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McKesson: Trial Judge Recuses Self From Two Remaining Issues in Transfer Pricing Case

In McKesson v. The Queen (2014 TCC 266), Justice Patrick Boyle recused himself from the two remaining issues with which he was seized in the transfer pricing case – costs and the content of the court’s public file (i.e., the determination of whether certain information may be confidential).

This unusual decision arises as a result of the content of the Appellant’s factum filed in the Federal Court of Appeal in the appeal of Justice Boyle’s trial decision in McKesson (see our posts on the Tax Court case here and the Federal Court of Appeal proceeding here and here).

In his recusal reasons, Justice Boyle wrote:

[4]        As detailed below, I have, of my own motion, decided that I am compelled to consider whether I need to recuse myself from the two remaining issues before this Court. A consideration of this issue is required because I became aware that the Appellant and Appellant’s counsel, together with its co-counsel in the Federal Court of Appeal in respect of the appeal of the trial decision, had made certain public written statements about me in its factum in the Federal Court of Appeal (the “Factum”) which, upon reflection, appear to me to clearly include:

(i)         allegations that I was untruthful and deceitful in my Reasons;

(ii)         clear untruths about me, what I said and heard in the course of the trial, as well as the existence of evidentiary foundations supporting what I wrote in my Reasons; and

(iii)        allegations of impartiality on my part.

[5]        This requires me to consider whether:

(i)         I believe that a reasonable person reading the Factum, my Reasons, and the relevant portions of the transcript would believe that the trial judge so strongly complained of by McKesson Canada might not be able to remain impartial in his consideration of costs and confidential information;

(ii)         I believe I can impartially consider, weigh and decide the costs and confidential information issues before me; and

(iii)        whether the public challenge of my impartiality expressed by McKesson Canada and its co-counsel in the Factum is itself sufficient to warrant recusing myself at this stage.

 …

[133]     I view these as public allegations by a party to the costs and confidential information matters remaining before this Court that, regardless of the merits of their reasoning or their thoughts, I am unable to decide the remaining matters impartially. I believe that a reasonable person reading only these phrases from the Factum, without reviewing my Reasons or the trial Transcript, would believe that such strong complaints by McKesson Canada and its counsel may give rise to a serious doubt that I will be seen to be able to dispose of the two remaining issues and discharge my duties on an impartial basis.

[136]     For the Reasons identified above, I have decided I have to recuse myself from the remaining costs and confidential information issues in McKesson Canada’s proceeding in this Court.

[137]     It may be that some of the perceived untruths about the trial judge described above under heading II might individually not warrant recusal, and may be within an appellate advocate’s licence to overstate through the use of absolutes like ‘never’, ‘only’ and ‘any’.

[138]     However, I am satisfied that a reasonable fair-minded Canadian, informed and aware of all the issues addressed above, would entertain doubt that I could remain able to reach impartial decisions. I believe that such a reasonable fair-minded and informed person, viewing this realistically and practically would, after appropriate reflection, be left with a reasoned suspicion or apprehension of bias, actual or perceived. Canadians should rightly expect their trial judges to have broad shoulders and thick skins when a losing party appeals their decision, but I do not believe Canadians think that should extend to accusations of dishonesty by the judge, nor to untruths about the judge. Trial judges should not have to defend their honour and integrity from such inappropriate attacks. English is a very rich language; the Appellant and its counsel could have forcefully advanced their chosen grounds for appeal without the use of unqualified extreme statements which attack the personal or professional integrity of the trial judge.

[139]     For these reasons, I will be advising my Chief Justice that I am recusing myself from completing the McKesson Canada proceeding in the Tax Court. This extends to the consideration and disposition of the costs submissions of the parties in this case, as well as to the 2010 confidential information order of Justice Hogan in this case and its proper final implementation by the Tax Court and its Registry.

No date has been set for the hearing of the main matter by the Federal Court of Appeal.

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McKesson: Trial Judge Recuses Self From Two Remaining Issues in Transfer Pricing Case

Communications With Experts: Moore v. Getahun and the Advocates’ Society Report

An expert does not draft his/her report in a vacuum. Communication with counsel is required. Ultimately, an expert must provide independent and objective evidence at a hearing. So the question arises as to what amount of communication is appropriate between counsel and the expert during the drafting stage. This was an issue considered by the Ontario Superior Court of Justice in Moore v. Getahun (2014 ONSC 237).

In Moore, the plaintiff suffered a wrist injury in a motorcycle accident, and claimed medical negligence against the treating doctor. The defendants called an expert to testify on the medical treatment of the plaintiff following the accident. During the preparation of the expert’s report, the expert and defence counsel had a 90-minute conference call during which the draft report was discussed.

In 2010, sections 4.1 and 53.03 of the Ontario Rules of Civil Procedure were amended to (among other things) codify the expert’s duty to the court and to require the execution and filing of an expert’s certificate acknowledging this duty.

These amendments are similar to the recent amendments to the Tax Court of Canada Rules (General Procedure): Section 145 (“Expert Witnesses”), Form 145(2) (“Certificate Concerning Code of Conduct for Expert Witnesses”) and Schedule III (“Code of Conduct for Expert Witnesses”).

