into account the variables that can influence its price, it was appropriate for the taxpayer to apply the CUP method, taking as comparable the sale price of coal set in those lists.

 

Based on the above, it stated that the foreign affiliate acted as a commercial agent with functions and risks in accordance with its participation in the transaction, to which a commission of 5% of the sale price should be applied, as provided for in article 121 of the ET and Resolution 2296 of 22 March 1976. In accordance with the above, it recalculated the sales invoices provided by applying the international quotation price for the date of the transaction, to which it subsequently subtracted the 5% commission corresponding to the foreign affiliate, and thus adjusted the plaintiff's income tax return by adding income, which resulted in the aforementioned decrease in tax loss.

 

Regarding the violation of the right to due process by not giving reasons for the act being appealed, he argued that he did not agree, because the plaintiff had all the relevant instances to exercise her right of defence. Furthermore, he acted in accordance with the evidence in the file (art. 742 of the ET).

 

Regarding the improper evaluation of the evidence, he argued that he did not disregard article 102 of the CPC because the entire process was carried out in Spanish.

 

In relation to the disregard of the principle of free will and the violation of articles 1602 of the CC and 121 of the ET for improper application, he stated that he studied the way in which the method should be chosen to determine the price or profit margin of the plaintiff, based on the evidence provided by the plaintiff.

 

Finally, he indicated that the penalty imposed on the plaintiff is that established in article 647-1 of the ET, which refers to the theoretical tax resulting from the reduction of the net loss, which can be proposed in the special requirement without the need for a statement of objections or a separate penalty resolution.

Judgment appealed

The Tribunal Administrativo del Atlántico, Subsección de Descongestión, by judgment of 27 March 2015, denied the pleas of the claim based on the following considerations, without ordering costs (fls. 289 to 305):

 

It declared the plea of unfounded claim not proven because the untimeliness of the appeal for reconsideration has the same effect as not having filed it, which implies that the plaintiff did not exhaust governmental channels to go directly to the administrative jurisdiction within the four months following the notification of the official review liquidation.

 

On the merits of the case, he stated that although it is the taxpayer's right to choose the most appropriate method to determine the price or market margin applicable to the transaction subject to the transfer pricing regime, the CUP method is the one that best suits the transaction because independent coal companies usually set their prices according to the market values of thermal coal and, therefore, the comparable price was the one provided by the international market databases.

 

It stated that since the disputed transaction should have been agreed according to the international price applicable in October, November and December 2007, as stated by the defendant, and in those months according to the McCloskey database the market price was higher than 70 dollars, the sale of coal between the related parties did not comply with the transfer pricing regime. Accordingly, the taxpayer could not set a price lower than the international market price, and thus carry a loss on its return that would decrease taxable income.

 

In addition, it considered that the defendant demonstrated the situation of control of the foreign affiliate over the plaintiff, with which the source of income of the foreign affiliate should be via dividends and not payments for commercial intermediation, especially when such income amounts to 54% of the total of the transaction.

 

As for the inappropriateness of the penalty for inaccuracy, it considered that the plaintiff was not right either, because the plaintiff omitted income and incurred in a punishable conduct that makes the penalty for inaccuracy of article 647-1 of the ET applicable.

Appeal

The plaintiff appealed the judgment of first instance, reiterating the arguments of the complaint and adding the following (fls. 307 to 339):

 

The Court violated article 170 of the CCA and its right to due process, because despite the fact that in the supporting documentation it accredited each comparability requirement as required by article 7 (num. 7, lit. B) of Decree 4349 of 2004, and justified the absence of internal comparables, the Court did not specify the legal basis and the evidentiary assessment that led it to consider that the CUP method was the appropriate one, and not the TNMM method applied by the plaintiff.

 

He also stated that the Court limited itself to transcribing sections of the contested act, vitiated by false reasoning, and therefore failed to note that the transaction between the plaintiff and its related party consisted of the former selling thermal coal to the latter, and the latter remaining free to resell it at its own risk abroad.

 

The applicant cannot be forced to use the CUP method, which is not based on the profitability of the business, but on a market price at a time after the goods were traded. It added that its related party is an essential part of the coal production and marketing chain, insofar as it is responsible for the resale of the product to the final consumer, the supply of the asset, delivery delays, knows the needs of the customers and the types of coal required. Therefore, it is not true that the work of that company is minimal and that it is the complainant who must obtain a higher profitability in order to justify the modification of the chosen method. It reiterated that the CUP method is not applicable because it is not based on comparable data since it does not take into account the terms of negotiation, the forward price contracts and the distribution of the risks assumed by each party to the transaction.

