In one fell swoop, Justice John Owen rebuked the CRA for its “fundamental misunderstanding of the concept of sham,”
restricted the scope of the CRA’s power under the Income Tax Act to recharacterize transfer pricing arrangements that are commercially rational, and refused to read the Organization for Economic Co-operation and Development’s Base Erosion and Profit Shifting Project into Canadian tax law absent the appropriate legislative action.
“This is a decision that respects contracts, respects transactions and recognizes that parents and their subsidiaries are separate
legal entities for tax purposes,” says Al Meghji, a partner in taxation at Osler, Hoskin & Harcourt LLP’s Toronto office, who worked with Joseph Steiner, a partner in litigation at Osler, in representing Cameco Corporation.
“The court has affirmed that principles that have informed Canadian tax law for decades are still a fundamental part of our system,” says Meghji.
Saskatoon-based Cameco Corporation is the world’s largest uranium producer. Cameco entered into long-term contracts to sell uranium to its Swiss subsidiary (Swiss Cameco) and also guaranteed the subsidiary’s purchases from third parties. Swiss Cameco then bought the uranium from Cameco Corporation and third parties at the contract prices and sold it at market levels, which had risen significantly in a short period of time.
Swiss Cameco kept all the revenue from the sales, meaning that the sales by the subsidiary to customers outside Canada were realized in Switzerland, a low-tax jurisdiction. Swiss Cameco, however, compensated its parent for administrative services rendered under a services agreement and for the third-party guarantees.
The CRA asserted that the arrangements were a sham; did not constitute arm’s length transactions and were therefore open to recharacterization by the Agency; and offended portions of the BEPS initiative.
Justice Owen showed little taste for the sham argument.
“I have heard no evidence to suggest that the written terms and conditions of the many contracts entered into by the Appellant, Cameco US and CESA/CEL between 1999 and the end of 2006 do not reflect the true intentions of the parties to those contracts, or that the contracts presented the resulting transactions in a manner different from what the parties knew the transactions to be,” said the ruling.
“Quite the contrary, I find as a fact that the Appellant, Cameco US and CESA/CEL entered into numerous contracts to create the very legal relationships described by those contracts. The arrangements created by the contracts were not a façade but were the legal foundation of the implementation of the Appellant’s tax plan.”
Steve Suarez, a partner at Borden Ladner Gervais LLP in Toronto, says the court “rejected what the CRA was proposing as not being even nearly close to a sham.”
“A sham requires intentional deceit, and what we had here, at most, was sloppy documentation that constituted the exception and not the rule,” he says. As Suarez points out, Cameco was a very large Canadian public company that had retained a “Big Four” audit firm.
“The message from the court was that if the CRA was going to assert a sham, it better have a whole lot more than what it had here,” he says. “And that’s a real victory for taxpayers, because the agency tends to throw stuff at the wall and see what sticks.”
Hill says, “Cameco only did what taxpayers do to minimize their global tax position, but CRA just didn’t like the end result, which they obviously found offensive.”
“Consequently, they weren’t focused on the transfer pricing issue and may have made a mistake by throwing everything but the kitchen sink at the case,” he adds.
Christopher Steeves, in Fasken Martineau Dumoulin LLP’s Toronto office, says the CRA’s “stance grabbed a lot of headlines, forcing Cameco to defend itself to the public, to the markets, and to its shareholders.”
“It’s a means of applying public pressure, and in this case, that’s exactly what the sham allegations did,” says Steeves.
A sham allegation, Suarez says, also has personal consequences.
“Maybe CRA and Justice Canada genuinely don’t understand how really serious it is for an officer or director to have a sham allegation thrown at them,” says Suarez.
“The CRA’s pending appeal to the Federal Court of Appeal drops the sham issue entirely,” says Suarez. But the recharacterization issue — in what Meghji calls the “first case to address and speak directly to these provisions in the Income Tax Act” — remains very much alive.
At first instance, Owen affirmed the significance of multinationals’ normal commercial practices in interpreting transfer pricing rules, including the recharacterization provisions.
“The court refused to read anything nefarious into a parent company taking the opportunity to set up a foreign entity instead of doing certain things themselves,” says Suarez.
“It is not a violation of transfer pricing when a Canadian entity doesn’t run each foreign subsidiary as if were a standalone, and outsourcing is perfectly OK if the pricing is right.” As Owen saw it, Cameco was only doing what the ITA permitted it to do.
“The purpose of the foreign affiliate regime is to allow Canadian multinationals to compete in international markets through foreign subsidiaries without attracting Canadian income tax,” he says.
“The tax plan conceived and implemented by the Appellant sought to take advantage of the foreign affiliate regime by having a contract with an arm’s length non-resident person (Tenex) executed by a controlled foreign affiliate of the Appellant.”
There was, therefore, “nothing exceptional, unusual or inappropriate” about Cameco’s arrangements.
“What the decision on this issue amounts to is a declaration that recharacterization will not apply where transactions are commercially rational,” says Steeves. “And I think that’s quite favourable to taxpayers.”
So is Owen’s ruling that BEPS forms no part of Canadian tax law.
“The court was clear that the ITA looks to the legal rights and obligations that contracts have created, not some sort of amorphous economic analysis as to who’s managing risk and performing value-adding activities,” says Suarez.
“BEPS may be great economics, but it’s not in our statute, and departing into that netherworld would leave us quite unsure of where we are.”
However that may be, the 700 pages of concluding arguments filed with the TCC in the $2.1 billion dispute could well mark a new era of complexity for corporate tax litigation in Canada.
In June 2016, the Liberal government increased the budget for the historically underfunded the CRA by about $90 million annually over the next five years. The CRA promptly claimed that its half-billion dollar bonanza would yield $2.6 billion in recovered taxes through increased targetting of tax havens, stepped-up audits of large foreign transfers of money, and more intense investigation of consultants selling shelters.
In pursuit of that objective, the agency hired 100 new auditors, increased its audits of high-risk taxpayers fivefold to 3,000 annually from 600, and ramped up its review of tax shelters tenfold to include 200 promoters a year.
The stakes also keep increasing. Some fifteen years ago, Canada’s largest tax disputes were in the $200 million range.
“Now we’re seeing billion-dollar cases docketed or in the works,” says Jacques Bernier, a partner in Baker & McKenzie LLP’s Toronto office.
“Cases involving at least $100 million are becoming routine enough so that four weeks of trial is not uncommon.”