In Moore, the court considered the Ontario Rules of Civil Procedure amendments and concluded:

Whether it is appropriate for counsel to review experts’ draft reports

[519]      Defence counsel reviewed Dr. Taylor’s draft report during a one-and-a-half-hour telephone conference call.

[520]      The purpose of Rule 53.03 of the Rules of Civil Procedure is to ensure the independence and integrity of the expert witness. The expert’s primary duty is to the court. In light of this change in the role of the expert witness under the new rule, I conclude that counsel’s practice of reviewing draft reports should stop. There should be full disclosure in writing of any changes to an expert’s final report as a result of counsel’s corrections, suggestions, or clarifications, to ensure transparency in the process and to ensure that the expert witness is neutral.

(See also the court’s discussion of this issue at paragraphs 47-52 of the Moore decision.)

Not surprisingly, the Ontario court’s narrow interpretation of Rule 53.03 attracted the attention of litigators across the country.

In response, the Advocates’ Society has drafted a position paper (and a set of nine principles) regarding communications with expert witnesses. The Advocates’ Society has taken the position that the view expressed by the court in Moore (i.e., that the amendments constitute a change in the role of expert witnesses) is mistaken. The case law prior to Moore on the subject of experts’ testimony had established that experts must testify independently and objectively. Further, the amendments were likely responding to the specific problem of “hired guns” or “opinions for sale”, and thus codified the expert’s duty and imposed the certificate requirement so that testifying experts clearly understand their duty to the court.

The report also notes the problems and unintended consequences of the court’s ruling in Moore – namely, that the ruling fails to recognize the “important and entirely appropriate role” of advocates in ensuring that expert evidence is presented in a cogent, succinct and well-organized fashion that will assist the trier of fact; further, a “one-size-fits-all” approach to communications with experts is discordant with the realities of modern litigation.

Given the similar language in the Tax Court’s rules regarding expert evidence, Moore could have an impact on the manner in which expert reports are to be prepared for a Tax Court proceeding.

Moore has been appealed to the Ontario Court of Appeal.

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Communications With Experts: Moore v. Getahun and the Advocates’ Society Report

Marzen: Tax Court Upholds Transfer Pricing Adjustments

The decision of the Tax Court of Canada in Marzen Artistic Aluminum Ltd. v. The Queen (2014 TCC 194) is the latest addition to a growing body of Canadian judgments on the application of the transfer pricing rules in section 247 of the Income Tax Act (Canada) (the “Act”).

In a lengthy set of reasons, the Tax Court upheld all but a fraction of the CRA’s reassessment of the taxpayer, such reassessments having disallowed the deduction of approximately $7.1M of fees paid by the Canadian taxpayer to its Barbados subsidiary. The Court also upheld the imposition of a penalty under subsection 247(3) of the Act.

The taxpayer was in the business of designing, manufacturing and selling aluminum and vinyl windows. Beginning in 1999, the taxpayer implemented what the Court referred to as the “Barbados Structure”. Under this structure, the taxpayer entered into a “Marketing and Sales Services Agreement” (“MSSA”) pursuant to which the taxpayer’s Barbados subsidiary (“SII”) would provide certain marketing and other sales-related services to the taxpayer in respect of certain jurisdictions, notably the U.S. The fee was calculated as the greater of $100,000 or 25% of sales originated by SII. In total, amounts paid by the taxpayer to SII under the MSSA and related agreements was $4.1M for 2000 and $7.8M for 2001. These amounts were deducted by the taxpayer in computing its Canadian income. SII paid nominal income tax in Barbados on this income. SII then declared dividends to the taxpayer, which were generally received tax-free as dividends out of exempt surplus, pursuant to the deduction in section 113 of the Act.

The Canada Revenue Agency reassessed under section 247 of the Act to disallow a portion of the deduction and imposed a penalty.

In considering the transfer pricing rules in section 247, the Court stated the issues were as follows: (i) whether the terms and conditions imposed in respect of the MSSA differed from what would have been agreed to by persons dealing at arm’s-length, (ii) if so, what adjustments should be made to the quantum of the fees paid under the MSSA so that it was equivalent to the price that would have been paid had the parties been at arm’s-length, and (iii) whether the taxpayer was liable to penalty under subsection 247(3) for the 2001 tax year.

The Court determined that the terms and conditions of the arrangement were not consistent with what arm’s-length parties would have agreed to. In the Court’s view, SII provided few or no marketing and sales services (such services having been subcontracted to another of the taxpayer’s foreign subsidiaries). Further, the Barbados Structure was purely tax-motivated, allowing deductible fees to be repatriated as tax-free exempt surplus dividends. These “attractive advantages” in the Court’s view, would not be available to arm’s-length parties. In the Court’s opinion, applying the “comparable uncontrolled price” method of determining the transfer price, as argued by the Crown, provided the most accurate arm’s-length price.

In this case, the taxpayer was entitled to deduct certain of the fees paid to SII plus $32,500 in each year for corporate and directorship services provided to SII by its director. In the result, the vast majority of the fees paid by the taxpayer to SII were denied and added back into the taxpayer’s income. The Court also found that the transfer pricing penalty was applicable, as the taxpayer failed to make reasonable efforts to determine and use arm’s-length transfer prices in 2001 (the 2000 adjustment did not meet the $5 million threshold for imposing a penalty under subsection 247(3) of the Act).