 

He stated that the profitability of the taxpayer was adjusted to that obtained by independent companies, functionally and objectively comparable, which were part of the sample of the price study developed under the TNMM method, in such a way that the principle of full competition was respected, which undermines the Court's thesis that the sales price of the plaintiff with its related party abroad was much lower than the internationally agreed.

 

He stated that the average price of the official liquidation, which the Court endorsed (US$88.14), does not take into account the economic reality of the taxpayer nor the price that the Ministry of Mines and Energy established that year for large companies in the sector, and which is much lower than the one stated by the defendant, which violates the principles of legality and equality.

 

With respect to the sanction imposed, he stated that it is not based on a clear and thorough investigation by the Administration, since it takes the information from a database - McCloskey - that does not adjust to the economic reality of the plaintiff. The above shows a clear difference of criteria between the parties, arising from the defendant's lack of knowledge of the applicable law and the use of irrelevant elements of evidence, as well as the misrepresentation of the transaction on the basis of unrealistic assumptions, such as that its related party should receive dividends without being a shareholder of the plaintiff.

 

Arguments in conclusion

 

The plaintiff insisted on the points made in the appeal and the defendant in turn reiterated the arguments of the defence.

 

The Public Prosecutor's Office remained silent at this stage of the proceedings.

CONSIDERATIONS OF THE COURT

1.         The Chamber must decide on the nullity of the contested act in accordance with the precise grounds of appeal raised by the applicant against the judgment under appeal.

 

Specifically, it is for the Chamber to determine whether the amendment of the income tax return, based on the change of transfer pricing method proposed by the defendant, whether the transfer pricing penalty regime was violated due to the lack of a prior audit of the DIPT and the supporting documentation, and whether the penalty for inaccuracy derived from the reduction of the tax loss is appropriate.

 

2.         In relation to the applicable method for determining the price or profit margin of the controlled transaction, the applicant claims that the TNMM method is the most appropriate method for determining compliance with the arm's length principle in its operation of selling thermal coal to its related party abroad, since it meets the requirements laid down in Article 7(7) of Decree 4349 of 2004 to be considered the most appropriate method. Furthermore, it argues that the regulation does not establish any particular preference or order in the application of transfer pricing methods.

 

For its part, the Administration argues, based on its analysis of the structure of the transaction, that the CUP method is the most appropriate method for determining the market price, because in the world coal trade there are public price lists applicable to a standard quality of coal, with reference to which the price can be directly determined. To this end, it added that, depending on the assumption of risk involved in the transaction, the foreign related party should obtain a lower return and the plaintiff a higher return, a situation which is not reflected in the method selected by the latter.

 

2.1. It should be made clear that the first legal problem raised is related to the selection of the most appropriate transfer pricing method for the controlled transaction, i.e. the sale of thermal coal from the plaintiff to its foreign affiliate, and not, as the defendant argues, in the sense of understanding that between the related parties an intermediation or commercial agency operation has been executed, for which the plaintiff should recognise a 5% commission to its affiliate. This would lead not only to a distortion of the contracts and their actual execution, but also to an inconsistency in the application of the transfer pricing regime, since it would be recharacterising the controlled transaction - a sales operation - as an intermediation, which in turn would lead to the questioning of the method used and the price of the goods used in the sales transaction, referring to a transaction between independent parties, i.e. between the plaintiff and the final customers, since the related party would remain as a commission agent in relation to its relationship with the plaintiff, in the terms set out in the defendant's act.

 

3.         The Chamber emphasises that, as stated in the judgment of 22 February 2018 (exp. 20524, CP. Julio Roberto Piza Rodríguez), the objective of the transfer pricing regime is that, in the determination of income tax, the taxpayer that carries out operations with foreign economic partners quantifies its income, costs and deductions, at values that are comparable with those determined between independent parties, so that market prices are used, taking into account the existing relationship, in accordance with the provisions of article 260-1 of the ET, in force at the time of the facts.

 

In order to demonstrate compliance with the arm's length principle, the taxpayer must comply with the formal duty to file the informative declaration of the operations carried out with foreign economic partners or related parties, and to prepare the supporting documentation regulated in article 260-4 of the same law, which acts as support for the information reported in the informative declaration.

