EXCLUSIVE

Aggressive tax avoidance tactics: Glencore Coal International Australia Pty Ltd.

Aggressive tax avoidance tactics: Glencore Coal International Australia Pty Ltd. Photo: Bloomberg

Australia's largest coalminer, Glencore, paid almost zero tax over the past three years, despite income of $15 billion, as it radically reduced its tax exposure by taking large, unnecessarily expensive loans from its associates overseas.

At up to 9 per cent, the interest rates on these $3.4 billion in loans were double what the company would have had to pay had it simply borrowed the money from the bank.

As it was claiming tax breaks in Australia on these inflated interest payments, the secretive Swiss-based multinational actually increased its lending to other related parties interest free. This may include its executives. Nobody from Glencore, which used to be called Xstrata, was available for comment despite repeated requests.

"The reality is that the whole of the Glencore Xstrata Group is now run as a series of business units controlled by one company".

"The reality is that the whole of the Glencore Xstrata Group is now run as a series of business units controlled by one company". Photo: Reuters

The aggressive tax avoidance tactics of Glencore Coal International Australia Pty Ltd have been identified in an independent analysis of the company's accounts for Fairfax Media by an expert in multinational financing.

Along with the blatant irregularities in its borrowing and lending, the study also found a hefty increase in Glencore's coal sales to related companies (up from 27 per cent to 46 per cent of total sales, with no explanation), indicative of transfer pricing - also known as profit-shifting - and an activity that appears to breach Section IVA of the Income Tax Assessment Act - the part that deals with schemes designed to comply technically with the law but whose ''dominant purpose'' is really to avoid tax.

''The reality is that the whole of the Glencore Xstrata Group is now run as a series of business units controlled by one company (Glencore Xstrata Plc, incorporated in the UK, listed on the London and other stock exchanges), with its registered office in Jersey (a tax haven) and its head office is in Baar (Switzerland),'' the report said.

''The truth is that Glencore Coal Investments Australia's operations in Australia are, because of the Group's business model, branch operations of the Swiss-domiciled parent entity, which uses the now dormant legal shell of an Australian body corporate in an attempt to hide the reality of its branch business in Australia.

''There also appears to be an increase in transfer pricing activity which may explain differences in revenues disclosed in the Australian accounts versus revenues reported as being from the same source in the group's consolidated accounts.''

The source of the analysis is a former multinational executive who is independent of Glencore and its commercial rivals, prefers to remain anonymous but is personally concerned at the rampant levels of tax evasion and tax avoidance by multinationals operating in Australia.

The focus on Glencore's tax is timely. Research from the Australia Institute this week identified $17.6 billion in government subsidies and assistance for the mining industry. As the third largest resources group in the country after BHP and Rio Tinto, Glencore is a beneficiary of this largesse.

The figures earlier in the story refer merely to the group's coal interests. Its nickel, copper and zinc assets are of a similar size to its coal operations and its presence in Queensland - where the Australia Institute's study highlighted $9.5 billion of taxpayer assistance - is enormous.

As is the trend among the new wave of digital giants, such as Google and Apple. Multinationals are increasingly likely to regard the payment of tax in Australia as an optional affair. The ramifications for the country's tax base are dire.

Glencore is an extreme case: founded as it is by US tax exile Marc Rich, controlled from a tax haven, and with a colourful history as a corporate maverick.

It is chaired by Swiss-based Ivan Glasenberg, who ranks No.5 on BRW's rich list announced this week, after lifting his wealth by $1.01 billion on the back of Glencore's rising share price.

In the past two years globally, this company has presided over 53 workplace deaths, a worse safety record than BHP and Rio Tinto.

Glencore takes over Xstrata

In 2012 the chief executive of Glencore Xstrata Group Plc, Ivan Glasenberg, announced the restructure of the company’s operations in Australia. Glencore, the commodity trader, was to take over Xstrata, the mining group in which it already had the controlling stake.

The deal would throw up annual synergies of 500 million pounds. Sydney would be the only remaining corporate office in this country. Several others would close. The coal business unit (GCIA) would share offices with Glencore/Xstrata’s metals business in Australia. There were savings to be had by doing away with duplication of activities in Australian businesses. There would be job losses and some functions replaced by offshore service providers. A significant proportion of savings should therefore be reflected in the results of Australian coal operations, you would think.

With the present head of operations in Australia – and one of GCIA’s two directors - Peter Freyberg responsible for rolling out the changes, he should be in a position to advise how much in savings was delivered to GCIA’s bottom line in 2013, and the forecast for full year 2014. He would also advise on the tax effects of the merger of Glencore and Xstrata.

Administration and distribution and selling expenses were both lower in 2013 than their 2012 equivalents, but tax expense also went down. This is partly because volumes were up so the increase in cost of goods sold more than offset the reported savings. Market prices were down in 2013 so sales revenue was down too, but it is difficult to isolate how revenue may have been affected by the massive increase in the percentage of sales struck with related parties.

