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Federal Court of Appeal Reserves Judgment in Transalta Corporation v. The Queen (Allocation of Goodwill in Arm’s-Length Transaction)

The Federal Court of Appeal heard the appeal in Transalta Corporation v. The Queen (Court File No. A-350-10) on December 13, 2011 in Calgary. The panel consisted of Justices Evans, Layden-Stevenson and Mainville.

The case concerns the allocation to goodwill of $190 million of a $818 million purchase price paid by AltaLink LP (“AltaLink”) to Transalta to purchase an electricity transmission business.  The Tax Court (2010 TCC 375) partially upheld the application of section 68 of the Income Tax Act  (the “Act”) to re-allocate a portion of the amount allocated to goodwill to tangible assets, despite the fact that the goodwill amount was approximately the amount in excess of the amount that all parties accepted as the net book value of the business assets and working capital.

On appeal, the Crown maintained its argument that not everything that increases the price of a business above its net book value must be regarded as goodwill, since goodwill is a distinct asset of the business with a value.  The Crown argued that the owners of a business would not receive any additional benefit from items such as a skilled employee force.

Transalta argued that the Tax Court had erred by adopting a new test for goodwill as something other than the established residual definition, i.e., the value of a business in excess of its realizable assets.  The test adopted by the Tax Court would require undue and costly subjective analysis and would be commercially unworkable.  Furthermore, one side of a transaction would usually be unaware of the reasons that another party would pay an amount in excess of the realizable value of the business assets.

Transalta argued that where sophisticated arm’s-length parties have agreed to an allocation, for the purposes of section 68 of the Act, there should effectively be a shift of the onus to the Minister of National Revenue to demonstrate that the allocation was not reasonable.  Translta argued that the test for section 68 should be whether a reasonable business person would have agreed to the allocation, having only business considerations in mind.  This would extend the test in Gabco Ltd. v. The Queen (68 DTC 5210), which is well-established as the test for the purpose of section 67 of the Act.

At the conclusion of the parties’ submissions, the panel reserved judgment.

The taxpayer’s Memoranda of Fact and Law are here and here.

The Crown’s Memorandum of Fact and Law is here.

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Federal Court of Appeal Reserves Judgment in Transalta Corporation v. The Queen (Allocation of Goodwill in Arm’s-Length Transaction)

Transfer Pricing Case Opens in the Tax Court of Canada – McKesson Canada Corporation v. The Queen

A transfer pricing trial commenced on October 17, 2011, in the Tax Court of Canada in Toronto.  Mr. Justice Patrick Boyle will decide whether paragraph 247(2)(a) of the Income Tax Act (the “Act”) applies to the transaction at issue (the factoring of accounts receivable) to reduce the deduction of an amount paid by a Canadian corporation to a non-resident affiliate which assumed the risks of collecting the Canadian corporation’s accounts receivable.  The agreed-upon discount rate was 2.2% but the Minister of National Revenue (the “Minister”) says it would have been just over 1% had the parties been dealing at arm’s length.  The trial is expected to take approximately 6-7 weeks.  The hearing began on Monday, October 17, 2011 with an opening statement by counsel for the Appellant, McKesson Canada Corporation (“McKesson Canada”).

McKesson Canada contracted to sell its accounts receivable to a related, non-resident company, McKesson International Holdings III S.à R.L. (“McKesson International”). McKesson Canada and McKesson International agreed to a variable discount rate that would be applied to the accounts receivable.  The rate was calculated using a formula that resulted in a discount rate of 2.2% for the 2003 taxation year.  According to the terms of the agreement, all bad debt risk relating to the accounts receivable that were sold was assumed by McKesson International. The discount rate was intended to compensate McKesson International for assuming the risk that some of the accounts receivable may not be collected and would have to be written off.

The Minister disallowed a portion of the amounts deducted by McKesson Canada in respect of the discount on the sale of accounts receivable. The Minister determined that, based on the terms and conditions in the agreement, the discount rate that would have been agreed upon had the parties dealt with one another at arm’s length would not have exceeded 1.0127%. Accordingly, the Minister added some $26 million to the Appellant’s income for its 2003 taxation year, reflecting a discount rate of 1.0127% rather than the rate of 2.2% as agreed by the parties.

In his opening statement, counsel for McKesson Canada contended that the issue should be whether the discount rate agreed upon by the parties was appropriate for an arm’s length transaction given the amount of risk that was being transferred from the vendor to the purchaser of the accounts receivable and that the issue should not be what the discount rate should be if the principal terms of the contract were changed to reflect some other hypothetical agreement used by the Minister for purposes of his assessment.

In addition to the Part I appeal, there is a Part XIII appeal as well. The issue there is whether McKesson Canada conferred a benefit on its controlling shareholder, McKesson International, under subsection 15(1) of the Act by selling certain of it accounts receivable and, therefore, whether McKesson Canada should be deemed to have paid a dividend to McKesson International under paragraph 214(3)(a) of the Act. Including interest, the Part XIII assessment is approximately $1.9 million.

In conclusion, counsel for McKesson Canada argued that the Part XIII assessment is barred by virtue of the Canada-Luxembourg Income Tax Convention (1999) (the “Treaty”), which is applicable since McKesson International is a company existing under the laws of Luxembourg. As Article 9(3) of the Treaty includes a five year time limit for changes by Canada to the income of a taxpayer, the time for the adjustment expired on March 29, 2008 (before the Part XIII assessment was mailed).

The hearing continues.

For the link to the Part I Notice of Appeal, click here.

For the link to the Part I Amended Reply, click here.

For the link to the Part XIII Amended Notice of Appeal, click here.

For the link to the Part XIII Reply, click here.

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Transfer Pricing Case Opens in the Tax Court of Canada – McKesson Canada Corporation v. The Queen