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).