Of total sales of $4.3 billion last year, almost $2 billion were made to related parties – to other Glencore entities that is. This related party business as a proportion of total sales was 46 per cent, up from 27 per cent in the prior year. It accounted for just 10 per cent of total sales in 2010. Here was a company whose sales to itself had multiplied by a factor of almost five in four years.

Meanwhile, the integration was afoot in top mnagement too. Marketing of Glencore’s Australian coal had been brought under the control of Tor Peterson, director of Coal/Coke Commodity Department, Glencore Plc. Peterson is an American and one of the six instant billionaires (awarded a five per cent stake in the new company listed on the UK bourse) to benefit from Glencore’s merger with Xstrata.

He is also based in Glencore’s head office in Baar, Switzerland, and reports to Ivan Glasenberg, CEO of the Glencore Xtrata Group . Peter Freyberg is Global head of Industrial for Coal and is based in the Gateway tower in Sydney.

Freyberg is responsible for the operations of the Coal Business Unit and he also reports to Ivan Glasenberg. The only other director now in Australia is Earl Melamed, also based in Sydney. His functional reporting line is now to Glencore’s CFO Steven Kalmin (awarded a 1 per cent stake in UK-listed Glencore Xstrata) who is based in Baar, Switzerland.

By now both Freyberg and Melamed are well established as reporting directly to their superiors at Glencore’s global headquarters. Their careers depend on it, so there is potential for conflict of interest in relation to their duties as directors of GCIA. They also now have cross-border authority delegations direct from their seniors in the “global company”.

Sydney has now been reduced to the status of a Business Unit (Glencore’s own term) which includes the Australian Coal Business Unit. Given the new authority structure, it seems the real directors of the Australian coal companies may include Glasenberg, Peterson and Kalmin. It might also extend to all members of the board of Glencore Xstrata (acting as shadow directors).

If this is the case, it potentially exposes them to obligations imposed by Australian legislation, on safety for instance. Any business culture, including workplace safety, emanates from the top. The board is apparently adapting some practices used in the Australian coal business which have achieved good results in the past. However, Glencore’s people come from a trading background. They are traders not miners. Peter Freyberg is the only local director in charge of operations. Malamed is a finance man.

The roles of these two as directors of an Australian body corporate appear to be now merely window dressing to comply with Corporations law. The fact that GCIA’s directors continue to be residents of this country is probably also an indication that the group convinces itself that its Australian incorporated subsidiaries are still operating as body corporates which satisfy the Australian tax residency test.

The reality is that the whole of the Glencore empire is now run as a series of business units controlled by one company which is incorporated and listed in the UK, registered in Jersey, and with its head office in Switzerland. Australia has become but a branch, or perhaps more accurately, it has become more of a branch than it already was.

Glencore Xstrata Plc’s own 2013 annual report describes itself as an integrated producer and marketer. In an operational and financial sense, this company is even more globalised than an oil giant the likes of Shell, but like Shell its corporate borders have been swept aside. Glencore Xstrata Plc no longer operates behind corporate veils or glass partitions between legal entities. The veils and glass partitions have become so transparent that local tax authorities such as the ATO are yet to see that they are gone.

The head company financial statements also provide a description of the group business model. Not one mention is made here of legal entities or even of working with the boards of those entities to achieve the objectives of the global management team. The head board pays little heed at all to the existence of legal boundaries or sovereign jurisdictions if they constitute a nuisance to its corporate objectives like tax avoidance.

Then there are the policy statements regarding “Principle of Risks and Uncertainties”. These fail to recognise any risk in the method by which this borderless business model has been implemented. Perhaps they see little risk of any near-term action by authorities such as the ATO or successive Australian governments to protect their Australian revenue.

There is certainly no hint of an impending threat. Finance Minister Mathias Cormann was busy sidestepping questions this week as to why Australia had not signed up to a multilateral anti-avoidance agreement.

Intra-group loans

The 2013 financial report for the Glencore mothership goes on to say that group debt funding is arranged centrally, with proceeds applied to marketing and industrial activities as needed. “Activities” are one step below Business Units in the hierarchy of the Glencore business model though neither is capable of borrowing. Only legal entities have the capacity to borrow.

The comment however illustrates that the process of allocating debt is directed from the top. No mention is made of the legal entities which own and operate those activities. Nor is there mention of working with directors of local entities to ensure funds provided are structured to best meet the commercial needs of each legal entity as appropriate.

There is no doubt that Glencore has ordered its affairs in this country with top-flight legal advice. Perhaps it is availed of the most expensive advice available. Indeed the world of top tax lawyers and chief financial officers is rarified and grey, even arcane. It is not so much about right and wrong but about what may be possibly established as arguably right or wrong after six weeks and millions of dollars in the Federal Court, and the risk and the price of avoiding such a contest.

