Taxpayer wins Canadian transfer pricing reconstruction case – Cameco Corporation

14 July 2020

In brief

On 26 June 2020, the Canadian Federal Court of Appeal (FCA) unanimously dismissed an appeal by the Canadian Revenue Agency (CRA) from a judgment of the Canadian Tax Court which rejected the CRA’s attempt to reconstruct transactions by eliminating an intra-group sale under the Canadian transfer pricing provisions. The CRA sought to disregard the business decision made to acquire uranium using a foreign subsidiary and the subsequent sale of rights within the global group. 

Under the OECD guidelines, a revenue authority must respect the terms and conditions of a transaction unless one of two ‘exceptional’ reconstruction exemptions apply. The FCA confirmed that the CRA’s ability to reconstruct under its domestic transfer pricing laws and the  reconstruction exemptions have no application if a taxpayer can demonstrate that a transaction can be priced and that unrelated parties in similar circumstances would have entered into a similar transaction. 

The decision reinforces the threshold that needs to be met for a revenue authority to reconstruct transactions under the OECD Guidelines. The FCA focused the inquiry on whether the transactions would have been entered into between persons dealing with each other at arm’s length (i.e. an objective test), and not whether the particular taxpayer (in this case, Cameco), would have entered into the transaction with an arm’s length party (i.e. a subjective test). 

The principles arising from Cameco are consistent with the Australian Federal Court decision in Glencore Investment Pty Ltd v Commissioner of Taxation [2019] FCA 1432 (Glencore) which, while currently the subject of appeal, provided much needed clarity on the operation of Australia’s transfer pricing rules and reinforced their alignment with international standards. See our previous insights for a summary of the Glencore decision here.

In detail

Facts

Subject to seeking leave to appeal to the Supreme Court of Canada, the FCA decision will mark the end of a 12 year dispute. The Tax Court hearing lasted 69 days. Cameco called seven lay witnesses and five expert witnesses, while the CRA called two lay witnesses and three expert witnesses. The FCA ordered that the CRA pay CAD10.25m of Cameco’s legal fees and up to CAD17.9m of Cameco’s disbursements. The Canadian Government is also still holding CAD303m in cash and CAD482m in letters of credit, which it will be required to return to Cameco. 

Cameco Corporation (Cameco) is a large uranium producer and supplier of services that convert one form of uranium into another form. In 1999, Cameco Europe (CESA), a Cameco subsidiary based in Luxembourg, entered into long-term agreements with Tenex and Urenco to purchase uranium. At the time, the price of uranium was low. In 2002, CESA transferred its business (including the rights that CESA had to purchase uranium from Tenex and Urenco) to Cameco Europe AG (SA Ltd) (CEL), a Cameco subsidiary based in Switzerland. When the price of uranium subsequently increased, CEL realized substantial profits from the agreements.

The CRA sought to allocate the profits of CEL to Cameco for the 2003, 2005 and 2006 taxation years. 

At first instance, the CRA argued that: (1) a reorganisation undertaken by Cameco in 1999 was a sham; (2) that CESA/CEL performed few, if any, valuable functions during the years under consideration and; (3) reassessments were consequently warranted under transfer pricing rules as enacted by section 247(2) of the Canadian Tax Act. Section 247(2) is similar to section 815-130(2) and (3) of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997). 

The Tax Court ruled that the transfer pricing provisions did not apply to any of the transactions because the transactions were not a sham or commercially irrational and the profits were based on future price increases that the parties did not know would occur at the time of entering into the transactions. 

Appeal 

On appeal, the CRA argued for a broad interpretation of paragraph 247(2)(b) and submitted that Cameco would not have entered into any of the transactions with CESA and CEL if they had been dealing at arm’s length. The CRA’s alternative postulate was that Cameco would have sold uranium directly to purchasers, bypassing CEL, and realized the profits itself. 

The FCA held that: 

• section 247 does not refer to whether the particular taxpayer would not have entered into the particular transaction with the non-resident if that taxpayer had been dealing with the non-resident at arm’s length or what other options may have been available to that particular taxpayer;

• rather, it concerns whether arm’s length persons would not have entered into the particular transaction or series of transactions under any terms and conditions, which is an objective test;

• the Canadian transfer pricing provisions adjust the prices paid for goods and services if the prices differ from the amount that would be paid in an arm’s length transaction. The provisions do not allow the CRA to simply reallocate all of the profit of a foreign subsidiary to its Canadian parent on the basis that the Canadian corporation would not have entered into any transactions with its foreign subsidiary if they had been dealing at arm’s length;

• an interpretation that might enable an adjustment in the pricing of relevant transactions was to be preferred over an interpretation that would allow the Minister to pierce the corporate veil;

• the two exceptional circumstances identified in the OECD Transfer Pricing Guidelines that would permit a tax authority to disregard the actual transaction did not apply because the form and substance of the transactions were aligned and there was no indication that the structure impeded the determination of an appropriate transfer price; and

• it is not appropriate for a tax administration to use hindsight to suggest that no two persons dealing at arm’s length would have entered into a transaction.

The CRA also did not allege in the appeal that the guarantee fee paid by CEL to Cameco was not an amount that would be paid in an arm’s length transaction. 

Parallels with Recent Australian Case Law 

Parallels can be drawn with the recent decision in Glencore. Davies J in Glencore cited the Cameco Tax Court decision and determined that the pricing analysis under Subdivision 815-A of the ITAA 1997 should be based on the form of the actual transaction entered into and the Commissioner is unable to simply “recast” the transaction “as a different transaction”. Her Honour noted that Subdivision 815-A does not permit the Commissioner of Taxation to “engage in a speculative task of re-imagining all of the terms of the contract to which independent parties might be expected to have agreed”. This is because “fundamentally rewriting the actual arrangement and engaging in an extensive exercise in commercial judgment…does not accord with, or give effect to, the objective of the arm’s length principle”. Davies J held that this approach was consistent with the decisions in Chevron, both at first instance and on appeal, as well as the OECD Guidelines.

The takeaway

Fundamentally, the outcome is unsurprising given the simple narrative tested before the Court that foreign assets acquired by a foreign company and sold to foreign customers, should not be brought to tax in Canada. 

The Cameco decision further reinforces that the OECD Guidelines, required to be considered under Australian transfer pricing rules, do not support speculative reconstruction exercises by revenue authorities and that actual transactions and business decisions made should only be disregarded or substituted in exceptional cases. In Australia, the need for the Commissioner to respect commercial decisions made by businesses is not a new development. The Courts have repeatedly held that it is not for the Commissioner to dictate to a taxpayer in what way a business should be run or the efficiency it should operate at (see Tweddle v FCT (1942) 180 CLR 1; Magna Alloys & Research Pty Ltd v FCT (1980) 11 ATR 276).