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Marzen: Tax Court Upholds Transfer Pricing Adjustments

Morris Meadows: Judge Declines Job Offer and Workers Were Employees

In Morris Meadows Country Holidays and Seminars Ltd. v. M.N.R. (2014 TCC 191), the Tax Court considered whether certain hospitality workers were employees or independent contractors for the purposes of the Employment Insurance Act and the Canada Pension Plan.

Morris Meadows offered meeting facilities, sleeping facilities and dining facilities. In doing so it hired workers, as required, to perform certain duties such as cleaning, gardening, maintenance, cooking and serving food.

The CRA classified the workers as employees, and assessed the taxpayer for additional CPP contributions and EI premiums. The taxpayer appealed on the basis that the workers were (i) independent contractors or (ii) casual employees not employed for the purposes of Morris Meadows’ business.

In respect of the evidence, the Tax Court made this comment on a witness’s testimony:

[3] Mr. Morris, the moving force behind Morris Meadows, was the only witness for the Appellant. He was refreshingly forthright in his testimony to the point of offering me work as a cook at Morris Meadows. I declined the offer.

On the issue of the classification of the workers, the Tax Court considered the applicable tests in 671122 Ontario Ltd. v Sagaz Industries Canada Inc. (2001 SCC 59) and 1392644 Ontario Inc. o/a Connor Homes v Minister of National Revenue (2013 FCA 85) (see our previous post on Connor Homes).

In the present case, the Court held there was no written agreement expressing intent and thus no mutual intent (as per the Connor Homes analysis). The Court then pursued the traditional Sagaz/Wiebe Door analysis to determine whether the workers performed their services in business on their own account. On this point, the Court concluded that all but one of the workers were employees.

On the issue of whether the workers were engaged in employment of a casual nature other than for the purpose of the employer’s trade or business (see subsection 5(2) of the Employment Insurance Act and subsection 6(2) of the Canada Pension Plan), the Tax Court cited the Federal Court of Appeal’s decision in Roussy v Minister of National Revenue ([1992] F.C.J. No. 913), which stated:

[7] … the duration of the time a person works is not conclusive in categorizing employment as casual; the length of time may be a factor to be considered, but a more important aspect is whether the employment is “ephemeral” or “transitory” or, if you will, unpredictable and unreliable. It must be impossible to determine its regularity. In other words, if someone is spasmodically called upon once in a while to do a bit of work for an indeterminate time, that may be considered to be casual work. If, however, someone is hired to work specified hours for a definite period or on a particular project until it is completed, this is not casual, even if the period is a short one.

The Tax Court held that the workers were engaged in unpredictable “part-time” work rather than casual employment. Further, the Court noted that Morris Meadows advertised its dining facilities (available for business meetings or weddings), hired workers to serve the food, and profited from such commerce. In the Court’s view, Morris Meadows was in a business to which the employment related, and the casual employment was for the purpose of Morris Meadows’ business. The Court held the workers were not engaged in casual employment for the purposes of the EI Act and the CPP.

The Court allowed the appeals only in respect of the one worker who was an independent contractor.

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Morris Meadows: Judge Declines Job Offer and Workers Were Employees

Tax Court Upholds Penalties Imposed for False Statements

In Morton v. The Queen (2014 TCC 72), the Tax Court of Canada upheld penalties imposed by the Minister of National Revenue (the “Minister”) under subsection 163(2) of the Income Tax Act (Canada) (the “Act””) despite novel arguments by the taxpayer to the contrary.

In this case, the taxpayer originally filed his income tax returns for the relevant years and paid taxes on the reported income.  After the normal reassessment periods expired, utilizing the taxpayer “fairness” provisions in subsection 152(4.2) of the Act, the taxpayer filed T1 Adjustment Requests containing false information in the form of additional income and expenses that would place the taxpayer in a tax loss position in each year. If the Minister had accepted the adjustments, the taxpayer would have received refunds in excess of $202,000.

However, the taxpayer’s plan did not work out as expected. The Minister not only denied the T1 Adjustment Requests, but also levied penalties in excess of $75,000 pursuant to subsection 163(2) of the Act.  These penalties were the subject of the appeal to the Tax Court.

During testimony, the taxpayer admitted to supplying false information in the T1 Adjustment Requests intentionally, knowingly and without reliance on another person. In defense of his actions the taxpayer claimed that he was under stress due to financial difficulties, a marriage breakdown and loss of access to his business books and records. At trial, the Tax Court found as a matter of fact that the misrepresentations were made fraudulently and rejected the taxpayer’s defense since no documentary evidence could be supplied in respect of the alleged stress.

