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McKesson: Taxpayer Files Supplementary Factum

As expected, the taxpayer has filed a Supplementary Memorandum of Fact and Law in its transfer pricing appeal in the Federal Court of Appeal.

Earlier, the Federal Court of Appeal allowed the taxpayer’s motion to add a new ground of appeal and to file a supplementary factum.

(See our previous posts on the McKesson transfer pricing appeal here and here.)

The taxpayer’s Supplementary Memorandum of Fact and Law is substantially identical to the draft factum that it had filed with its motion materials. The original draft factum was 30-pages, whereas the taxpayer’s filed Supplementary Memorandum of Fact and Law has been, on the instructions of the Court of Appeal, reduced to 20-pages. In its Order on the motion, the Court stated,

[24] Unnecessarily lengthy, diffuse submissions are like an unpacked, fluffy snowball. Throw it, and the target hardly feels it. On the other hand, short, highly focused submissions are like a snowball packed tightly into an iceball. Throw it, and the target really feels it. Shorter written submissions are better advocacy and, thus, are much more helpful to the Court.

In its supplementary factum, the taxpayer has stated:

  • The trial judge’s recusal reasons compromise the appearance or reality of a fair process such that a new trial is necessary;
  • A trial judge has no right or duty to intervene in the conduct of an appeal;
  • The trial judge in this case “put himself into the appellate arena in a direct and sustained manner”;
  • The recusal reasons raise “serious concerns” and would cause “any reasonable observer to doubt the impartiality” of the trial judge;
  • The recusal reasons “stack the deck” against the taxpayer;
  • An intervention by the trial judge interferes with the autonomy of the parties to frame the issues before the Court of Appeal on their own terms;
  • This interference is a deliberate attempt to meddle in the case on its merits;
  • The trial judge has suggested to the Court of Appeal that it must choose between allowing the taxpayer’s appeal and upholding the trial judge’s honesty and integrity;
  • A reasonable person would conclude the trial judge harbours some animus against the taxpayer that pre-dates the trial judge’s reading of the taxpayer’s factum in the Court of Appeal;
  • The trial judge was not detached and even-handed in how he dealt with this case;
  • A litigant in the taxpayer’s position could not reasonably believe it had received a “fair shake” from a process that produced “such an extraordinary intervention” in the appeal by the trial judge; and
  • The trial judge’s conduct calls into question the fairness of the entire process and must be remedied by a new trial before a different judge.

The Crown’s responding memorandum has not yet been filed.

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McKesson: Taxpayer Files Supplementary Factum

McKesson: FCA Allows Taxpayer’s Motion

The Federal Court of Appeal has allowed the taxpayer’s motion to amend its Notice of Appeal to add a new ground of appeal and to file a Supplementary Memorandum of Fact and Law.

(See our previous posts on the McKesson transfer pricing appeal here and here.)

The Court of Appeal stated that the lower court’s recusal reasons “depart from the norm”, and were a “new, material development ” in the appeal and “have become part of the real issues at stake”. The Court stated that it was neither clear cut nor obvious that the new ground raised by the taxpayer would fail. Further, there were no reasons to refuse the entry of the new ground into the appeal.

The Court of Appeal also ordered that a Supplementary Appeal Book be filed, which shall contain the Tax Court’s recusal reasons and the Court of Appeal’s Order on the motion.

Finally, the Court of Appeal allowed the taxpayer to file a Supplementary Memorandum of Fact and Law, and the Crown to file a responding memorandum. Interestingly, the Court of Appeal limited the length of the memorandum to no more than 20 pages. The Court of Appeal stated,

[22] In the circumstances, 20 pages is generous. Parties normally make all of their written submissions for all grounds of appeal in less than the 30 page limit in Rule 70. And many of those appeals are more complex than this one. However, in this case, the new ground is somewhat novel and the circumstances are somewhat unusual, so I am prepared to grant the appellant some leeway.

[23] The difference between what the appellants propose in page length and what I am willing to grant is nine pages. Some might wonder, “What’s the big deal about nine pages?”

[24] Unnecessarily lengthy, diffuse submissions are like an unpacked, fluffy snowball. Throw it, and the target hardly feels it. On the other hand, short, highly focused submissions are like a snowball packed tightly into an iceball. Throw it, and the target really feels it. Shorter written submissions are better advocacy and, thus, are much more helpful to the Court.

