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Jean Coutu: SCC Revises Test for Rectification under the Civil Code

On December 9, 2016, the Supreme Court of Canada rendered its judgment in Jean Coutu Group (PJC) Inc. v Attorney General of Canada (2016 SCC 55) along with its companion case Canada (Attorney General) v Fairmont Hotels Inc. (2016 SCC 56).

Our post on the Court’s decision in Fairmont Hotels is available here.

In Jean Coutu, a 7-2 decision, the Supreme Court specified and enhanced the civil law test applicable to rectification of a written instrument where the taxpayer has suffered an unintended and adverse tax result. The Court had previously addressed this test in Quebec (Agence du revenu) v Services Environnementaux AES Inc. (2013 SCC 65).

The Supreme Court confirmed that a general intention of tax neutrality does not permit the modification instruments in accordance with the Civil Code of Quebec.

In Jean-Coutu, the taxpayer brought a motion for rectification in the Superior Court of Quebec in order to modify certain documents for transactions that were undertaken to neutralize the effect of the fluctuations in foreign exchange rates. The transactions had achieved this goal, but such transactions had the unexpected and adverse effect of creating foreign accrual property income for one of the companies in the corporate group.

The taxpayer argued that the constant and clear intention of the parties to address the exchange rate fluctuation without generating adverse tax consequences was not reflected in the transaction documents.

The Quebec Superior Court allowed the taxpayer’s motion on the basis that the evidence showed there was discrepancy between the clear intention of the parties and the tax consequence of the transaction as executed.

The Quebec Court of Appeal allowed the Crown’s appeal and stated that the taxpayer’s general intent that its transactions be completed in a tax-neutral manner was insufficient to support a motion for rectification.

On appeal, the Supreme Court defined the issue as follows:

[14] This appeal raises the following key issue: Where parties agree to undertake one or several transactions with a general intention that tax consequences thereof be neutral, but where unintended and unforeseen tax consequences result, does art. 1425 C.C.Q. allow the written documents recording and implementing their agreement to be amended with retroactive effect to make them consistent with that intention of tax neutrality?

In its analysis, the Court applied and confirmed the guidelines it developed in Services Environnementaux AES Inc.

Pursuant to an exhaustive review of the provisions of the Civil Code of Quebec applicable to contracts, the Supreme Court reaffirmed that under the Quebec civil law the agrement or contract lies in the common intention of the parties. A contract is created by “an agreement of wills by which one or several persons obligate themselves to one or several other persons to perform a prestation” (see Article 1378 of the C.C.Q.), which prestation must be “possible and determinate or determinable” (see Article 1378 of the C.C.Q.), and must have a cause (see Article 1410 of the C.C.Q.) and an object (see Article 1412 of the C.C.Q.).

For the majority, Justice Wagner stated that, in light of these provisions of the Civil Code of Quebec, a court may not use the remedy offered by article 1425 C.C.Q. to modify a transactional scheme because it generated unforeseen adverse tax consequences. The Court stated:

[23] A taxpayer’s general intention of tax neutrality cannot form the object of a contract within the meaning of art. 1412 C.C.Q., because it is insufficiently precise. It entails no sufficiently precise agreed-on juridical operation. Nor can such a general intention in itself relate to prestations that are determinate or determinable within the meaning of art. 1373 C.C.Q. It says nothing about what one party is bound to do or not to do for the benefit of the other. Therefore, a general intention of tax neutrality, in the absence of a precise juridical operation and a determinate or determinable prestation or prestations, cannot give rise to a common intention that would form part of the original agreement (negotium) and serve as a basis for modifying the written documents expressing that agreement (instrumentum). As a result, art. 1425 C.C.Q. cannot be relied on to give effect to a general intention of tax neutrality where the writings recording the contracting parties’ common intention produce unintended and unforeseen tax consequences.