 

In order to determine compliance with the arm's length principle, article 260-2 of the ET (under the wording of Law 788 of 2002), established the methods for determining the price or profit margin of operations with related parties, among which it listed: comparable uncontrolled price, resale price, added cost, profit split, residual profit split and transactional profit margins of the operation. In addition, the same provision indicated that the price or profit margin in transactions between related parties could be determined by applying any of the methods listed, for which the most appropriate one should be taken into account, in accordance with the characteristics of the transactions analysed.

 

In relation to the specific information that forms part of the supporting documentation, article 7 of Decree 4349 of 2004, in force at the time of the facts, established that the documentation and information to be kept, insofar as it was compatible with the type of operation under analysis and with the method used, should include the method used by the taxpayer to determine the prices, amounts of consideration or profit margins, indicating the criteria and objective elements considered to conclude that the method used is the most appropriate in accordance with the characteristics of the type of operation analysed.

 

In addition, the same provision stipulated that, in order to determine that the method used was the most appropriate, it should be the one that best reflects the economic reality of the type of transaction, be compatible with the business and commercial structure, have the best quantity and quality of information, provide the highest degree of comparability and require the lowest level of adjustments.

 

3.2. For their part, the OECD Transfer Pricing Guidelines (1999) noted on the selection of methods, that they allow determining whether the terms of the commercial or financial relationships between associated enterprises are compatible with the arm's length principle, that no single method is useful in all circumstances, nor should the application of any particular method be disregarded (paragraph 1.68). These Guidelines also point out that it is not possible to establish specific rules covering all cases, and that in general, parties should try to reach a reasonable compromise, bearing in mind the imprecision of the various methods, the preference for higher degrees of comparability and for a more direct and closer relationship to the transaction (para. 1.70).

 

In particular, regarding the CUP method, which falls within the traditional methods, the cited Guidelines indicated that it consists of comparing the price charged for assets or services transferred in a controlled transaction with the price charged for assets or services transferred in a non-controlled transaction in comparable circumstances (para. 2.6.). For these purposes, a non-controlled transaction is comparable to a controlled transaction for purposes of applying the CP method if: (i) none of the differences (if any) between the two transactions being compared, or between the two undertakings involved in those transactions, is likely to materially affect the free market price; or (ii) sufficiently precise adjustments can be made to eliminate the effects of those differences (para. 2.7.). It may be difficult to find a transaction between two independent companies that is sufficiently similar to a controlled transaction that there are no differences that have a material effect on the price. For example, a minor difference in the assets transferred could affect the price, even though the nature of the business activities may be sufficiently similar to generate the same profit margin. Where this is the case, some adjustments are appropriate, and the extent and reliability of these adjustments will affect the reliability of the analysis performed under the CUP method (paragraph 2.8).

 

In addition, in considering whether controlled and uncontrolled operations are comparable, the effect on prices of other broader functions of the undertakings, and not just the degree of comparability of the product, must be considered. As with any other method, the relative reliability of the CP method is conditional on the degree of precision with which adjustments can be made to achieve comparability (paragraph 2.9.). If precise adjustments cannot be made, the reliability of the CUP method would be reduced and it would be necessary to supplement it with other, less direct methods, or, ultimately, to use these other methods (paragraph 2.11.).

 

Now, while traditional methods may be the most straightforward way to establish whether conditions in commercial and financial relationships between related parties are conducted on an arm's length basis, the complexities of real business life may pose practical difficulties in the application of traditional methods. In these exceptional situations, when there is insufficient information available, or the information available is not of sufficient quality to use a traditional method, it may be necessary to define whether and under what conditions other methods can be used, i.e. transactional utility methods, of which the TNMM method is one (paragraph 2.49). 

 

In short, although the CUP method may be the most direct means of determining whether the price set in a transaction between related parties corresponds to the market price between independent parties in comparable transactions, it is not always possible to find means of comparison that ensure that there are no significant differences that could materially affect the determination of the price, or that such differences cannot be accurately calculated and adjusted, in terms of the characteristics of the good, the functions performed by the parties, including the risks assumed, and the terms of negotiation. In such cases, it may be necessary to conduct the comparability analysis using a transactional utility method to determine whether the transaction under analysis ensures compliance with the arm's length principle, in which case the TNMM method may be more appropriate. Under this method, special emphasis is placed on the functions performed by the parties and the utility indicators may be less affected by differences in the goods and conditions of the transaction.