[25] Structures that lead to repetition, over-elaboration of arguments, block quotations, and rhetorical flourishes make submissions diffuse. Simple but strategic structures, arguments presented only once and compactly, tight writing that arranges clinical details in a persuasive way, and short snippets from authorities only where necessary make submissions highly focused. The former dissipates the force of the argument; the latter concentrates it.

[26] If the parties can make their submissions on the new ground in fewer than 20 pages, so much the better.

*     *     *

No date has been set for the hearing of the full appeal.

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McKesson: FCA Allows Taxpayer’s Motion

McKesson: Additional Submissions on Motion

“The Order and Reasons for Recusal do not and should not form part of the record before this Court. Their existence in the public domain does not compromise the ability of this Court to adjudicate the appeal or the appearance and reality of a fair process.”
-Crown’s Written Representations

In the most recent developments in the McKesson transfer pricing case, the Respondent has filed its Written Representations in response to the Appellant’s motion to raise new issues on appeal, and the Appellant has filed a Reply submission.

In the Written Representations, the Respondent has argued that the trial judge’s Order and Reasons for Recusal are irrelevant to the issues to be decided on appeal and do not properly form part of the record before the Federal Court of Appeal. The Respondent has also argued that the Order and Reasons for Recusal do not compromise the appearance and reality of a fair process in the appeal.

In its Reply, the Appellant has argued that the Respondent’s “remarkable position” that the Reasons for Recusal are not part of the record on appeal cannot be right. Rather, the Appellant argues, the Court of Appeal should perform a “meaningful review” of the Reasons for Recusal, as such reasons should not be “immune from review” or “shielded from appellate scrutiny”. The Appellant states, “The panel of this Court hearing the Appellant’s appeal must be given the opportunity to adjudicate [the Recusal Reasons'] legal effect.”

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McKesson: Additional Submissions on Motion

McKesson: Taxpayer Seeks to Raise Additional Issue on Appeal

“Judges are expected to decide cases as framed by the parties, then step back and allow the appellate process to unfold. In this case, the trial judge did neither.”
- Taxpayer’s Supplemental Memorandum of Fact and Law

The transfer pricing case of McKesson v. The Queen has raised procedural issues that are without precedent in Canadian tax cases. This week, those procedural issues became a central part of the matters that will be considered by the Federal Court of Appeal.

In a Notice of Motion (and other materials) filed this week, the taxpayer has asked for a new trial before the Tax Court.

Background

McKesson is a case involving transfer pricing adjustments under section 247 of the Income Tax Act (Canada) in respect of the factoring of accounts receivable as well as the limitation period in Article 9(3) of the Canada-Luxembourg Tax Convention. The Tax Court dismissed the taxpayer’s appeal.

After the taxpayer had commenced an appeal in the Federal Court of Appeal, Tax Court Justice Patrick Boyle recused himself (2014 TCC 266) from the two remaining issues before the lower court (i.e., costs and the content of the Tax Court’s public file) on the basis that the taxpayer had, in its materials filed in the Court of Appeal, accused of him of bias (see our previous post here).

Notice of Motion

On November 3, the taxpayer filed a Notice of Motion in the Federal Court of Appeal for leave to file (i) an Amended Notice of Appeal, and (ii) a Supplementary Memorandum of Fact and Law. In its Motion, the taxpayer states that Justice Boyle’s reasons for recusal raise a further ground of appeal in addition to those already set out in the original Notice of Appeal. The proposed Amended Notice of Appeal and Supplementary Memorandum of Fact and Law address the following additional ground of appeal:

Do the trial judge’s Recusal Reasons compromise the appearance and reality of a fair process in this case such that a new trial is necessary?

Specifically, the proposed Amended Notice of Appeal states,

8. The Trial Judge’s Reasons for Recusal dated September 4, 2014 interfere with the fairness of the appellate process and compromise the appearance and reality fairness of both the trial and appeal.

The taxpayer has also hired additional counsel in respect of the motion, namely Henein Hutchison LLP, a Toronto-based litigation law firm.

Taxpayer’s Arguments

The taxpayer’s Written Representations in support of its Motion argue that the recusal reasons were directed at the Court of Appeal and have compromised the fairness of the case. The taxpayer argues that this “improper intervention” has compromised the integrity of the appeal process.

