The decision in SNF (Australia) Pty Ltd v. Commissioner of Taxation [2010] FCA 635 is good news for Australian businesses with international operations. It is the first Federal Court decision handed down on substantive transfer pricing issues.

However, the case highlights the Tax Office's hard-line approach to transfer pricing. The case also demonstrates the Tax Office's preference to use the statistics-driven "transactional net margin method" (TNMM) to establish prices between international related parties.

SNF's transfer pricing issue

SNF was importing products from related companies in France, China and the United States.

The Tax Office considered SNF was paying amounts that were greater than "arms length", and therefore reducing SNF's taxable income in Australia.

The Tax Office based its case around the argument that SNF had returned losses for each of the income years. This was supported by a TNMM analysis that found that taxpayers with a comparable business profile returned an average net margin of 1.7% for the relevant income years. On this basis, the Tax Office concluded that SNF was paying too much for the imported goods.

SNF argued that its overseas suppliers had made sales to independent parties that were comparable to the transactions made with SNF in Australia. SNF contended that these sales established a "comparable uncontrolled price" (CUP) that was equal to or that exceeded the price paid by SNF in Australia.

This demonstrated SNF was not paying too much for the goods it imported from related parties. SNF also explained that it sustained losses due to competition in the Australian market, excessive stock levels, below average sales per salesperson and poor management decisions.

Decision of the Federal Court

The Federal Court accepted SNF's arguments, and in particular, its use of the CUP method. Middleton J stated that where there are transactions that establish a comparable uncontrolled price, these should be preferred to relying on the TNMM. He stated:

"In my view undertaking the TNMM does not provide a proper basis for determining what consideration it was reasonable to expect that an independent purchaser would pay for the products. The TNMM does not address the issue as is required by Div 13 of the ITAA, as interpreted earlier in these reasons. I reject the use of applicability of the TNMM as contended for by the Commissioner in the context of applying Div 13."

His Honour also agreed with the comments of Downes J in Roche Products Pty Limited v Commissioner of Taxation [2008] AATA 639, who noted that the TNMM attributes all losses to transfer pricing, regardless of whether there were other circumstances that actually caused or contributed to those losses.

The taxpayer won - do you need to do anything?

The case highlights that the Tax Office continues to take issue with businesses recording losses where they have international related party transactions.

The Commissioner attacked the reliability of SNF's comparable transactions. Businesses should be careful that, when establishing a transfer price, their "comparables" are the same or similar to the related party transactions and that appropriate adjustments are made.

Businesses also need to ensure that there is sufficient documentation in place to protect their transfer pricing policies. This becomes more important in the wake of the slowdown of the global economy, in the context of falling sales volumes and falling profits. Maintaining this documentation is particularly relevant for transfer pricing matters, as there is no limitation period for the Tax Office to amend assessments.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.