 

4.         In view of the above, in order to establish whether the change of method claimed by the Respondent was appropriate, and thus the adjustment raised in the official assessment, the Chamber considers the following facts to be proven:

 

1. After filing the income tax return for the taxable year 2007, the plaintiff submitted the corresponding DIPT, in which it reported net income operations for the sale of inventories produced for $63.804.872.000 (fl. 14 Volume II).

 

2. When requested by the defendant, the plaintiff submitted the transfer pricing study, in which it stated that (fls.114 A 253 Cuaderno Corrección Demanda):

 

a.         It recorded income operations for the sale of inventories produced (sale of thermal coal produced by the company itself) with its foreign affiliate Glencore International AG. In the specific case, the plaintiff, in administrative and judicial proceedings, affirmed that the contract signed with its foreign affiliate was for the supply of coal.

 

b.         Within the review of the attributes of the relevant transactions to carry out the comparability analysis, it included the "risks" of market, credit, interest, exchange rate, inventory, compliance, supply, force majeure, environmental and country (fls. 157 and 161 of the Complaint Correction Notebook).

 

c.         The method selected as appropriate was the Transactional Transaction Profit Margins, TU (f. 115 Claim Correction Booklet). To apply it, it chose the profit indicator "Operating income over total cost" (OITC), defined as operating profit over total costs and expenses.

 

d.         The party to be examined was the Complainant itself (fl. 114) and the comparables selected were fifteen companies located abroad (fl. 165 Cuaderno Corrección Demanda).

 

e.         The operating margins of the selected comparables were subjected to economic adjustments for accounts receivable, inventories and accounts payable, and the interquartile range was narrowed to increase the reliability of the comparability analysis. The result was (fl. 115 Demand Correction Booklet):

 

Statistical measure Adjusted Range

Lowest value 4.352

Lower quartile 6.534% Median

Median 16.653% Median 16.653% Upper quartile

Upper quartile 25.197% Maximum value

Maximum value 46.909%.

 

f.          The margin determined for the appellant for the period under examination was 22.234%, i.e. within the adjusted range.

 

4.1. Now, taking into account that the appellant's arguments are aimed at demonstrating the validity of the TNMM method over the one determined by the respondent in the official liquidation (CUP method), on the basis of which the latter made the adjustment of the income operation analysed with the foreign related party, the first thing to mention is that the rule in force at the time of the facts did not establish any preference for the application of one or the other method of those listed in article 260-2 of the ET (in force at the time of the facts).

 

In fact, the literal wording of the rule shows that the legislator referred to the fact that the taxpayer "could" determine the price or profit margin by "any" of the methods listed in article 260-2, the only orientation being "which one is more appropriate according to the characteristics of the transactions analysed". The legislator did not foresee an order of priority in the methods, nor did it specify the cases in which each one was applicable, so that for the tax year under discussion, the Colombian rule left the taxpayer free to choose the method, as long as he demonstrated the reasons why the one selected was the most appropriate for the particular circumstances of the transaction analysed.

 

Therefore, under the assumption of the power granted by the rule to the taxpayer to choose the most appropriate method, it must be analysed whether the plaintiff demonstrated the circumstances for which the TNMM method was the most appropriate for its particular transaction. In this regard, the taxpayer submitted the following information in its transfer pricing study (f. 113 et seq. in the Complaint Correction Notebook): 

 

1. Corporate purpose - Carbones El Tesoro S.A.: CET belongs to the Glencore group and operates as a producer and exporter of thermal coal in Colombia. Its corporate purpose includes, principally, the prospecting, exploration, exploitation, production, transformation, acquisition, sale, marketing and transportation of coal and any other mineral substance related to coal. Its principal place of business is in the city of Barranquilla. The company exports coal extracted from the El Tesoro mine, located in the municipality of La Jagua de Ibirico, Department of Cesar, which is transported to the yards of the Sociedad Portuaria de Santa Marta and then loaded onto ships bound for international markets. The company operates exclusively within Colombia and has no international operations or offices. (fl. 145 Cuaderno Corrección Demanda).