The taxpayer’s Supplementary Memorandum of Fact and Law states that the trial judge’s “intervention in this appeal was ill-advised and improper”. The taxpayer argues that the trial judge should have remained “above the fray” and should not have “put himself into the appellate arena”.

The taxpayer characterizes the recusal reasons as a “post-hoc attempt to justify to an appellate court a decision given many months earlier” [emphasis in original]. The taxpayer states that the “Recusal Reasons are nothing less than an explicit attempt by the trial judge to insert himself into the appellate process as an advocate against the Appellant and its lawyers.”

The taxpayer argues that the recusal reasons must be considered part of the record in the case before the Federal Court of Appeal. A new trial would, in the taxpayer’s view, give it “an opportunity to make its case at trial, free of the unfairness that has now tainted this proceeding.”

The taxpayer also argued that the recusal reasons have undermined the solicitor-client relationship, and retrospectively reveal the trial judge’s disposition against the taxpayer.

The taxpayer has requested that the appeal be allowed and the matter remitted to the Tax Court for a new trial before a different judge.

*     *     *

The Crown has not yet filed its response to the taxpayer’s Notice of Motion.

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McKesson: Taxpayer Seeks to Raise Additional Issue on Appeal

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

McKesson: Respondent’s Factum Filed

Earlier this year, McKesson Canada Corporation appealed the decision of the Tax Court of Canada in McKesson Canada Corporation v. The Queen (2013 TCC 404) (see Federal Court of Appeal File Nos. A-48-14 and A-49-14).

At issue was the appropriate discount rate paid under a receivables sales agreement between McKesson Canada and its parent company, MIH, under section 247 of the Income Tax Act (Canada). A secondary issue was the assessment of withholding tax on a deemed dividend that arose as a result of the lower discount rate. For our earlier blog post on the Tax Court decision see here.

In the Federal Court of Appeal, the Appellant’s Memorandum of Fact and Law was filed on June 11, 2014. For our earlier post summarizing the appellant’s memorandum see here.

The Respondent’s Memorandum of Fact and Law was recently filed on August 11, 2014.

In its Memorandum, the Respondent states that the trial judge’s “carefully reasoned decision” and findings were “amply supported” by the evidence at trial and no palpable and overriding error can be found in the trial judge’s conclusions.

The Respondent summarizes its points at issue at paragraph 56 of its Memorandum:

  • The trial judge applied the correct test. His decision was based on what arm’s-length persons would agree to pay for the rights and benefits obtained and not on findings of tax avoidance, lack of need for funds, or group control.
  • Ample evidence supports the trial judge’s determination of the arm’s-length discount rate. Since no palpable and overriding error was committed, his decision should not be disturbed.
  • The trial judge did not commit an error of law in concluding that the five-year limitation period in Article 9(3) of the Canada-Luxembourg Tax Treaty does not apply to the Part XIII tax reassessment at issue.

No hearing date has yet been set for the hearing in the Federal Court of Appeal.

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McKesson: Respondent’s Factum Filed

McKesson: Appellant’s Factum Filed‏

On January 10, 2014, McKesson Canada Corporation appealed the decision of the Tax Court of Canada in McKesson Canada Corporation v. The Queen (2013 TCC 404) (see Federal Court of Appeal File Nos. A-48-14 and A-49-14).

In McKesson, the Tax Court upheld the CRA’s transfer price adjustments (made pursuant to section 247 of the Income Tax Act (Canada)) that had reduced the discount rate paid under a receivables sales agreement between McKesson Canada and its parent company, MIH, from 2.206% to 1.013%. The Tax Court also upheld the assessment of withholding tax on a deemed dividend that arose in a secondary adjustment resulting from the lower discount rate.

The Appellant’s Memorandum of fact and law was filed on June 11, 2014.

In its Memorandum, the Appellant states that the Trial Judge made a “fundamental error of law” and requests that the appeal be allowed with costs and the matter be remitted to the Tax Court for a new trial before a different judge. The Appellant describes the issues on the appeal as follows:

Did the Trial Judge err in law by stepping outside the pleadings and the case put forward and as developed by the parties over the course of the trial to find against McKesson Canada, thereby depriving McKesson Canada of its right to know the case it had to meet and its right to a fair opportunity to meet that case?