And Glencore would rightfully contend that it is the duty of directors to minimise tax for shareholders. The question is, are they sailing too close to the wind, and should the ATO be at least seeming to do something in the face of aggressive avoidance?

In any case, debt funding of the parent entity, at 51 per cent, is slightly higher than that of GCIA. Unlike GCIA though, the parent does not borrow to provide non interest-bearing debt to entities outside its group. Nor does it hold such comparatively large amounts of cash and cash equivalents.

GCIA is paying 8.25 per cent to 9 per cent fixed rates on intra-group debt – though disclosure falls away in the most recent two years - when it could borrow from local banks at less than half that rate. It claims tax relief on its interest payments but lends a large proportion of that money to related parties interest-free - and also places large amounts on deposit at nominal floating rates.

In 2013, only 75 per cent of borrowings were deployed in the business, but in prior years the figure has been as low as 33 per cent. The amounts disclosed as interest in the income statement and cash-flow statement are normally nearly identical. However, in GCIA’s 2013 financial statements the cash-flow statement shows $130 million more has been supposedly paid as interest to related parties than was booked in the income statement. There was no explanation provided.

Product sales to related parties

GCIA does not break out sales volumes for the coal it produces in Australia. However there is some information available in the parent’s consolidated financial statements.

The parent also provides consolidated sales revenue for Australian produced coal. These figures exclude “bought in” coal (volumes acquired by the trading arm should explain most of that), but curiously the consolidated revenues disclosed by the parent are much higher than those disclosed by GCIA.

“Australian Group volumes should be coming from GCIA, so why is the Group’s consolidated revenue, reported as Australian sourced, roughly 50 per cent higher than that disclosed by GCIA? Does part of the explanation involve transfer pricing?” asks the analysis of the accounts prepared for Fairfax Media.

Prior to 2012, the local financial statements disclosed “Coal Sales Commissions paid to Glencore”. No disclosures were made in either the 2012 or 2013 financial statements prepared under the influence of Glencore in the UK and Switzerland (that is, following the decision that Glencore would merge with Xstrata).

In 2012, sales from what was then known as Xstrata Coal Investments Australia to related parties increased from 16 per cent of total sales to 27 per cent. In 2013 the renamed GCIA sales to related parties increased again to 46 per cent of total. Glencore and its subsidiaries were related in both years. “The increase seems to be a reflection of the level of influence that Tor Peterson (and possibly Ivan Glasenberg) has had on the mind and management of GCIA given the Group’s desire to grow the marketing side of the business,” says the report.

While there are spot price markets for coal, most mines initially require security of off-take commitments before mine development begins. Sales contracts with third parties therefore tend to be long term supply agreements, where prices (coal and freight) are periodically renegotiated. They can even include take-or-pay terms. “Given this phenomenon, one wonders how GCIA has made such large and rapid transition from third party to related party sales and why?”

“Were GCIA’s contract rights with third parties actually assigned by GCIA to GX’s trading company or has the borderless company overlooked the need for window dressing and merely transferred these “activities” for nil consideration? Presumably buyer’s consent requirements were covered. If the contracts were legally assigned, how was GCIA compensated? Is the compensation on arm’s length terms and where is this compensation disclosed in GCIA’s financial statements?” asks the Glencore research.

The answers to these critical questions cannot be found in the statutory disclosures.

Meanwhile, GCIA’s cost of goods sold (COGS) as a percentage of sales revenue has been trending up, which is not surprising (in light of falling coal prices), but if you look at the information provided in the parent company accounts about Australian volumes and average “market” prices - and also make some reasonable assumptions about the mix of volumes between thermal and semi-soft coal plus domestic volumes sold at lower prices and the timing of price changes - the calculations of expected sales revenue for 2013 (and the 2012 comparative data) is close to the revenue from Australian sources reported by the parent.

In contrast, the revenue reported by GCIA is roughly only two thirds of each of those amounts – that is, close to the figures reported in the consolidated accounts as Australian-sourced revenue.

While part of the explanation must relate to marketing activities and the group’s ability to identify and arbitrage gaps in the market, it is impossible to identify the extent to which Glencore has shifted margins offshore to the detriment of Australian taxpayers.

"Any shift ought to reflect the relevant risks taken by each related party. Traders generally try to push risk back to both the supplier and the end buyer so that their exposure is usually minimal. However, when the trader and the seller are part of the same group and the seller is in a high tax location and the trader is in a low tax one or a tax haven, pressure is usually brought to bear (by the trader with the support of the Parent) on the seller to accept non arms-length (lower) prices. Trader’s margins tend to be high, but do not reflect the risk they are taking. The increase in related party transactions would probably be worth the ATO having a closer look.”