And specifying the applicable test developed in Services Environnementaux AES Inc., the Court stated:

[24] In my opinion, when unintended tax consequences result from a contract whose desired consequences, whether in whole or in part, are tax avoidance, deferral or minimization, amendments to the expression of the agreement in accordance with art. 1425 C.C.Q. can be available only under two conditions. First, if the unintended tax consequences were originally and specifically sought to be avoided, through sufficiently precise obligations which objects, the prestation to execute, are determinate or determinable; and second, when the obligations, if properly expressed and the corresponding prestations, if properly executed, would have succeeded in doing so. This is because contractual interpretation focuses on what the contracting parties actually agreed to do, not on what their motivations were in entering into an agreement or the consequences they intended it to have.

Furthermore, the Court distinguished Jean Coutu from Services Environnementaux AES Inc.:

[31] In contrast, in the appeal here, the parties to the contract did not originally and specifically agree upon a juridical operation for the purpose of turning their general intention to neutralize tax consequences into a series of specific obligations and prestations. This general intention of the parties was not sufficiently precise to establish the details of a contemplated operation […] The determinate scenario agreed on by PJC Canada and PJC USA was drawn up properly, but because it was drawn up properly, it produced unintended and unforeseen tax consequences.

The Court dismissed the taxpayer’s appeal and affirmed the decision of the Quebec Court of Appeal.

In dissent, Justice Côté stated that the convergence of principles between the common law and the civil law as expressed by the majority in Jean Coutu was inconsistent with the contract law applicable in Quebec:

[91] […] I agree with my colleague that convergence between Quebec civil law and the common law of the other provinces is desirable from a tax policy perspective (para. 52). Indeed, in this Court, the parties agreed that the common law and the civil law are functionally similar with respect to the availability of rectification. But retreating from the interpretation of art. 1425 C.C.Q. adopted in AES in order to achieve harmony with this Court’s contraction of equitable discretion in Fairmont is inconsistent with the law of contract in Quebec.. […] Given that contracts can be expressed orally without recourse to written instruments, AES left open the possibility of rectifying errors in oral expression (paras. 28 and 32). This is consistent with the civil law principle, inherent in arts. 1378 and 1425 C.C.Q., that a contract is based on the common intention of the parties, not on the expression of that intention.

[92] The majority’s reasons in Fairmont are irreconcilable with these articles of the Code. Rectification in Canadian common law jurisdictions in now “limited to cases where the agreement between the parties was not correctly recorded in the instrument that became the final expression of their agreement” (Fairmont, at para. 3). There appears to be no scope for rectifying oral agreements. With respect, to the extent that my colleague in this case would import this limitation into the civil law, the “convergence” between the two legal systems is, in my opinion, far from “natural” (majority reasons, at para. 52).

The decision rendered by the Supreme Court in Jean Coutu is of significant importance as it restricts the circumstances in which taxpayers may rely on Article 1425 of the Civil Code to rectify transaction documents in tax cases.

Quebec tax professionals should carefully consider the additional guidelines provided in Jean Coutu in assessing whether or not a motion for rectification is available to correct mistakes resulting in unintended and unforeseen adverse tax consequences.

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Jean Coutu: SCC Revises Test for Rectification under the Civil Code

Wilson: SCC Overhauls Standard of Review?

Tax professionals who advise clients on judicial review of the CRA’s discretionary decisions should monitor developments in the standard of review in light of the Supreme Court of Canada’s decision in Wilson v Atomic Energy of Canada Ltd (2016 SCC 29).

In Wilson, the appellant was a non-unionized procurement specialist who worked for Atomic Energy of Canada Ltd. for four and a half years. He was dismissed in November 2009 and filed an unjust dismissal complaint under the Canada Labour Code. At issue was whether the significant severance package provided to Mr. Wilson rendered the dismissal just.

The labour adjudicator found that a severance payment did not exempt an employer from a determination with respect to whether a dismissal was just. Applying a standard of review of reasonableness, the application judge reversed the decision of the labour adjudicator, finding that the Code permitted the dismissal of non-unionized employees without cause. The Federal Court of Appeal agreed, but held that the appropriate standard of review was one of correctness.

The Supreme Court of Canada allowed the appeal and restored the decision of the labour adjudicator. The Court split 5-3 and issued several sets of reasons in its decision.