The remainder of Justice Bocock’s decision contained a thorough analysis of the provisions of subsection 152(4.2) of the Act in the context of levying a penalty pursuant to subsection 163(2) of the Act. Justice Bocock provided the following insights:

  • Even where information is supplied to the Minister outside of the context of filing a return for a particular taxation year, if the taxpayer makes fraudulent misrepresentations sufficient to assess under subparagraph 152(4)(a)(i) of the Act, for instance in requesting that the Minister reopen the taxation year under subsection 152(4.2) of the Act, the Minister may assess penalties for a statute barred year.
  • The penalty provisions in subsection 163(2) of the Act apply even in the absence of the Minister issuing a refund or reassessment that relies upon the incorrect information. The Tax Court found it would be absurd to require the Minister to rely on the fraudulent misrepresentations before levying a penalty; and
  • The meaning of the words “return”, “form”, “certificate”, “statement” and “answer” in subsection 163(2) of the Act should be defined broadly to include documents such as the T1 Adjustment Request. Limiting the application of penalties to prescribed returns and forms ignores the plain text, context and purpose of the Act and would lead to illogical results.

It should come as no surprise that the Tax Court upheld the penalties. Nevertheless, the decision provides an enjoyable and thought provoking analysis of the provisions contained in subsections 152(4.2) and 163(2) of the Act.

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Tax Court Upholds Penalties Imposed for False Statements

Tax Court Rules Amounts Paid Out of Ponzi Scheme Not Taxable

The tax treatment of amounts paid out of failed Ponzi schemes is once again in the news. In Roszko v. The Queen (2014 TCC 59), the Tax Court of Canada allowed the taxpayer’s appeal and held that amounts paid out of a fraudulent scheme were not taxable as interest income.

Roszko follows two recent decision on this issue. In Johnson v. The Queen (2012 FCA 253), the Federal Court of Appeal held that amounts paid out of a Ponzi scheme in excess of the duped taxpayer’s original investment were taxable as income. And in Orman v. Marnat (2012 ONSC 549), the Ontario Superior Court of Justice held that amounts received out of a Ponzi scheme were not investment income (see also this article on the court’s consideration of whether it could rectify certain corporate documents of two companies that had invested in the fraud).

In Roszko, the taxpayer was induced to invest in TransCap Corporation, which was allegedly trading commodities, on the basis that the investment would return 18% to 22% annually. In 2006, the taxpayer made an initial investment of $100,000, which was structured as a loan.  In 2006 and 2007, the taxpayer loaned a total of $800,000 to TransCap. From 2006 to 2009, TransCap paid to the taxpayer a total of $408,000 as follows: $22,500 in 2006, $81,000 in 2007, $156,000 in 2008, and $148,500 in 2009.

In December 2009, the taxpayer became suspicious of the activities of TransCap, which lead to an investigation by the Alberta Securities Commission, which eventually determined that TransCap had perpetrated a fraud on investors.

The issue before the Tax Court was whether the $156,000 received by the taxpayer in 2008 was interest income under paragraph 12(1)(c) of the Income Tax Act.

The Tax Court cited the Federal Court of Appeal’s decision in Johnson for the proposition that there can indeed be a source of income in a Ponzi scheme. However, the Tax Court held that the facts in the Johnson case – wherein the Federal Court of Appeal held that the $1.3 million received by the taxpayer out of the Ponzi scheme was taxable – were different from the facts of the present case. Specifically, in Roszko, the taxpayer’s agreement with TransCap stipulated how the funds were to be invested, the taxpayer was lead to believe the funds would be so invested, the funds were not invested in that manner (i.e., the taxpayer’s contractual rights were not respected), it was agreed that TransCap perpetrated a fraud, and the fraud was described in a decision of the Alberta Securities Commission.

The Tax Court held that the facts of Roszko were more like those in the case of Hammill v. The Queen, in which the Federal Court of Appeal held that a fraudulent scheme from beginning to end cannot give rise to a source of income from the victim’s point of view and hence cannot be considered as a business under any definition.

The Tax Court noted that, in Roszko, the Crown had argued that the income was property income in the form of interest. However, the Tax Court held the amount received by the taxpayer was not income from property, but rather a return of capital to the extent of the original amounts invested. The Tax Court noted that excess returns might be considered income. The Tax Court allowed the appeal .

This is a victory for the taxpayer for the 2008 tax year, but the unanswered question that looms in the background is how the taxpayer’s overall loss ($392,000) on the Ponzi scheme investment will be treated for tax purposes.

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Tax Court Rules Amounts Paid Out of Ponzi Scheme Not Taxable

Tax Court Interprets “Ownership” For Purposes Of GST/HST New Housing Rebate

In Rochefort v. The Queen (2014 TCC 34), the Tax Court of Canada provided clarity on the definition of “ownership” for the purposes of the GST/HST New Housing Rebate. Justice Campbell Miller held that “ownership” in subparagraph 254(2)(e) of the Excise Tax Act (the “ETA”) does not necessarily mean holding legal title but denotes a more expansive view of ownership.

In the case, the recently-married Mr. and Mrs. Rochefort decided to buy a new home. Unfortunately, shortly before the closing, Mr. Rochefort was advised by his bank that, due to his failure to sell his current property and his wife’s poor credit rating, the couple no longer qualified for a mortgage. Having already paid $20,000 in deposits, the couple chose to close the deal, and so they enlisted Mr. Fontaine, the nephew of Mr. Rochefort, to act as a co-signor on a mortgage from another bank.