Did the Trial Judge err in law when he misconstrued the arm’s-length principle by holding that, in determining what terms and conditions arm’s length parties would have made or imposed, he was to assume that one party (purchaser) controls the other (seller)?

As a result of stepping outside of the pleadings and the case put forward and as developed by the parties over the course of the trial and committing an error of law, did the Trial Judge calculate the discount rate in a manner that ignored the assumption of risk by MIH, contrary to the terms of the Agreement and resulted in a discount rate that is commercially absurd?

Did the Trial Judge err in permitting the Minister to assess non-resident withholding tax after the expiry of the applicable limitation period and in contravention of Canada’s obligations under a bilateral tax treaty?

See our previous commentary on the Tax Court’s McKesson decision here.

 

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McKesson: Appellant’s Factum Filed‏

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

International and Transfer Pricing Audits: Toronto Centre Canada Revenue Agency & Professionals Breakfast Seminar

International and Transfer Pricing Audits

At the Toronto Centre Canada Revenue Agency & Professionals Breakfast Seminar on February 18, 2014, the CRA provided an update on international and transfer pricing audits. The slides can be found here. The discussion was led by Paul Stesco, Manager of the International Advisory Services Section, International and Large Business Directorate, Compliance Programs Branch of the CRA and Cliff Rand, National Managing Partner of Deloitte Tax Law LLP.  Here is a brief overview of some of the highlights from the presentation on how such audits are performed:

  • Research and Analysis Stage: the CRA uses the internet extensively for research (e.g. industry analysis, competitor analysis, etc.) as well as prior audit reports, tax returns and annual reports of taxapyers to identify transactions and the appropriate transfer pricing methods applicable to those transactions.
  • Mandatory Referrals to Headquarters: mandatory referrals by the field auditor to the International Tax Division (“ITD”) are required in several situations including: cost contribution arrangements, reassessments that could be issued after the tax treaty deadlines, transfer pricing penalties under subsection 247(3), recharacterization under paragraphs 247(2)(b) and (d), the application of subsection 95(6) and downward pricing adjustments under subsection 247(2) and (10). Situations which involve the use of “secret comparables” to reassess the taxpayer (i.e. comparables used by the CRA that cannot be found in a public database) will automatically be forwarded to the ITD; the CRA will not forward audit issues to the ITD if the “secret comparables” were used only for risk analysis.
  • Access to Taxpayers: during an audit, the CRA may request access to certain individuals involved in the taxpayer’s business. The CRA does not necessarily require physical access to non-resident taxpayers; a telephone interview may suffice. An interview with operational personnel is likely to streamline the audit and, as such, is in the best interests of the taxpayer. Taxpayers are permitted to record such interviews (even including the use of a court reporter to produce a transcript).
  • Currency of Auditsinstead of proceeding on a year by year basis, audits will now generally begin with the most current risk-assessed taxation year (and one back year) and may then move back to other open years in respect of the same issue.  Having said that, there are still “legacy files” within the CRA’s system.
  • Concerns/Complaints: a taxpayer who wishes to express concerns about a transfer pricing audit should follow the appropriate local chain of command: first contact the auditor, then the Team Leader and the relevant Section Manager at the local TSO. Taxpayers should refrain from directly contacting Head Office. The CRA stressed the importance of communicating with the audit team on a regular basis.
  • Contemporaneous Documentation Requirement in subsection 247(4): the CRA acknowledged that transfer pricing studies have been accepted even if they were prepared after the period to which they relate.
  • Transfer Pricing Review Committee (TPRC): two types of referrals proceed to the TPRC: (1) penalty referrals under subsection 247(3) which involve transfer pricing adjustments in excess of 10% of gross revenue or greater than $5,000,000; and (2) referrals of recharacterization as an assessing position under paragraph 247(2)(b).
    • As of October 31, 2013, penalty referrals made up 86.5% of all referrals while recharacterization referrals accounted for 13.5% of all referrals.
    • The taxpayer does not have direct access to the TPRC to make submissions. However, minutes of committee meetings may be obtained by making an Access to Information request.

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International and Transfer Pricing Audits: Toronto Centre Canada Revenue Agency & Professionals Breakfast Seminar

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