On the merits, Justice Abella wrote for the Court that the standard of review with respect to a labour arbitrator was one of reasonableness, to be assessed in the specific context under review. In this case, Justice Abella found the interpretation of the labour adjudicator was reasonable. However, Justice Abella remarked – albeit in obiter – that the line between reasonableness and correctness had begun to blur in the case law. A single standard of reasonableness, she stated, would operate to both protect deference and give effect to one correct answer where the rule of law required it. This would give effect to the different gradations of deference to be given to administrative decision makers in different contexts.

Chief Justice McLachlin and Justices Karakatsanis, Wagner and Gascon concurred with Justice Abella’s reasons and expressed appreciation for her attempt to galvanize constructive conversation about the standard of review. However, they declined to recast the standard of review. Justice Cromwell also concurred in the result, but rejected Justice Abella’s attempt to define a new framework, finding that the correctness/reasonableness distinction that emerged in Dunsmuir was still appropriate.

Justices Cote, Brown and Moldaver dissented. Agreeing with the Federal Court of Appeal, they stated that a standard of correctness applied and that the contradictions inherent in a growing body of labour decisions called for judicial clarity. Specifically, they held that “where there is lingering disagreement on a matter of statutory interpretation between administrative decision-makers, and where it is clear that the legislature could only have intended the statute to bear one meaning, correctness review is appropriate”.

What does Wilson mean for tax litigators? First, even though four members of the Court declined to overhaul the Dunsmuir framework, they lauded Justice Abella’s attempt to refine this area of law. The views expressed in the reasons indicate that the Court may be willing to revisit and clarify Dunsmuir (which also contained three sets of reasons).

Second, to the extent that members of the Court wish to supplant the Dunsmuir test with a single standard of reasonableness (containing gradients of deference), attempts to challenge the CRA’s discretionary decisions could be met with increased difficulty in the future.

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Wilson: SCC Overhauls Standard of Review?

SCC Clarifies Law on Admissibility of Expert Evidence

The Supreme Court has released its decision in White Burgess Langille Inman v. Abbott and Haliburton (2015 SCC 23) in which it considered whether the standards for admissibility of expert evidence should take into account the proposed expert’s (alleged) lack of independence or bias.

The Supreme Court’s decision brings some much-needed clarity to the issue of whether a trial judge can disqualify an expert based on impartiality and lack of independence at the qualification stage (i.e., Mohan).  Until now, there has been conflicting case law on this issue, with the majority of the cases supporting the conclusion that, at a certain point, expert evidence should be ruled inadmissible due to the expert’s lack of impartiality and/or independence.

The important questions that remained unanswered, and that trial courts struggled with, were (1) should the elements of an expert’s duty (i.e., independence and impartiality) go to admissibility of the evidence rather than simply to its weight? (2) If so, is there a threshold admissibility requirement in relation to independence and impartiality?

The Supreme Court unanimously answered both questions with “yes.”

(1)   The Expert’s Duty

The Supreme Court stated that expert witnesses have a duty to the court to give fair, objective and non-partisan opinion evidence.  They must be aware of this duty and be able and willing to carry it out.  Underlying the various formulations of the duty of an expert are three related concepts:

(i)        Impartiality: The expert’s opinion must be impartial in the sense that it reflects an objective assessment of the questions at hand.

(ii)        Independent: It must be independent it in the sense that it is the product of the expert’s independent judgment, uninfluenced by who has retained him or her or the outcome of the litigation.

(iii)        Absence of Bias: It must be unbiased in the sense that it does not unfairly favour one party’s position over another.  The “acid test” is whether the expert’s opinion would not change regardless of which party retained him or her.

However, the Supreme Court recognized that these concepts must be applied to the realities of adversary litigation.  Experts are generally retained, instructed and paid by one of the adversaries. According to the Court, “these facts alone do not undermine the expert’s independence, impartiality and freedom of bias.”

(2)   The Framework

The Court concluded that concerns related to the expert’s duty to the court and his or her willingness and capacity to comply with it are best addressed at the “qualification of expert” element of the Mohan framework (which is part 4 of that test).  A proposed expert witness who is unable and unwilling to fulfill his or her duty to the court is not properly qualified to perform the role of an expert.  If the expert witness does not meet this threshold admissibility requirement, his or her evidence should not be admitted.  Once this threshold is met, however, remaining concerns about an expert witness’s compliance with his or her duty should be considered as part of the overall cost-benefit analysis which the judge conducts to carry out his or her gatekeeping function.

