The Queen v. Cameco Corporation: FCA Rejects Minister’s Attempt to Recharacterize Pursuant to Paragraphs 247(2)(b) and (d) of the Transfer Pricing Rules
On June 26, 2020, the Federal Court of Appeal dismissed the Minister of National Revenue’s appeal of the Tax Court of Canada’s decision that reversed approximately $500 million of adjustments the Minster made in aggregate to the income of Cameco Corporation (“Cameco”) for the 2003, 2005, and 2006 taxation years. The adjustments, which were made pursuant to the transfer pricing rules contained in section 247 of the Income Tax Act (the “Act”), or on the basis that the relevant transactions were a sham, essentially attributed profits to Cameco that were earned by a non-resident subsidiary from the sale of uranium several years after a global reorganization of the group businesses.
The Tax Court had concluded that the relevant transactions were not a sham, and that neither the conventional transfer pricing rules in paragraphs 247(2)(a) and (c) or the recharacterization rules in paragraphs 247(2)(b) and (d) applied to reprice or recharacterize the transactions.
For the most part, the Minister restricted its appeal in the Federal Court of Appeal to the Tax Court’s conclusion that the recharacterization branch of the transfer pricing rules – paragraphs 247(2)(b) and (d) of the Act – could not apply to allow the Minister to treat the subsidiary’s profits as income of the taxpayer. As discussed below, the Federal Court of Appeal dismissed the Minister’s appeal and, in so doing, emphasized that the recharacterization power under the transfer pricing rules requires a determination of whether any non-arm’s length parties would ever enter into the transaction or series of transactions that was entered into between the taxpayer and the non-resident, non-arm’s length entity.
Cameco’s worldwide group of companies was in the business of mining and selling uranium and providing uranium conversion and enrichment services to utility companies.
Although the reassessments were for the 2003 and later taxation years, the relevant transactions between the taxpayer and its non-resident subsidiary were part of a procurement and sales structure that the group companies put in place several years earlier to have its uranium trading business in a European subsidiary.
Back in 1999, Cameco led a consortium with some of its competitors to each purchase uranium that was formerly used by Russia in its nuclear arsenal from AO “Tecnhsnabexport” (“Tenex”), a Russian state-owned company. Cameco designated a Luxembourg subsidiary (“Luxco”) as its signatory for the supply agreement (the “Tenex Agreement”), which originally provided for options to purchase but was amended a few years later to require the consortium members to exercise their purchase options in exchange for reduced pricing. That same year, Luxco entered into a supply agreement with an arm’s length uranium enricher Urenco Limited to purchase uranium that Urenco obtained from Tenex (the “Urenco Agreement”). Luxco also began entering into agreements with Cameco to acquire its existing inventory of uranium and uncommitted future production other than uranium that was intended for the taxpayer’s Canadian customers.
In 1999, Cameco also formed a Swiss subsidiary (“Swissco”). In October 2002, Luxco transferred its business to Swissco pursuant to an asset purchase and transfer of liabilities agreement, which included the transfer to Swissco of Luxco’s rights to purchase uranium pursuant to the then existing supply agreements.
At all relevant times, Luxco and later Swissco generated revenues through uranium sales to the taxpayer and the taxpayer’s U.S. subsidiary. Due to a sharp increase in the world market price for uranium during the term of the supply agreements, Swissco earned substantial profits due to the spread between Swissco’s sale price to the taxpayer and the U.S. affiliate and Swissco’s cost for acquiring the uranium under its supply agreements, which had become favourable due to market factors. It was this profit that was earned by Swissco in 2003, 2005 and 2006 that the Minister sought to attribute to Cameco under the relevant reassessments.
The Tax Court of Canada
In the Tax Court, the Minister relied on three alternative bases to support the reassessments that included in Cameco’s income the non-resident subsidiary’s profits from uranium trading: (i) the relevant transactions were a sham and the non-resident subsidiary’s uranium sales should be treated as the taxpayer’s sales, (ii) the transactions were not transactions that arm’s length parties would enter into and the Minister was entitled to recharacterize them pursuant to paragraphs 247(2)(b) and (d) of the Act to treat the taxpayer as having made the profits that the non-resident subsidiary earned from the sale of uranium, and (iii) the pricing of the transactions between the taxpayer and the non-resident subsidiary should be adjusted pursuant to paragraphs 247(2)(a) and (c) of the Act to increase the taxpayer’s revenues from its sales to, and/or decrease its cost for any purchases from, the non-resident subsidiary. The Tax Court ruled that the income adjustments could not be supported on the basis of sham or either branch of the transfer pricing rules in subsection 247(2).
The Federal Court of Appeal
As noted above, in the Federal Court of Appeal, the Minister appealed the Tax Court decision largely on the basis that, in the Crown’s view, the Tax Court erred in failing to apply the recharacterization provisions in paragraphs 247(2)(b) and (d) of the Act to uphold the income adjustments under the reassessments. The Minister did not appeal the Tax Court’s finding that the relevant transactions were not a sham and that the terms and conditions of the actual transactions between the taxpayer and its non-arm’s length, non-resident affiliates under the group’s uranium procurement and sales structure reflected an arm’s length price. (The Minister also raised an alternative argument in the Federal Court of Appeal that the Tax Court Judge erred in his interpretation of paragraph 247(2)(a). However, the alternative argument was quickly reject by the Federal Court of Appeal, as it found that the alternative argument was rooted in the Tax Court’s factual findings and the Minister was not challenging any of the Tax Court determinations on the facts before the Federal Court of Appeal.)