Mr. Fontaine testified that he was prepared to help his uncle by signing whatever documents were required. Mr. Fontaine in fact signed a Fixed Rate Mortgage form, as well as a Direction re: Title, authorizing the lawyers to transfer the deed to Mr. Rochefort and Mr. Fontaine as joint tenants.  It was evident from Mr. Fontaine’s testimony that he was not entirely clear as to what he had signed, and he had no intention of ever living in, or receiving a benefit from, the property. Rather, it was clear that the new home was for the sole benefit of Mr. and Mrs. Rochefort, and Mr. Fontaine was merely assisting a family member by doing a favour.

Mr. Rochefort signed the new housing rebate in 2010 and, as a result, the developer was credited with $27,278. The Minister of National Revenue reassessed Mr. Rochefort on the basis that he was not entitled to the rebate as the definition of “ownership” in subparagraph 254(2)(e) of the ETA had not been satisfied.

The Minister argued that, under subparagraph 254(2)(e), “ownership” must be transferred to a “particular individual” (the Court noted that, where there is more than one purchaser, subsection 262(3) of the ETA makes it clear that “particular individual” refers to both purchasers). Ownership had not been transferred to Mr. and Mrs. Rochefort but had been transferred to Mr. Rochefort and Mr. Fontaine. Therefore, in the Minister’s view, this requirement had not been met.

The Tax Court disagreed. Mr. and Mrs. Rochefort were the “particular individuals” who signed the Agreement of Purchase and Sale and, thus, Mr. Fontaine was not a “particular individual” for the purposes of the ETA. The requirements in subsection 254(2) of the ETA had been met by Mr. Rochefort. The only question was whether the other “particular individual” (i.e., Mrs. Rochefort)  had ownership transferred to her as required by subparagraph 254(2)(e).

The Minister argued that “ownership” meant title to the property, and suggested that definition of owner in the Ontario Land Titles Act (i.e., an owner in fee simple) should apply for the purposes of the ETA. However, the Tax Court noted that, if the drafters of the ETA had intended ownership to mean title, they could have said as much in the ETA. The Tax Court held that “ownership” for purposes of the GST/HST New Housing Rebate must be explored in a “textual, contextual and purposive manner for a fuller meaning than simply title.”

The Court interpreted subparagraph 254(2)(e) as a timing condition – ownership happens after substantial completion. This view is consistent with the views expressed by the CRA in GST/HST Memorandum 19.3.1 “Rebate for Builder-Built Unit (Land Purchased)” (July 1998, as amended in 2002 and 2005).

The Tax Court viewed Mr. and Mrs. Rochefort as the individuals the rebate was intended to benefit. They were the buyers of the property, the individuals liable for the GST, and they took possession of the property after its substantial completion in order to reside in it as their primary residence. Moreover, Mrs. Rochefort had acquired sufficient rights to constitute ownership thereby satisfying the requirements in 254(2)(e): she had signed the Agreement of Purchase and Sale to become an owner, she had made the necessary deposits, she acted as an owner in making decisions to amend the Agreement of Purchase and Sale, she was liable for the GST, she took possession of the property with her husband, and had acted in every way as an owner by enjoying the property.

The Tax Court concluded that Mrs. Rochefort was a beneficial owner of the property and that Mr. Fontaine had agreed to hold title solely for the benefit of the Rocheforts. As a trustee, Mr. Fontaine was required to convey title to the Rocheforts on demand or to any third party at their request. “Ownership” of the property had been transferred to Mrs. Rochefort.

Accordingly, the taxpayer’s appeal was allowed and Mr. Rochefort was entitled to the GST/HST New Housing Rebate under subsection 254(2) of the ETA.

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Tax Court Interprets “Ownership” For Purposes Of GST/HST New Housing Rebate

Taxable in Canada? Not a Black and White Situation

In Black v. The Queen (2014 TCC 12), Lord Conrad Black argued that he was not subject to tax in Canada on certain income and taxable benefits. Both Lord Black and the CRA agreed that he was a resident of both Canada and the U.K. in 2002, and that under Article 4(2)(a) of The Canada-United Kingdom Income Tax Convention (the “Convention”) he was a “deemed” resident of the U.K. for the purposes of the Convention.

Lord Black had filed his Canadian tax return for 2002 on the basis that some $800,000 of income from the duties of offices or employments performed by him in Canada was taxable in Canada. However, Lord Black did not include certain other remuneration and benefits totalling $5.1 million in his Canadian income, including some $2.8 million of income from the duties of offices or employments performed outside Canada, $326,177 of taxable dividends, $365,564 of shareholder benefits, and $1.3 million of benefits arising as a result of his use of an airplane owned by Hollinger International Inc.

At the Tax Court hearing, Lord Black argued that by virtue of his “deemed” U.K. residency these other amounts were not taxable in Canada. As it happens, since he was not domiciled in the U.K., Lord Black was subject to tax in the U.K. only on the portion of his non-U.K. source income that was remitted to or received in the U.K.

The CRA alleged that, notwithstanding Lord Black being deemed a U.K. resident for the purposes of the Convention, he was subject to Canadian tax on income and benefits that were not covered by the Convention.

The Tax Court dismissed Lord Black’s appeal and held that he could be a deemed resident of the U.K. for purposes of the Convention and also be a resident of Canada for purposes of the Canadian Income Tax Act. Chief Justice Rip noted that the arguments presented on behalf of Lord Black had no supporting authority and were contrary to the liberal and purposive approach that must be taken when interpreting a tax treaty.