The Supreme Court essentially adopted the 2-part test set out by the Ontario Court of Appeal in R. v. Abbey (2009 ONCA 624) and added its own gloss with respect part 4 of that test:

Step 1

The proponent of the expert evidence must establish the threshold requirements of admissibility.  These are the four Mohan factors (relevance, necessity, absence of an exclusionary rule, and properly qualified expert).

In addition, in the case of an opinion based on novel or contested science or science used for a novel purpose, the reliability of the underlying science for that purpose (see R. v. J.-L.J. (2000 SCC 51) per Binnie J.).

After reviewing Canadian, British, Australian, and U.S. authorities, the Supreme Court concluded that an expert’s lack of independence and impartiality goes to the admissibility of the evidence in addition to being considered in relation to the weight to be given to the evidence if admitted.  In reaching this conclusion, it relied upon Justice Binnie’s oft cited quote in R. v. J-L.J.: “The admissibility of the expert evidence should be scrutinized at the time it is proffered, and not allowed too easy an entry on the basis that all of the frailties could go at the end of the day to weight rather than admissibility”.

The Court concluded that concerns related to the expert’s duty to the court and his or her willingness and capacity to comply with it are best addressed initially in the “properly qualified expert” element of the Mohan framework.  In another recent decision, the Supreme Court held that for expert testimony to be inadmissible, more than a simple appearance of bias is necessary.  The question is not whether a reasonable person would consider that the expert is not independent.  Rather, what must be determined is whether the expert’s lack of independence renders him or her incapable of giving an impartial opinion in the specific circumstances of the case (Mouvement Laïque Québécois v. Saguenay (City) (2015 SCC 160) at para. 106).

Evidence that does not meet these threshold requirements should be excluded.

Step 2

Finding that expert evidence meets the basic threshold does not end the inquiry. At the second discretionary gatekeeping step, the judge balances the potential risks and benefits of admitting the evidence in order to decide whether the potential benefits justify the risks (put another way, whether otherwise admissible expert evidence should be excluded because its probative value was overborne by its prejudicial effect).  This is a residual discretion to exclude evidence based on a cost-benefit analysis. The Court adopted Doherty J.A.’s summary of this balancing exercise in Abbey – that the “trial judge must decide whether expert evidence that meets the preconditions to admissibility is sufficiently beneficial to the trial process to warrant its admission despite the potential harm to the trial process that may flow from the admission of the expert evidence.”

(3)   The Threshold

The Court also discussed the appropriate threshold for admissibility.  If a witness is unable or unwilling to fulfill his or her duty, they do not qualify to perform the role of an expert and should be excluded.  The expert witness must, therefore, be aware of this primary duty to the court and be able and willing to carry it out.  While the Court wouldn’t go so far as to hold that the expert’s independence and impartiality should be presumed absent challenge, the Court did state that absent such challenge, the expert’s attestation or testimony recognizing and accepting the duty will generally be sufficient to establish that this threshold is met.

Once the expert testifies on oath to this effect, the burden is on the party opposing the admission of the evidence to show that there is a realistic concern that the expert’s evidence should not be received because the expert is unable and/or unwilling to comply with that duty. If the opponent does so, the burden to establish on a balance of probabilities this aspect of the admissibility threshold remains on the party proposing to call the evidence.  If this is not done, the evidence, or those parts of it that are tainted by a lack of independence or by impartiality, should be excluded.

The Court held that this threshold requirement is not particularly onerous and it will likely be quite rare that a proposed expert’s evidence would be ruled in admissible for failing to meet it. The trial judge must determine, having regard to both the particular circumstances of the proposed expert and the substance of the proposed evidence, whether the expert is able and willing to carry out his or her primary duty to the court.  It is the nature and extent of the interest or connection with the litigation or a party thereto which matters, not the mere fact of the interest or connection.  The Court further stated that the existence of some interest or a relationship does not automatically render the evidence of the proposed expert inadmissible.  For example, a mere employment relationship with the party calling the evidence will be insufficient to do so.

