Her Majesty the Queen v. Cameco Corporation: A transfer pricing case for the books

The Supreme Court of Canada (“SCC”) recently dismissed leave to the Federal Court of Appeal’s (“FCA”) decision of Her Majesty the Queen. v. Cameco Corporation, 2020 FCA 112 [Cameco]. The FCA ruled in favour of the taxpayer, Cameco Corporation (“Cameco”), and rejected the Crown’s broad interpretation of paragraphs 247(2)(b) and (d) of the Income Tax Act, RSC 1985, c. 1 (the “Act“).

Although the FCA made its decision in July 2020, the decision, and the subsequent dismissal by the SCC, are essential to future interpretations of the section 247 transfer pricing regime — an area of tax law that prevents large corporations from shifting profits to low tax jurisdictions among other purposes.

The Facts

Cameco and its subsidiaries make up a multinational uranium producer and supplier, with uranium mines in Saskatchewan and the U.S. and processing facilities in Ontario (Cameco, para 7). In 1993, Cameco negotiated an agreement to purchase uranium from a consortium of companies and designated the agreement to its Luxembourg subsidiary — Cameco Europe S.A. (“CESA”) (Cameco, para 8). Luxembourg is a European country known for its relatively low tax.

In 1999, CESA further entered into an agreement with Urenco, a uranium enricher, to purchase more uranium (Cameco, para 10). Also in 1999, Cameco formed a subsidiary in Switzerland, another low tax jurisdiction, which was named Cameco Europe AG (“CEL”) (Cameco, para 11). CESA subsequently transferred its rights to purchase uranium from Urenco to CEL (Cameco, para 11).

The profits at issue arose due to a sale of uranium by CEL to Cameco. CEL purchased this uranium from Urenco and Cameco years before when the price of uranium was low. (Cameco, para 13). The price then increased substantially, and CEL was able to realize an enormous profit.

The arrangements took place through subsidiaries in Switzerland and Luxembourg and not in Canada, where Cameco holds much of its operations. Thus, Cameco substantially minimized the tax on this profit (Cameco, para 14). As a result, the Minister of National Revenue (“Minister”) reassessed Cameco on two bases (Cameco, para 1):

• The use of its Swiss and Luxembourgian subsidiaries constituted a sham
• The transfer pricing regime in the Act under paragraph 247(2)(b) and (d) permitted the Minister to reallocate all profits from foreign subsidiaries of Cameco to the parent Cameco corporation in Canada

Tax Court of Canada

The Tax Court of Canada (“TCC”) decision was notoriously long, totaling 282 pages. Webb J.A., writing for the FCA, described the TCC decision as a “factual data dump,” with some parts having little to no relevance (Cameco, para 5). The TCC considered the Minister’s two arguments relating to a sham transaction and 247(2)(b) and (d) of the Act.

Sham

The U.K. case Snook v. London & West Riding Investments, Ltd., [1967] 1 All E.R. 518 defined a sham as an act or documents executed with the intention to give third parties or the Court the appearance of creating legal rights and obligations between parties which are different from what actually exists. In this case, the Minister claimed that the transactions by CESA/CEL were a sham. The Tax Court Judge disagreed.

Transfer pricing

The main focus of the TCC decision was the application of the section 247 transfer pricing rules. The general purpose of the transfer pricing regime is to ensure transactions between non-arm’s length parties are conducted in a manner that arm’s length parties would accept. This prevents Canadian corporations from effectively shifting profits to a lower tax jurisdiction by selling goods or providing services to a subsidiary in another jurisdiction for an amount more or less than what arm’s length parties would charge.

If an entity infringes on section 247, then the regime can adjust the taxpayers’ incomes to ensure transactions between closely related parties align with how arm’s length parties would have transacted.

The Tax Court judge determined that the arrangements in which CESA/CEL purchased uranium from Cameco and Urenco and in which CESA/CEL later sold back to Cameco at a higher price were not commercially irrational (Cameco, paras 19 – 20). Therefore, these transactions did not warrant an adjustment via section 247. CESA/CEL ultimately assumed the price risk related to its uranium inventory between the time of purchase and sale. It was therefore entitled to the upside (Cameco, para 22).

Federal Court of Appeal

At the FCA, the Crown did not appeal their prior submission based on a sham transaction. Instead, they claimed the Court should “adopt a broader view of paragraphs 247(2)(b) and (d)” and that “Cameco would not have entered into any of the transactions that it did with CESA and CEL with any arm’s length person.” As a result, the Court should reallocate profits from CESA/CEL to the Canadian-based Cameco. The Crown further provided an alternative argument on the interpretation of paragraph 247(2)(a) of the Act.