 

2.         Business strategy: Since the start of mining activities in 2007, CET does not have its own marketing infrastructure to penetrate the existing market, nor any capacity to increase its market share. Its operational structure responds to its profile as a limited risk producer.

 

In order to achieve rapid growth in production and sales, and with the objective of achieving cost effective growth in planned production, CET has adopted the strategy of utilising Glencore's globally recognised marketing expertise and infrastructure. CET is not expected to extend any credit terms to end customers and is therefore considered to have zero exposure risk. All credit risk is borne externally by Glencore and therefore CET does not assume any risk related to debt collection or the processing of negotiable instruments. CET has not incurred any additional start-up or development costs, as the products are marketed immediately after production. As a production service provider, CET does not directly manage or assume market risk (fl. 146 Correction to Complaint).

 

3.         Scope of operations: CET's operational network is limited to operations at the El Tesoro mine. The company's expertise is mainly in technical areas of coal production, these being the key areas along with logistics and finance. The company has no direct experience or networks in the market area in Colombia or globally (fl. 148 Cuaderno Corrección Demanda).

 

4.         Marketing and sales: CET's responsibility is to plan production at the El Tesoro mine, coordinate the receipt of coal purchased from local suppliers and transport it to Santa Marta, where it is loaded onto vessels contracted by Glencore. Thanks to the efficiency at the port and the high level of coordination between supplier and trader, Glencore can guarantee quality and reliability to its customers. CET prepares regular production, transportation and inventory forecasts for distribution to Glencore, reporting on coal availability to ensure the timeliness of vessel arrival.

 

Based on its experience and knowledge of the market, Glencore decides on the sales strategy for the coal it purchases from CET (fl. 155 Statement of Claim).

 

5.         Distribution and delivery logistics: The planning, coordination, contracting and procurement of ship insurance is the responsibility of Glencore. All logistics related to the delivery of coal to customers from Carbosan is the responsibility of Glencore. All risks related to the coal are transferred to Glencore once the coal has been loaded onto the vessels (fl. 156 Correction to Complaint).

 

6.         Quality control: CET is responsible for ensuring that the coal loaded onto the vessels complies with the specifications agreed with Glencore's customers (fl. 156 Correction Statement of Claim).

 

7.         Comparables search strategy - internal comparables and external comparables: It indicated that it does not have internal independent comparable transactions because it does not sell thermal coal to independent third parties, and that its related company abroad does not buy the same type of coal from unrelated companies in Colombia. Likewise, it indicated that the information in the Superintendencia Financiera is not sufficient to guarantee comparability (fl. 165 Cuaderno Corrección Demanda).

 

8.         Adjustments: It indicated that by using the TNMM method, it only had to make routine adjustments to balance sheet accounts, accounts receivable, inventory and accounts payable (fl. 115 Cuaderno Corrección Demanda).

 

9.         Functional analysis and assumption of risks (f. 161 Complaint Correction Book):

 

Glencore CET Risks

Market risk - price X   

Market risk - volume X           

Market risk - price/volume (long term) X

Credit risk X    

Interest risk X

Country risk X

Exchange Rate Risk X

Inventory risk (during storage) X

Inventory risk (from delivery at port) X         

Compliance risk - quality X

Compliance risk (delivery term to port) X

Compliance risk (delivery term from port) X 

Supply risk X

Force majeure risk X  

Environmental risk X

Glencore CET functions

Operational - distribution X   

Operational - production X

Strategic - production X

Strategic - sales X       

Intangibles Glencore CET

Know How Sales processes X 

Sponsorship (know how production processes) X

 

10.       Selection of the TNMM method: It indicated that the selection of the most appropriate transfer pricing method is based on the determination of the method, which under the facts and circumstances of the transactions under review, provides the most reliable measure to determine the correct application of the arm's length principle in transactions between related parties. To determine the appropriate choice of method, the Colombian transfer pricing regulations establish the following factors to be taken into account: (a) that it is the one that best reflects the economic reality of the type of operation; (b) that it is compatible with the corporate and commercial structure; (c) that it has the best quantity and quality of information; (d) that it contemplates the highest degree of comparability; and (e) that it requires the lowest level of adjustments (fl. 162 Cuaderno Corrección Demanda).