The Court went on to provide some examples of types of interests/relationships that may warrant exclusion of the expert’s evidence:

  • A direct financial interest in the outcome of the litigation will be of some concern;
  • A very close familial relationship with one of the parties;
  • Situations in which the proposed expert will probably incur professional liability if his or her opinion is not accepted by the court; or
  • An expert who, in his or her proposed evidence or otherwise, assumes the role of an advocate for a party.

The decision as to whether an expert should be permitted to give evidence despite having an interest or connection with the litigation is a matter of fact and degree.  The concept of apparent bias is not relevant to the question of whether or not an expert witness will be unable or unwilling to fulfill its primary duty to the court.  When looking at an expert’s interest or relationship with a party, the question is whether the relationship or interest results in the expert being unable or unwilling to carry out his or her primary duty to the court to provide fair, non-partisan and objective assistance.

The Court emphasized that exclusion at the threshold stage of the analysis should occur only in very clear cases in which the proposed expert is unable or unwilling to provide the court with fair, objective and non-partisan evidence.  Anything less than clear unwillingness or inability to do so should not lead to exclusion, but be taken into account in the overall weighing of costs and benefits of receiving the evidence.


SCC Clarifies Law on Admissibility of Expert Evidence

SCC Grants Leave to Appeal in Guindon v. The Queen

The Supreme Court of Canada has granted leave to appeal in Guindon v. The Queen (Docket # 35519).  In this case, the Supreme Court of Canada will consider whether penalties imposed under section 163.2 of the Income Tax Act (Canada) constitute an “offence” within the meaning of s. 11 of the Charter.

The Tax Court found that the penalty imposed under section 163.2 of the Act is a
criminal penalty, not a civil one, and therefore subject to the same constitutional protections as other penal statutes enacted by the federal government.

The Federal Court of Appeal reversed the Tax Court’s ruling, first on the basis that Ms. Guindon had not followed the proper process in challenging section 163.2 by failing to provide notice of a constitutional question, and so the Tax Court lacked the jurisdiction to make the order it did. However, the Federal Court of Appeal considered the merits of the issue in any event, and held that advisor penalty proceedings are not criminal in nature and do not impose “true penal consequences.”

Our previous comments on the decisions are here and here.

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SCC Grants Leave to Appeal in Guindon v. The Queen

Section 31 of the Income Tax Act – Moldowan Overruled!

It’s been just over four months since the Supreme Court of Canada (the “SCC”) heard oral argument in The Queen v. John H. Craig (see our prior blog post for coverage of the hearing and background on section 31), the only section 31 restricted farm loss case to reach the SCC since the oft-criticized Moldowan v. R., 1977 DTC 5213.

Result: Moldowan has been overruled. It took an uncharacteristically short period of time for the SCC to render its judgment – the unanimous decision emphatically stated that “Moldowan cannot stand.”

Justice Rothstein delivered the reasons, which prescribe a new analysis to be undertaken when a taxpayer needs to determine if his or her income from farming activities (such as a horse racing or breeding business), when combined with some other source of income (such as employment or business income) constitutes a “chief source of income.” If this test is satisfied, then the taxpayer may deduct the full amount of any losses from the farming operation against the other source of income, without restriction. If the test is not satisfied, then section 31 restricts the amount of the deductible loss in any given taxation year to $8,750.

The New Test: The new test outlined by the SCC is still a fact-based analysis to be applied to the particular circumstances of the taxpayer, and has two steps:

Step 1: At the outset, a determination needs to be made that the farming business is in fact a business (a source of income from which losses may be deducted), as opposed to a personal endeavour. This test is enunciated in Stewart v. Canada (2002 SCC 46) as the “commercial manner” test, stating that the farming operation is a business if there is no personal or hobby element; or if there is a personal or hobby element, then the venture must be undertaken in a sufficiently commercial manner “in accordance with objective standards of businesslike behaviour” in order to be considered a business.