In applying a liberal and purposive approach to Article 4(2) of the Convention, the Tax Court noted that the tie-breaker rule at issue merely provided a preference to the taxing authority of the U.K., but did not extinguish Canada’s claim to tax. Lord Black’s argument that there was an inconsistency between the Income Tax Act and the Convention was incorrect as it did not take into account the role of Article 4 in allocating taxing jurisdiction to avoid double taxation. As such, Lord Black was unable to point to any provision in the Convention that would result in double taxation if he were resident in Canada.

Lord Black also sought to rely on Article 27(2) of the Convention, which addressed the tax treatment of non-domiciled residents of the U.K. who are required to pay tax on foreign income only when received in the U.K. Article 27(2) essentially provides that where a person is subject to income tax in the U.K., and the Convention provides for tax relief in Canada, the tax relief will only be in respect of the amount of income that is actually taxed in the U.K. Thus, Lord Black argued that the Minister could not assess his non-Canadian income because none of the income was remitted or received in the U.K., and so there was no tax from which he could have been relieved in Canada.

Since the Tax Court had already determined that Lord Black was a resident of Canada for purposes of the Income Tax Act, the argument based on Article 27(2) could not succeed. The Tax Court agreed with the CRA that the Convention allocates the right to tax between Canada and the U.K. on an item-by-item basis, and any items not covered by the Convention were thus subject to tax on the basis of Lord Black’s residence in Canada. As a resident of Canada, Lord Black was subject to tax on his worldwide income, including income earned in the U.S.

We note that both parties agreed that subsection 250(5) of the Act, which deals with the deemed non-residency of a Canadian where the individual is deemed to be a resident in another country by virtue of a tax treaty, did not apply. This was because of the “grandfathered” application of subsection 250(5) (i.e., the provision is not applicable to a Canadian resident individual who was (i) a resident of two countries and (ii) deemed resident of one of those countries under a tax treaty at the time the subsection became effective in 1999). If subsection 250(5) had applied, then Lord Black would not be a resident of Canada for the purposes of the Income Tax Act.

On January 22, 2014, Lord Black filed his appeal in the Federal Court of Appeal (File No. A-70-14).

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Taxable in Canada? Not a Black and White Situation

The McKesson Case – A Holiday Gift from Justice Boyle of the Tax Court of Canada: Ask and You Shall Receive(able) – Canada’s Latest Transfer Pricing Decision

On Friday, December 20th, the Tax Court of Canada released the long-awaited and lengthy decision of Justice Patrick Boyle in McKesson Canada Corporation v. The Queena case involving transfer pricing adjustments under section 247 of the Income Tax Act (the “Act”) and the limitation period in Article 9(3) of the Canada-Luxembourg Tax Convention.

McKesson Canada is the principal Canadian operating company in the McKesson Group. The core business of the McKesson Group and of McKesson Canada is the wholesale distribution of “over the counter” and prescription pharmaceutical medicine products. Effective December 16, 2002 McKesson Canada and its Luxembourg parent company, MIH, entered into a Receivables Sales Agreement (the “RSA”) and a Servicing Agreement. Under the RSA, MIH agreed to purchase all of McKesson Canada’s eligible receivables as of that date (about $460,000,000) and committed to purchase all eligible receivables daily as they arose for the next five years unless earlier terminated as provided for in the RSA and subject to a $900,000,000 cap. The price to be paid for the receivables was at a 2.206% discount to their face amount (if one takes into account that historically receivables were paid on average within 30 days, this rate equates to an annual financing rate of approximately 27%). The Canada Revenue Agency reassessed McKesson Canada’s 2003 taxation year on the basis that if the RSA had been made between arm’s length parties the Discount Rate would have been 1.013% and made a transfer pricing adjustment under section 247 of the Act of $26,610,000 (the taxation year of McKesson Canada under appeal ended March 29, 2003 and was approximately three and a half months long – the annualized transfer pricing adjustment was therefore approximately $80,000,000).

The Tax Court trial lasted 32 days over a period of five months from October, 2011 to February, 2012 and following the Supreme Court of Canada’s decision in Canada v. GlaxoSmithKline Inc. in October, 2012, both parties made further written submissions.

Under the RSA, eligible receivables were trade receivables owing by arm’s length customers not in default and whose receivables would not represent in the aggregate more than 2% of McKesson Canada’s then outstanding receivable pool. However, the 2% concentration limit on eligibility did not apply to McKesson Canada’s largest customers who accounted for about one-third of the sales. MIH had the right to put non-performing receivables back to McKesson Canada for a price equal to 75% of the face amount to be later re-adjusted to the amount actually collected and MIH did not otherwise have recourse against McKesson Canada for unpaid purchased receivables. The receivables under the RSA were expected to be collected in a short period of time (historically, payment was made by customers in 30 days) and the historical bad debt experience was .043%.

Under the Servicing Agreement, McKesson Canada agreed to service the accounts receivable and received a servicing fee of $9,600,000 annually regardless of the amount outstanding. The amount paid under the Servicing Agreement was not challenged by the CRA.

