The Federal Court of Appeal (FCA) upheld the decision of the Tax Court of Canada (TCC) in Cameco Versus The Queen. The main issue addressed during the appeal was recharacterization. The Court rejected the Crown’s arguments and, in turn, has provided taxpayers clarity on the application of the recharacterization rule.
The Canada Revenue Agency (CRA) reassessed Cameco Canada based on the selling agreement between itself and its non-arm’s length Swiss subsidiary. A set price for uranium was established in the agreement prior to an unexpected material market price increase of uranium. This resulted in the Swiss subsidiary having unexpected high profits. The Crown did not dispute the findings in the TCC regarding the key facts or the finding that the arrangement between Cameco Canada and its Swiss subsidiary was not a Sham. The Crown appealed and seeks to nullify the agreement based on the recharacterization rule.
Is the Recharacterization Rule Objective or Subjective?
The Court addressed if the recharacterization rule imposes an objective test or a subjective test on the transaction. To do this, the Court determined Parliament’s intent of 247(2) of the Income Tax Act (the Act) through a textual, contextual, and purposeful analysis. That is, what was Parliament’s intent in 247(2)(b) and (d)?
The Crown argued on the side of subjectivity. Specifically, that Cameco Canada would not have entered into the same arrangement it entered into with their Swiss subsidiary with an arm’s length party. The Court disagreed in their decision and concluded the test is objective. And if Parliament had intended a subjective test, then 247 (2)(b)(i) of the Act would have been worded differently. It would have stated:
"would not have been entered between [persons] the participants if they had been dealing at arm’s length."
The underlined section above is the addition and the word in brackets is from the legislation.
What is the difference between 247(2)(a) and (c), versus 247(2)(b) and (d) of the Act?
247(2)(a) and (c) covers transactions that use non-arm’s-length terms and conditions. So, the terms and conditions would be adjusted so it becomes representative of terms and conditions.
247(2)(b) and (d) covers transactions that follow a non-arm’s-length structure and nature for a transaction that was only structured in order to obtain a tax benefit. In that case, this would result in the transaction being restructured.
Piercing the Corporate Veil
The recharacterization rule was used by the Crown to attempt to pierce the corporate veil. It argued that the arrangement between Cameco Canada and its Swiss subsidiary should be ignored and should be amalgamated with Cameco. The FCA identified a number of problems with this approach. For one, for some transactions, the Swiss subsidiary purchased uranium outside of Canada and sold it to customers, primarily in the US. It did not involve Canada. If there were to be a different entity that would enter into this transaction, Cameco US would be a more logical choice than Cameco Canada.
The main objection to this position by the Court was the legislation state the transaction would be replaced with another transaction that would occur between arm’s length parties, and not to be completely disregarded.
Definition: Piercing the corporate veil or lifting the corporate veil is a legal decision to treat the rights or duties of a corporation as the rights or liabilities of its shareholders.
Recharacterization for Exceptional Cases
One of the contextual references the Court relied on was none other than the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the Guidelines). The Guidelines view recharacterization would occur in exceptional cases, such as where the transactions impede the tax administration from determining an appropriate transfer price. The Court held that no such exceptional circumstances existed.
Final Thoughts
The ability to recharacterize a transaction causes havoc for even the smallest multinational. A business purposely structures a transaction or a series of transactions that is in line with the industry and business, as well as the scope and responsibilities of each of the parties to the transaction. Changes to the structure has unintended tax and legal ramifications. A restructured transaction may incur a material cost when updating the internal financial reporting system. The win for Cameco in the appeal adds certainty to policies designed to mitigate the risk of the CRA applying the restructuring rule.
ABOUT DEAN MORRIS
Dean Morris is the Senior Transfer Pricing Advisor at Trowbridge and provides businesses of all sizes across multiple industries with innovative solutions for their transfer pricing issues.