Step 2: Once it is determined that the farming operation is a business, the taxpayer is entitled to full deduction of farming losses against another source of income if it is determined that farming and the other source of income is his or her chief source of income, based on the following factors, taken together: the amount of capital invested in farming and the other source of income; the income from each of the two sources of income; the time spent on the two sources of income; and the taxpayer’s ordinary mode of living, farming history and future intentions and expectations. To be successful, it must be shown that the taxpayer has invested significant funds and has spent considerable time attending to the farming business and that the taxpayer places significant emphasis on both the farming and non-farming sources of income. Further, it is not necessary that income from the farming business exceed income from the other source of income – this fact is irrelevant to the analysis.

The new test could be described as the “significant endeavors” test – which is much more palatable than the defunct ‘reasonable expectation of profit’ test or ‘three classes of farmer’ test that has now been buried along with Moldowan. RIP.

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Section 31 of the Income Tax Act – Moldowan Overruled!

Reuters: Corporations Face Long Odds in Tax Cases Heard by the United States Supreme Court – Situation Brighter in Canada

Reuters recently reported a study showing that corporations face very long odds in tax appeals heard by the United States Supreme Court. There were 919 income tax cases in the Supreme Court of the United States from 1909 to 2011. 364 of those cases involved corporations. In “abuse” cases, the government won 61% of the time. In other cases, the government won 68% of the time. The real story is likely much grimmer since the statistics show that the US Supreme Court only grants review in about 2% of leave applications.

The Canadian Supreme Court heard 356 income tax cases between 1920 and 2003. Of these, the statistics show that the government won 223, or roughly 2/3. The record of Supreme Court tax cases between 2004 and 2012 is essentially similar. While an exact breakdown of corporate cases is not available, anecdotal evidence suggests that the success rate of corporations is roughly 1/3 (a more detailed analysis will be available in the future).

While the Canadian experience appears superficially to mirror the American statistics, a very different story is disclosed by Canadian leave to appeal statistics.

Year      Denied Granted




































Grand Total





As the chart demonstrates, roughly 12% of leave applications are granted in Canada. Thus, corporations and other taxpayers may have as high as 6 times more likelihood of success in a tax appeal before the Supreme Court of Canada than in cases before the Supreme Court of the United States.

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Reuters: Corporations Face Long Odds in Tax Cases Heard by the United States Supreme Court – Situation Brighter in Canada

Further thoughts on the Fundy Settlement decision: Supreme Court offers a nuanced view of trust residence

In Garron Family Trust v. The Queen (2009 TCC 450), Justice Judith Woods of the Tax Court of Canada came down with a very broad new rule for determining the residence of trusts.

[162]  I conclude, then, that the judge-made test of residence that has been established for corporations should also apply to trusts, with such modifications as are appropriate. That test is “where the central management and control actually abides.”

This was viewed widely as a repudiation of the historic test based on the residence of the trustee. Many tax professionals thought that the test for residence of a trust required a determination of the residence of the majority of the trustees and where their functions were performed, and that it was not necessary to go beyond this test.

The Federal Court of Appeal in St. Michael Trust Corp. v. Canada (2010 FCA 309) appeared to endorse Justice Woods’ new legal test but in a somewhat guarded fashion:

[63]    St. Michael Trust Corp. argues that a test of central management and control cannot be applied to a trust because a trust is a “legal relationship” without a separate legal personality. I do not accept this argument. It is true that as a matter of law a trust is not a person, but it is also true that for income tax purposes, a trust is treated as though it were a person. In my view, it is consistent with that implicit statutory fiction to recognize that the residence of a trust may not always be determined by the residence of its trustee.

[64]    St. Michael Trust Corp. also argues that the residence of the trust must be determined as the residence of the trustee because section 104 of the Income Tax Act embodies the trust, as taxpayer, in the person of the trustee. In my view, that gives section 104 a meaning beyond its words and purpose. Section 104 was enacted to solve the practical problems of tax administration that would necessarily arise when it was determined that trusts were to be taxed despite the absence of legal personality. I do not read section 104 as a signal that Parliament intended that in all cases, the residence of the trust must be the residence of the trustee.