The amount payable for a purchased receivable under the RSA was determined by multiplying the face amount of the receivable by one minus the Discount Rate. The Discount Rate was defined to be the sum of (a) the Yield Rate which was equal to the 30 day Canadian dollar banker’s acceptance (BA) rate or the Canadian dealer offered rate (CDOR) on the first business day of the relevant settlement plus (b) the Loss Discount which was intended to reflect the credit risk of the McKesson Canada customers whose receivables were covered by the RSA and was set at 0.23 for the year under appeal. For the remaining term of the RSA commencing January 1, 2004, the Loss Discount was to be recalculated as often as MIH considered necessary based on the credit risk of certain customers plus (c) the Discount Spread which was set at the fixed rate of 1.7305% and related to the risk that (i) McKesson Canada’s credit worthiness deteriorated significantly and receivable debtors might set off their rebate entitlements in such event, (ii) the risk that McKesson Canada’s customers might increase their take-up of available prompt payment discounts, (iii) the risk that MIH might decide to appoint a new service provider who would require a greater servicing fee, and (iv) the need for the Discount Rate to fully cover MIH’s cost of funds.

Toronto Dominion Securities Inc. (“TDSI”) was retained by counsel for McKesson Canada to provide advice on the arm’s lengths aspects of certain terms and conditions of the RSA and certain components of the Discount Rate calculation at the time the RSA was entered into. The TDSI reports were relied on by McKesson Canada as contemporaneous documentation and, therefore, a transfer pricing penalty under subsection 247(3) of the Act was not assessed by the CRA (had there been no contemporaneous documentation, McKesson Canada would have been automatically subject to a penalty of 10% of the transfer pricing adjustment). Interestingly, Justice Boyle states in a footnote that the CRA may need to review its threshold criteria in respect of contemporaneous documentation under subsection 247(4) of the Act and that he would not “have expected last minute, rushed, not fully informed, paid advocacy that was not made available to the Canadian taxpayer and not read by its parent would satisfy the contemporaneous documentation requirements.”

Justice Boyle stated that the CRA reassessment was made under paragraphs 247(2)(a) and (c) of the Act and that the task of the Court was to determine whether the terms and conditions of the transactions carried out by the parties resulted in a Discount Rate that was within the range of what McKesson Canada and MIH would have agreed to, had their transaction applied terms and conditions which persons dealing at arm’s length would have used. Interestingly, in light of recent OECD discussion papers, he noted that the CRA did not directly or indirectly raise “any fair share or fiscal morality arguments that are currently trendy in international tax circles” and that “it wisely stuck strictly to the tax fundamentals: the relevant provisions of the legislation and the evidence relevant thereto”. He noted that issues of fiscal morality and fair share are within the realm of Parliament.

Justice Boyle sets out in detail the evidence from the two material witnesses and the five expert witnesses who testified and criticizes much of the expert evidence. In respect of the transfer pricing report prepared by a major accounting firm in 2005 in response to the CRA’s review of the RSA transaction, he states that the report was primarily a piece of advocacy work, “perhaps largely made as instructed” and that the examples used by the accounting firm resulted in “picking and choosing” and mixing and matching the performance of the receivable pools which resulted in “transparently poor advocacy and even more questionable valuation opinions”.

Mr. Justice Boyle also criticized the taxpayer in respect of the manner in which the appeal was undertaken “Overall I can say that never have I seen so much time and effort by an Appellant to put forward such an untenable position so strongly and seriously. This had all the appearances of alchemy in reverse.”

In determining the appropriate methodology to determine the Discount Rate, Justice Boyle did not accept the conclusions of any of the experts or their reports in their entirety although he acknowledged that the Court’s analysis was informed by the testimony and information provided by the witnesses. He notes that the purpose of the RSA transaction was to reduce McKesson Canada’s Canadian tax liability by paying the maximum under the RSA that was justifiable (interestingly, McKesson Canada had been profitable for the years prior to the RSA but after the RSA was executed, McKesson Canada operated at a loss) and that there is nothing wrong with taxpayers engaging in “tax-oriented transactions, tax planning, and making decisions based entirely upon tax consequences (subject only to GAAR which is not relevant to this appeal)”. However, Justice Boyle also notes that the reasons for, and predominant purposes of, non-arm’s length transactions form a relevant part of the factual context being considered.

He then reviewed the various elements of the Discount Rate. In respect of the Yield Rate, he accepted that the 30 day CDOR rate is appropriate. However, for the period in question, he stated that it was necessary to review the historical evidence in respect of when payment would be made and that the parties should have taken into account the fact that the first period had a “missing” fifteen days because the agreement was entered into in the middle of the month. In respect to the Loss Discount which was fixed by the RSA at 0.23% Justice Boyle stated that this should be based on historical data which showed write-offs of approximately 0.04% and even if the parties provided a buffer of 50% to 100% increase in write-offs, the Loss Discount would be in the range of 0.6% to 0.8%. In respect of the Discount Spread, Justice Boyle looked at the various elements which were included in this number and based on the historical data and the facts provided, stated that the servicing discount risk would be in the range of 0.17% to 0.25%, the prompt payment dilution discount would be 0.5% to 0.53%, the accrued rebate dilutions discount (which involves a customer paying a lesser amount in respect of its accounts taking into account an expected rebate) was not justified and that the interest discount which was intended to provide MIH with a return from a discounted purchase of receivables would be between 0.0% and 0.08% for a total Discount Rate range of 0.959% to 1.17%. Accordingly, because the taxpayer did not rebut the CRA’s assumptions in respect of a reasonable Discount Rate, the taxpayer’s appeal in respect of the CRA’s transfer pricing adjustment was rejected.