Subsection 247(2) is the operative provision in the Act that allows the Minister to make income adjustments if a taxpayer transacts with a non-arm’s length, non-resident person and other requirements of that subsection are met. Paragraph 247(2)(b) permits an adjustment if the relevant transaction or series of transactions meets two requirements: (i) it would not have been entered into between persons dealing at arm’s length, and (ii) it can reasonably be considered not to have been entered into primarily for bona fide purposes other than to obtain a tax benefit. Where the two requirements of paragraph 247(2)(b) are met, paragraph 247(2)(d) allows the Minister to make adjustments to the taxpayer’s income on the basis of the amounts that would result from the transaction that would have been entered into by parties dealing at arm’s length.
The focus in the Federal Court of Appeal was the first requirement in paragraph 247(2)(b), namely, whether the transaction or series of transactions would have been entered into between parties dealing at arm’s length. The parties agreed that the taxpayer participated in three non-arm’s length transactions or series of transactions that were relevant to the paragraph 247(2)(b) analysis:
- The series of transactions that resulted in Luxco acquiring the right to be a purchaser under the Tenex Agreement and entering into the Tenex Agreement in 1999 (including Cameco’s designation of Luxco as the group company to sign the Tenex Agreement and Cameco’s guarantee of Luxco’s obligations under the Tenex Agreement).
- The series of transactions that resulted in Luxco acquiring from Cameco the right to be a purchaser under the Urenco Agreement and entering into the Urenco Agreement in 1999 (including Cameco’s designation of Luxco as the group company to sign the Urenco Agreement and Cameco’s guarantee of Luxco’s obligations under the Urenco Agreement).
- Intercompany sales of uranium between Cameco and Swissco.
The Minister urged the Federal Court of Appeal to interpret the first requirement in paragraph 247(2)(b) as one that examines the issue from the perspective of the taxpayer – i.e., would Cameco not agree to undertake the same transaction with an arm’s length party? If the Federal Court of Appeal accepted the Minister’s interpretation of the test, the Minister then wanted the Federal Court of Appeal to make a finding based on the evidence that, in the circumstances, Cameco would not have agreed to undertake the same transactions with a non-arm’s length party because doing so would allow a non-arm’s length party to obtain benefits that Cameco was seeking to retain within its group companies.
The Federal Court of Appeal undertook a textual, contextual and purposive analysis of paragraph 247(2)(b) to conclude that there was no support for the Minister’s interpretation of the recharacterization test. The Court concluded that the test is not whether Cameco would enter into the transactions with an arm’s length party, but whether any two (or more) persons dealing at arm’s length would have entered into the transactions, under any terms, and it is only when no arm’s length parties would enter into the transactions that the recharacterization rule can be applied.
The text of both paragraphs 247(2)(b) and (d) made it clear to the Court that those two provisions contemplate the standard of a transaction having the same terms and conditions as the taxpayer’s transaction but between two hypothetical arm’s length parties. This has the effect of facilitating an objective evaluation of the transaction at issue. By contrast, the Minister’s proposed approach of questioning whether the taxpayer would agree to undertake the same transaction with an arm’s length party is not supported by the text and inappropriately puts the focus on the taxpayer’s subjective motivations for participating in the transaction.
From a contextual and purposive perspective, the Federal Court of Appeal looked to the nature of the transfer pricing rules, Technical Notes issued by the Department of Finance when the transfer pricing rules were introduced, and certain statements from the OECD Transfer Pricing Guidelines. These materials confirmed that the transfer pricing provisions are directed at potentially adjusting the prices of the actual transactions between the taxpayer and non-arm’s length, non-resident person and that the recharacterization power is reserved for exceptional circumstances, such as situations where the transaction is akin to a sham or is structured in a way that makes it impossible for the tax authorities to identify an appropriate transfer price for the transaction. The Federal Court of Appeal saw this case as an attempt by the Minister to use paragraph 247(2)(b) as a tool to try to pierce the corporate veil of Swissco (i.e., to ignore Swissco) and to allow the Minister to do so would be inconsistent with the context and purpose of the transfer pricing rules, which generally takes the transactions as it finds them and examines the appropriateness of the amounts. The Court also observed that the relevant transactions in this case did not meet the standard of being an exceptional circumstance to justify the application of the recharacterization rule, since the Tax Court was able to come to a determination on an arm’s length price for each of those same transactions under the paragraph 247(2)(a) and (c) branch of the transfer pricing analysis in the lower court decision.
In the result, the Federal Court of Appeal dismissed the Minister’s appeal. This decision stands for the proposition that, when evaluating whether or not a transaction between the taxpayer and a non-arm’s length, non-resident person would have been entered into between persons dealing at arm’s length, the test calls for an objective assessment of what hypothetical arm’s length parties would do and not the subjective assessment of whether the taxpayer would have undertaken the same transaction with an arm’s length party. This case also confirms that the recharacterization power under paragraph 247(2)(b) and (b) is only engaged in exceptional circumstances and will likely only be available where it is impossible to establish a transfer price for the non-arm’s length transaction due to the way in which it was structured by the parties.
transfer pricing policy Federal Court of Appeal Income Tax Act