 

11.       Application of the CUP method: It indicated that in relation to the possibility of using external comparables, it was not possible to find comparables for transactions between unrelated entities that met the comparability criteria for using the PC. The possibility of using international coal market benchmark prices was ruled out as the above comparability requirements - (a) best reflecting the economic reality of the transaction; (b) compatible with the business and commercial structure; (c) with the best quantity and quality of information; (d) providing for the highest degree of comparability; and, (e) requiring the lowest level of adjustments - were not met, and the possibility of making adjustments to increase comparability might not result in appropriate conclusions. This is a different stage in the production chain as sales are not made to the final customer (fl. 162 Corrective Action Booklet).

 

4.2. On the occasion of the Ordinary Injunction No. 1-00-211-230-0003335 of February 4, 2010 (fl. 73 Volume I) in which the DIAN requested "How did you determine the unit sales price per metric ton that is detailed in each invoice", the plaintiff explained (fl. 161 Volume I):

 

In order to determine the unit selling price per metric tonne of coal, variables are considered such as: (i) the quality of the coal (calorific value, sulphur, humidity, volatile material, HGI, etc.) required by the final consumer, (ii) the type of vessel that can reach the country of final destination (cape, panamax, handymax, etc.), and (iii) the period of delivery of the coal (spot sales vs. long-term contracts).

 

Based on these variables, the possible ports of shipment of other exporters that meet the required quality characteristics are identified and an analysis is carried out to establish who can supply the type of coal required by the final consumer abroad. Subsequently, an analysis is made of the ports that meet the required specifications to load the vessels that will be received by the final consumer at the port of destination abroad. And finally, an analysis is made of the availability of coal inventories that these competitors have in order to determine which of them will be able to offer coal to the final consumer who is demanding it in the market.

 

Once the competitors and the ports of shipment have been defined, the price of maritime freight from each of these ports to the destination port abroad is analysed. In this way, the variables that allow the exporter to set the price at which he can sell coal to a specific customer abroad are available. This price is compared with the other possibilities of selling the coal to other consumers and it is determined whether the price to be offered maximises the company's profitability.

 

The ordinary request also asked "What criteria do you take into account to penalise or decrease the revenue or to grant a premium on the sale of coal" (fl. 73 Volume I), to which the plaintiff clarified (fl. 161 Volume I):

 

The calorific value of coal measured in Btu/Lb is the criterion taken into account to penalise or award a premium on the sale of coal. The calorific value is the amount of energy that coal can give off in an oxidising chemical reaction. The higher the calorific value of the coal sold compared to the contractual calorific value, the higher the premium and vice versa.

 

In the case of CET's coal sales, the typical calorific value is in the order of 12,400 Btu/Lb and based on the quality certificates issued by an internationally recognised independent laboratory, the premium or penalty is calculated according to the following formula (...).

 

4.3. Now, in the official liquidation under discussion, the defendant concluded, based on the information included in the supporting documentation submitted by the plaintiff, that (fl. 71):

 

a.         CET is the producer of that good which arrives at the port of the end user (consumer).

b.         CET establishes very clearly that the ownership of the coal will pass to the buyer when the ship leaves Colombian territorial waters, it is clear that in all that previous stage the risk is being assumed by CET, which coincides with the reality of the operation.

c.         CET is the one who must assume and guarantee the quality of the exported product, as defined in the contract signed between Glencore and CET.

d.         CET is the one who defines the annual production quantity, according to its mining planning submitted to the Ministry of Mines and Energy.

e.         CET is the one who transports the coal from its mines to the port of shipment, performing and assuming quality tests in each of them, until the product is shipped to its final destination.

 

Therefore, if CET is the one who exploits a natural product, determines the amount of coal to be produced in the year, guarantees the quality of the product, assumes the risk of transporting the coal from the point of exploitation until the product leaves Colombian territorial waters, has a high capital impact both in investment and operation, among other risk factors inherent to the operation, it should be CET who should have a higher return of profitability, since an independent operator would expect that higher profitability.

 

It went on to state that the CUP method was the most appropriate method for analysing the sale of thermal coal:

 

(... ) due to the structure of the operation' and warned that, because 'world trade in this product is driven by the different price lists issued by public databases with a standard coal quality at a given port and taking into account the different variables that can influence the price of the product, it is considered that for the present case it is possible to take these price lists as a basis for determining the price at which CET sells coal to Glencore; especially when it should have as a return a minimum margin and CET should obtain a higher profitability, a situation that is not reflected in the method selected by the taxpayer as was the transactional margin of profit; and taking into account that this method would be applicable if the market conditions were not adjusted to the situation of the product sold, if there were no public prices that could be applied to the product sold, if the product sold differed significantly from the public quotation (fl. 72). 