The second issue reviewed by the Court involves the shareholder benefit and withholding tax on the deemed dividend which resulted from the excess amount paid by McKesson Canada to its Luxembourg parent MIH under paragraph 214(3)(a) and subsection 15(1) of the Act. By utilising a Discount Rate which was greater than an arm’s length rate, McKesson Canada provided a benefit to MIH which is to be treated as a deemed dividend and is subject to non-resident withholding tax and McKesson Canada was jointly liable with MIH for the withholding tax under subsection 215(6) of the Act. The taxpayer did not deny this liability but stated that it was statute-barred because the Canada-Luxembourg Tax Convention specifically provided for a five-year limitation period (Article 9 (3)) and the reassessment of McKesson Canada in respect of withholding tax was issued after this period. Justice Boyle held that because Article 9(3) of the Convention only deals with Article 9(1) of the Convention in respect of transfer pricing adjustments and not deemed dividends and because there was no evidence that MIH was subject to any “extra tax” in Luxembourg because of the deemed dividend, the five-year time limit in Article 9(3) does not apply and, therefore, the withholding tax assessed against McKesson Canada was not subject to the limitation period in the Convention. Therefore the taxpayer’s appeal in respect of withholding tax was also dismissed.

As noted above, the decision is a lengthy one (probably one of the lengthiest Tax Court decisions). In his final footnote, Justice Boyle apologizes for the length of the decision and quoting Lord Neuberger of Abbotsbury from a 2013 address, states:

“we seem to feel the need to deal with every aspect of every point that is argued, that makes the judgement often difficult and unrewarding to follow. Reading some judgements one rather loses the will to live – and that is particularly disconcerting when it’s your own judgment that you are reading”.

It will be interesting to see whether McKesson Canada decides to appeal this decision and if it does so, how Justice Boyle’s decision will be dealt with by the Federal Court of Appeal.

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The McKesson Case – A Holiday Gift from Justice Boyle of the Tax Court of Canada: Ask and You Shall Receive(able) – Canada’s Latest Transfer Pricing Decision

The Tax Court of Canada and the World of Opera

Moliere once said, “Of all the noises known to man, opera is the most expensive.”

In Knapik-Sztramko v. The Queen (2013-799(IT)I, October 17, 2013), the Tax Court of Canada managed to reduce some of that cost, at least for one opera performer.

The taxpayer was an opera singer. In 1997, she entered a vocal competition organized by the Gerda Lissner Foundation. The taxpayer won the competition and from 1997 to 2006 she received monies for the payment of singing coaches, stage training, accommodation and travel expenses. The CRA reassessed the taxpayer to include in her income the amounts received from the Foundation.

Under paragraph 56(1)(n), a taxpayer must include in his/her income any amount received as or on account of a prize other than a “prescribed prize”. Section 7700 of the Income Tax Regulations states,

7700. For the purposes of subparagraph 56(1)(n)(i) of the Act, a prescribed prize is any prize that is recognized by the public and that is awarded for meritorious achievement in the arts, the sciences or service to the public but does not include any amount that can reasonably be regarded as having been received as compensation for services rendered or to be rendered.

In this case, the Crown conceded that the prize was recognized by the public and was for meritorious achievement in the arts. However, the Crown argued, the prize was paid as compensation for services. In the Crown’s view, the taxpayer had undertaken certain activities (coaching, training, career development, etc.) for, and provided services to, the Foundation in exchange for the money.

The Tax Court found that the taxpayer had provided no services to the Foundation, and that the activities undertaken by the taxpayer were consistently comprised of training, support and education to enhance her performance abilities:

The identification of the appellant as someone worthy of specialized study and training was the basis for awarding the prize from the Foundation’s perspective. This prize was not a relationship of, or in substitution for, employment, but a prize awarded on merit with reasonable conditions attached in order to ensure that the burgeoning talent identified was further refined by the benefactor.

The Tax Court allowed the taxpayer’s appeal.

The tax treatment of prizes is a nuanced area, dovetailing as it does with the taxation of scholarships, bursaries, fellowships and employment income. The issue seems to garner public attention every four years when the CRA responds to queries as to whether Olympic medal-winning athletes are subject to tax in Canada on their prizes (answer: Canadian athletes, yes (see CRA Document No. 2004-0098691E5 “Prizes paid to amateur athletes” (January 21, 2005), CRA Document No. 2008-0300071M4 “Olympic medals” (June 26, 2009) and CRA Document No. 2012-0458181M4 “Olympic performance awards” (September 18, 2012)); non-resident athletes, no (see subsection 115(2.3) of the Income Tax Act)).

The Tax Court’s decision in Knapik-Sztramko is a helpful case in a limited body of jurisprudence on what qualifies as a non-taxable prize under paragraph 56(1)(n) and Regulation 7700.

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The Tax Court of Canada and the World of Opera