When the Supreme Court of Canada granted leave to appeal, some tax professionals were puzzled.  These tax professionals believed that it was unlikely the decision would be reversed since the Crown had a very strong factual case that the trusts in question were managed in Canada by the trust beneficiaries.  The decision released on April 12 by the Supreme Court (Fundy Settlement v. Canada, 2012 SCC 14) in fact dismissed the appeal in somewhat cursory fashion.

[15]    As with corporations, residence of a trust should be determined by the principle that a trust resides for the purposes of the Act where “its real business is carried on” (De Beers, at p. 458), which is where the central management and control of the trust actually takes place.  As indicated, the Tax Court judge found as a fact that the main beneficiaries exercised the central management and control of the trusts in Canada.  She found that St. Michael had only a limited role ― to provide administrative services ― and little or no responsibility beyond that (paras. 189-90).  Therefore, on this test, the trusts must be found to be resident in Canada.  This is not to say that the residence of a trust can never be the residence of the trustee.  The residence of the trustee will also be the residence of the trust where the trustee carries out the central management and control of the trust, and these duties are performed where the trustee is resident.  These, however, were not the facts in this case.

[16]    We agree with Woods J. that adopting a similar test for trusts and corporations promotes “the important principles of consistency, predictability and fairness in the application of tax law” (para. 160).  As she noted, if there were to be a totally different test for trusts than for corporations, there should be good reasons for it.  No such reasons were offered here.  [Emphasis added]

On a close reading it is arguable that the Supreme Court has gently tempered the new rule set out by Justice Woods and, to some extent, by the Federal Court of Appeal.  Where the trustee does what it is supposed to do, including managing the trust and its properties, the operative test remains the residence of the trustee.  It would seem that only where the trustee carries on those “management and control” activities in a place other than where the trustee is resident, or where the trustee abdicates many of its powers to a third party, that Justice Woods’ new test becomes relevant.

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Further thoughts on the Fundy Settlement decision: Supreme Court offers a nuanced view of trust residence

Arguments conclude in first transfer pricing case heard by the Supreme Court of Canada: GlaxoSmithKline Inc. v. The Queen

On Friday morning January 13, 2012, the Supreme Court of Canada heard arguments in GlaxoSmithKline Inc. v. The Queen. See our earlier posts on the case here and here.

By way of background, Glaxo Canada purchased ranitidine, the active pharmaceutical ingredient in Zantac, a branded ulcer medication, from a non-arm’s-length non-resident. In 1990-1993, Glaxo Canada paid approximately $1,500 per kg of ranitidine, while generic purchasers of ranitidine were paying approximately $300 per kg. The Minister of National Revenue reassessed Glaxo Canada under former section 69 of the Income Tax Act on the basis that the taxpayer had overpaid for the ranitidine in light of the fact that generic manufacturers were paying considerably less for the same ingredient.

The issue before the Tax Court was whether the amount paid by the taxpayer to the non-arm’s-length party was “reasonable in the circumstances.” The Tax Court held that (a) the “comparable uncontrolled price” (or CUP) method was the most accurate way to determine the arm’s-length price for ranitidine and (b) the appropriate comparable transactions were the purchases of ranitidine by the generic manufacturers. Subject to a relatively minor adjustment, the Tax Court dismissed the taxpayer’s appeal.

The Federal Court of Appeal allowed the taxpayer’s appeal. The Court of Appeal held that the lower court had erred in its application of the “reasonable in the circumstances” test, and that it should have inquired into the circumstances that an arm’s-length purchaser in the taxpayer’s position would have considered relevant in deciding what reasonable price to pay for ranitidine. The Court of Appeal set aside the lower court judgment and sent the matter back to the Tax Court to be reconsidered.

The Crown appealed and Glaxo Canada cross-appealed the portion of the order sending the matter back to the Tax Court. The appeal was heard by a seven-member panel of the Court (Chief Justice McLachlin, Justice Dechamps, Justice Abella, Justice Rothstein, Justice Cromwell, Justice Moldaver and Justice Karakatsanis).

