News of Note

Marzen Artistic – Federal Court of Appeal confirms that a simplistic transfer pricing scheme is difficult to defend

The taxpayer, a Canadian window manufacturer which sold its windows in B.C. and the U.S., generated virtually all of its profits in its Barbadian subsidiary (SII), which essentially had no assets or employees other than its (very part-time) Barbadian managing director: the taxpayer sold windows for the U.S. market to its U.S. subsidiary ("SWI") at their retail price (i.e., the IRS was not expected to receive any income tax either); SII charged "marketing fees" to the taxpayer which were sufficient to reduce the taxpayer’s income to nil; SII paid fees to SWI for the SWI employees ("seconded" to SII) who did the marketing work at SWI’s payroll cost plus 10%; and SII paid dividends (out of exempt earnings generated from the substantial mark-up of its fees over those of SWI) to the taxpayer which essentially were equal to 100% of the profit of the consolidated group.

The Federal Court of Appeal has not found anything to reverse in the approach that Sheridan J took in the Tax Court, which was to apply s. 247(2)(c) to reduce the marketing fees to the sum of: the fees paid by SII to SWI; and those paid to its managing director (which she treated as the comparable uncontrolled price for SII’s services to the taxpayer) - so that virtually all of the consolidated profits were taxable in Canada. In response to a submission that Sheridan J had “erred in under-valuing the amounts paid by SII to SWI," (i.e., some of the Barbados profits assessed by CRA really belonged in the U.S.), Scott JA refrained from editorial comment, and instead simply noted that no evidence had been advanced at trial in its support.

Neal Armstrong. Summaries of Marzen Artistic Aluminum v. The Queen, 2016 FCA 34, under s. 247(2).

CRA considers that a Netherlands Antilles private foundation qualifies as a trust notwithstanding its separate legal personality

Although a Netherlands Antilles private foundation has separate legal personality (including a separate legal entity clause in the governing legislation) and capacity to acquire rights and liabilities (with no beneficiary liability), CRA nonetheless considers it to be a trust rather than a corporation given that it does not issue shares, the beneficiaries do not pay for their interests in the foundation, they cannot transfer their beneficial interests and they do not have a right to participate in any decisions of the foundation. Although it is still quite dissimilar to a common law trust, it is good enough that it is somewhat similar to a civil law trust.

Neal Armstrong. Summary of 4 October 2010 Memo 2008-0289461I7 under s. 104(1).

ConocoPhillips – Federal Court finds that CRA effectively has the discretion under s. 220(2.1) to indefinitely extend the period for filing a Notice of Objection

S. 220(2.1) provides that “where any provision of this Act… requires a person to file a… document…the Minister may waive the requirement, but the person shall provide the document…at the Minister’s request.” Boswell J has found that s. 220(2.1) accords the Minister the discretion to waive the requirement to file a Notice of Objection. Thus, it was improper for CRA to peremptorily reject (on the grounds that it had no power to do so) a ConocoPhillips request that CRA waive a requirement for it to object to a reassessment which ConocoPhillips found out about well after the deadline for getting an extension to object to it.

What does this mean? Boswell J indicated that if CRA waived the requirement for filing a Notice of Objection, it was then empowered by s. 220(2.1) to request the waived document (i.e., to request ConocoPhillips to file a Notice of Objection), so that the appeals process could get back on track – and noted that “should the Minister in this case unreasonably refuse to exercise her jurisdiction and authority to waive the requirement for a notice of objection, ConocoPhillips could then challenge that refusal by way of judicial review in this Court.”

Neal Armstrong. Summaries of ConocoPhillips Canada Resources Corp. v. M.N.R., 2016 FC 98 under s. 220(2.1) and Statutory Interpretation - French and English versions.

CRA doubts the GST free-supply rule provides ITCs to holdcos providing free management to operating subs which generate interest/dividends

A 2004 Interpretation (54669) indicated that a holding corporation supplying management services to related corporations with operating businesses or other exclusive commercial activity could claim ITCs to recover the GST on the expenses incurred in such management activities under the “free supply” rule in ETA s. 141.01(4).

More recently, CRA has substantially qualified this view by confirming that it would consider that “where a person provides property or a service to a person for no consideration but receives interest or dividend revenue from that person it is unlikely that ITCs would be available.” Based on an earlier comment, CRA's rationale might be that although the direct purpose of the management services is to further the operating business (which arguably is all that matters), the indirect purpose of promoting financial returns to the holding corporation (e.g., dividends) should govern.

Neal Armstrong. Summary of 26 February 2015 CBA Roundtable, Q. 34 under ETA s. 141.01(4).

Hedges – Federal Court of Appeal finds that marihuana sales were not zero-rated drug supplies

The zero-rating of controlled drugs in Sched. VI, Part I, s. 2(d) would apply to dried marihuana if it is viewed as a drug which may only be sold to a consumer under an "exemption" from Health Canada. After noting the Crown’s concession that marihuana is a “drug,” Rennie JA found that "Authorizations to Possess" (ATPs) issued by Health Canada were not such exemptions, so that marihuana did not come within this carve-out for drugs which could only be sold with an exemption. He also was not impressed by the “illogic” of arguing that over-the-counter drugs were taxable because they could be legally sold without exemption (or prescription), whereas sales of marihuana were zero-rated because exemptions were required – even though in the case before him of an unlicensed and illegal producer, no ATPs (incorrectly argued to be “exemptions”) had in fact been obtained.

The findings in this case suggest that licensed (as contrasted to illegal) producers also are required to charge GST or HST to consumers with ATPs.

Neal Armstrong. Summary of Hedges v. The Queen, 2016 FCA 19, under ETA, Sched. VI, Part I, s. 2.