 

As a consequence of the above, the defendant explained its methodology to increase the revenues from the sale of thermal coal and proceeded to adjust the price of each invoice, based on the international average price per ton of coal for the months of October to December 2007, indicated in the McCloskey database for coal of 11,300 Btus (British thermal unit); and to that result it applied the 5% commission, which in its opinion should be collected by the foreign affiliate, thus adjusting the price of coal sales in each invoice.

 

As to the use of the public price database, the defendant stated (fl. 72):

 

Throughout this brief we have been demonstrating the reasons why we move away from accepting the method selected by the taxpayer which was the "transactional of TU utility" and we consider the method to apply is the comparable price not controlled with existing databases either Platts, McCloskeys on the grounds that the price quoted corresponds to a coal with similar characteristics, do not require adjustments since the price given is in Colombian Port, with a minimum BTU of 11,300, similarly is the international reference price that would be the first called to analyze.

 

Even though we know that the price of these exchanges is not given in terms of the final client, it is true that it is the basis for negotiation between the final consumer and the market agent, inferring from this that the price at which the client (consumer) is invoiced is even much higher, due to this other stage of intermediation, which is not publicly known. Therefore, we start from the publicly quoted price and recognise Glencore's intermediation percentage, to which we assign 5% and the resulting difference is the price that should be recognised as the market price and which we consider complies with the arm's length principle and for Colombia the independent operator principle. 

 

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, and the sale 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 effect, it eliminated companies whose function in addition to coal mining was the performance of 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 engaged in the oil industry without segmenting their financial statements by activity, companies that were in Chapter 11, and companies that did not have insufficient descriptive information about the business (fl. 167 Cuaderno Corrección Demanda).

 

This demonstrates that the plaintiff undertook a functional level analysis to support that, under the TNMM method, the information that was 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 on the vessels (fls. 153 to 156 of the Correction to the Complaint).

 

4.6.      On the other hand, as stated in legal ground no. 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 Chamber finds that the defendant, by using 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 alternatives of buyers, 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 (TU) 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 submitted for the taxable year 2007 is not admissible.

 

The appeal charge is upheld.

 

5.         The Chamber will be relieved from analysing the other charges of appeal, insofar as, as stated throughout this ruling, the respondent act officially settled the income tax on the basis of an improper modification of the method selected to fix the transfer price of the plaintiff, which constitutes sufficient reason to declare it null and void.

 

6.         Finally, the Chamber will refrain from imposing costs in the second instance, since there is no evidence of bad faith or recklessness in the defendant's conduct, which would allow for such an imposition, in accordance with article 171 of the CCA.

 

In view of the foregoing, the Fourth Section of the Contentious-Administrative Chamber of the Council of State, administering justice in the name of the Republic of Colombia and by authority of the law,

ADJUDGES

1. Revoke the second paragraph of the operative part of the judgment appealed against, handed down on 27 March 2015 by the Administrative Court of Atlántico, Decongestion Subsection. In its place

 

SECOND: To declare the nullity of the Official Review Settlement 022412011000132 of 29 April 2011 by which the Settlement Management Division of the Barranquilla Regional Tax Directorate of the National Tax and Customs Directorate - DIAN modified the income tax return for the taxable year 2007 and imposed a penalty for inaccuracy.

 

By way of reestablishment of rights, declare the finality of the income tax return of CARBONES EL TESORO S.A. for the taxable year 2007.

 

2.         For the rest, to uphold the judgment under appeal.

 

3. Without an order for costs in the second instance.

 

4.         Recognise Dr. Mauricio Andrés Del Valle Chacón as a person authorised to act on behalf of the defendant, in accordance with the power of attorney contained in folio 451 of the file.

 

Copy, notify, communicate and return the file to the court of origin. Comply with

 

This order was adopted at the meeting of the day.

 

 

(Signed electronically)

MILTON CHAVES GARCÍA

President (Signed electronically)

STELLA JEANNETTE CARVAJAL BASTO

 

(Signed electronically)

MYRIAM STELLA GUTIÉRREZ ARGÜELLO (Signed electronically)

JULIO ROBERTO PIZA RODRÍGUEZ