The Crown argued that the analysis under subsection 69(2) required a “stripping away” of the surrounding circumstances of the transaction in question and, in particular, the license agreement pursuant to which Glaxo Canada was entitled to market and sell the drug ranitidine under the brand name Zantac.  Having done that, the only relevant comparator was the price of ranitidine on the “open market”, namely, the price paid for ranitidine by generic drug manufacturers.

The Court asked a number of questions about whether subsection 69(2) (with its reference to “in the circumstances”) makes the ultimate use of the ranitidine relevant to the analysis. Several judges asked whether it made a difference that the ranitidine purchased by Glaxo Canada was to be marketed and sold as Zantac, a branded product that would yield a higher retail price than the equivalent generic product.  Justices Abella and Rothstein were particular active during this discussion.

In stark contrast to the Crown’s position, Glaxo Canada contended that the only question to be answered under subsection 69(2) was whether two arm’s-length parties, sitting across a boardroom table, would arrive at the same deal that was concluded by Glaxo Canada and its non-resident parent company. Justice Abella wondered if, even in those circumstances, an arm’s-length party would pay $1,500 for a kilogram of ranitidine.

Chief Justice McLachlin asked about bundling and its relationship to transfer pricing – if the $1,500/kg price included an amount paid for something other than ranitidine why was it not identified by Glaxo Canada as such and why was withholding tax not remitted thereon under section 212 of the Act? Counsel for Glaxo Canada responded by making two points: First, if a portion of the price paid by Glaxo Canada for ranitidine were more properly characterized as royalties, for example, such amounts would be expenses to Glaxo Canada and thus there was no mischief from a transfer pricing perspective in bundling them into the cost of the goods. Second, it is not the policy or practice of the CRA to require taxpayers to unbundle intellectual property or other intangibles from tangible property as, presumably, the practical burden imposed by such a requirement would be difficult to overstate. It was unclear whether the tension between the issues of bundling and arm’s-length pricing was resolved at the hearing.

In a nutshell, the choice before the Court is this: Is the fact that the ranitidine purchased by Glaxo Canada was destined to become Zantac relevant to the analysis under subsection 69(2)? Glaxo contends that it is, while the Crown contends that it is not.

On the cross-appeal, Glaxo Canada argued that it had met the case against it on the pleadings and the matter should, therefore, have concluded at the Federal Court of Appeal and should not have been sent back to the Tax Court. There were a number of questions from the bench on that point.

The panel reserved judgment on both the appeal and cross-appeal.

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Arguments conclude in first transfer pricing case heard by the Supreme Court of Canada: GlaxoSmithKline Inc. v. The Queen

GlaxoSmithKline’s Factum Filed in the Supreme Court of Canada: Stage Set for Transfer Pricing Battle on January 13, 2012 (Tentative Date)

GlaxoSmithKline’s factum has now been filed with the Supreme Court of Canada addressing the arguments set out earlier in the Crown’s factum.  There are no particular surprises.

As noted in our earlier blog post, the Crown was granted leave to appeal the Federal Court of Appeal’s decision and GSK was granted leave to cross-appeal. The Crown contends in its factum that the FCA gave short shrift to the arm’s length principle which it was required to apply under subsection 69(2) of the Income Tax Act as developed in the OECD Guidelines. The Crown argues that the FCA has replaced the arm’s length standard with a “reasonable business person” test.

In its factum, GSK argues that the approach taken by the FCA in determining “reasonable in the circumstances” is consistent with the OECD Guidelines which call for the application of the arm’s length principle in light of the actual business circumstances faced by the taxpayer. Neither subsection 69(2) of the Income Tax Act nor the arm’s length principle require courts to ignore the circumstances of the marketplace. GSK also says that the Crown’s approach effectively reads out the phrase “in the circumstances” as used in subsection 69(2) of the Income Tax Act.

Finally, by way of cross-appeal, GSK takes issue with the FCA’s order that the matter be re-heard by the Tax Court of Canada, contending that that the FCA ought simply to have set the assessments aside.

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GlaxoSmithKline’s Factum Filed in the Supreme Court of Canada: Stage Set for Transfer Pricing Battle on January 13, 2012 (Tentative Date)