Paragraphs 247(2)(b) and (d) Interpretation

The focus of the FCA was the competing interpretations regarding one of the conditions in paragraph 247(2)(b) of the Act (Cameco, para 31). If the conditions in 247(2)(b) are valid, paragraph 247(2)(d) can readjust the income of the taxpayer to what it would have been if it transacted with an arm’s length person. Paragraph 247(2)(b) ‘s conditions are:

(b) The transaction or series

(i) would not have been entered into between persons dealing at arm’s length, and

(ii) can reasonably be considered not to have been entered into primarily for bona fide purposes other than to obtain a tax benefit.

The issue centred on subparagraph 247(2)(b)(i). The Court question which situation was required to satisfy 247(2)(b)(i) (Cameco, para 31):

• Cameco and CESA/CEL dealing at arm’s length would not have entered into the transaction at issue
• No person dealing in arm’s length would have entered into the transaction at issue

The Court commenced with a textual, contextual, and purposive analysis of 247(2)(b)(i) to resolve this issue.

Textual Analysis

The FCA reasoned that the requirement in subparagraph 247(2)(b)(i) was an objective test with a hypothetical person, such as whether persons dealing at arm’s length would have entered into the transaction or series of transactions. It is not a subjective test, such as whether the particular taxpayer (Cameco) would have entered into the transaction or series of transactions at issue with an arm’s length party (Cameco, para 43). The Crown submitted that the subjective test was the proper interpretation of subparagraph 247(2)(b)(i) (Cameco, para 39).

The FCA supported this reasoning by analyzing paragraph 247(2)(d), which requires the Court to replace an offensive transaction or series of transactions with what arm’s length parties would have entered into (Cameco, para 53). 247(2)(d), therefore, requires replacing the transaction with what a hypothetical person would do and not the particular taxpayer in question would do. This interpretation of 247(2)(d) ultimately supported an interpretation that 247(2)(b)(i) is an objective test focused on a hypothetical person.

Contextual and Purposive Analysis

To interpret paragraphs 247(2)(b) and (d) in a contextual and purposive approach, the Court looked at the heading of section 247 (Cameco, paras 58 – 60). The fact “Transfer Pricing” headed section 247 and “Transfer Pricing Adjustment” headed subsection 247(2) supported a 247(2)(b) and (d) interpretation that would result “in an adjustment in the pricing of the relevant transactions, rather than an interpretation that would allow the Minister to pierce the corporate veil of CEL and reallocate all of its profits to Cameco” (Cameco, para 60). Therefore, this contextual and purposive interpretation did not align with the Crown’s interpretation which wanted to pierce the veil on Cameco’s Swiss and Luxembourgian subsidiaries and reallocate their profits to Cameco in Canada.

The Court additionally analyzed the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations dated July 1995 (“1995 guidelines”). The 1995 guidelines provided two situations when a tax administration could disregard a structure put in place by a taxpayer (Cameco, para 68). However, the Court did not find Cameco falling into these circumstances (Cameco, paras 68-69). Therefore, the Court must respect Cameco’s multinational corporate structure.

Conclusion on Paragraphs 247(2)(b) and (d)

The FCA concluded that the Minister could not simply reallocate all the foreign subsidiary’s profits to the Canadian parent as if those subsidiaries did not exist (Cameco, para 81). Doing such was an improper use of 247(2)(b) and (d) (Cameco, para 82). What the Minister did was use hindsight to suggest that this transaction would not have occurred if it were with arm’s length parties; however, the parties had no idea that the price of uranium would increase substantially from the time CEL/CESA purchased and sold it (Cameco, para 86).

Alternative Argument on Paragraph 247(2)(a) Interpretation

The Crown alternatively argued that the TCC improperly interpreted paragraph 247(2)(a), which could also allow for an adjustment under 247(2)(d):

(a) the terms or conditions made or imposed, in respect of the transaction or series, between any of the participants in the transaction or series differ from those that would have been made between persons dealing at arm’s length

Specifically, the Crown submitted that the Tax Court judge should have favoured the evidence by its experts rather than Cameco’s (Cameco, para 90). However, the FCA found no basis for its Court to intervene with the weighing of evidence absent palpable and overriding error.

Implications

There are several key takeaways from both the FCA decision and the SCC’s decision to deny leave. First, the FCA allowed Cameco’s transaction, which provides the company with a significantly lower tax obligation than if the FCA had decided against Cameco. This means a loss in revenue for Canada. The Tax Court Judge also awarded Cameco costs of $10,250,000, which the FCA or SCC never denied (Cameco, para 2).

With respect to the Act’s transfer pricing regime, Cameco clarified the interpretation of 247(2)(b). Specifically, the paragraph refers to a hypothetical person from an objective perspective rather than the particular taxpayer in the situation.

Lastly, there are times when it may be appropriate for section 247 to pierce the corporate veil and ignore an enterprise’s corporate structure. However, this particular transaction is not one of them. Cameco has therefore highlighted another instance of when the transfer pricing regime is limited in its piercing capabilities.