Citation: 2009 TCC 477
Date: 20090925
Docket: 2007-2678(IT)G
BETWEEN:
1143132 ONTARIO LIMITED,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Jorré J.
INTRODUCTION
[1]
The Appellant
manufactured equipment and distributed related advertising materials. Its sales
were to customers in Canada and the United States.
[2]
Sales to the U.S. were channeled through a company incorporated in Barbados referred to in this judgment as “Barco”. The
Appellant sold its products to Barco. Barco then sold the products to the U.S. customers.
[3]
The Minister of
National Revenue (the “Minister”) reassessed the Appellant’s 1999 to 2004
taxation years on the basis that the transfer price between the Appellant and
Barco should be adjusted. The reassessments for the 1999 to 2002 years were made
more than three years but less than six years after the initial assessment. In
assessing the Minister relied on subparagraph 152(4)(b)(iii) and
subsection 247(2) of the Income Tax Act (the “ITA”).
FACTS
[4]
At trial, no witnesses
were called.
[5]
The Respondent served a
request to admit on the Appellant. The Appellant did not reply and, pursuant to
subsection 131(2) of the Tax Court of Canada Rules (General Procedure) (the “Rules”), the Appellant is deemed to
admit the facts.
[6]
The facts in the
request to admit are the same as the assumptions pleaded in the Minister’s reply.
[7]
Consequently, the facts
in this appeal are:
a) The Appellant was incorporated in Ontario on 20 September 1995, and
carried on business under the name Pro-Tect Plastic.
b) 2007336 Ontario Inc. (“Holdco”) was incorporated
in Ontario on 3 December
2001 and, at all material times, its shares were owned 50 percent by Jim
Swales (“Swales”) and 50 percent by his spouse Nancy Hunter (“Hunter”).
c) At all material times, the shares of the
Appellant were owned 50 percent by Swales and 50 percent by his
business associate Tom Medland (“Medland”), then 50 percent by Holdco and
50 percent by a corporation owned by Medland, and finally 100 percent
by Holdco.
d) At all material times, the Appellant, Holdco,
Swales, Hunter, Medland and the corporation owned by Medland were residents of Canada.
e) Pro-Tect Plastic Fabricators International Corp.
(“Barco”) was incorporated in Barbados as an international business corporation
(“IBC”) on 14 March 1996, and was a non-resident of Canada.
f) At all material times, the shares of Barco were
owned 100 percent by the Appellant. It follows that Barco and the
Appellant did not deal at arm’s length.
g) The Appellant was a manufacturer of point of
sale display units and distributor of related advertising materials, which it
sold to third party customers in Canada and (channeled through Barco as an
intermediary) the United States.
h) On behalf of the Appellant, Swales initiated in Canada all sales to the customers in the United States.
i) The Appellant manufactured its products in
Canada, and drop shipped them directly from Canada to the customers in the United States.
j) The Appellant “sold” its products at profit to
Barco, and Barco then “sold” them at profit to the customers in the United States, with the result that
approximately 60 percent of the overall profit from these “sales” was
earned by the Appellant, and 40 percent by Barco.
k) The Appellant performed the following business
functions: general management (including corporate strategy, treasury, legal,
regulatory, and personnel), manufacturing (including product design,
purchasing, and quality control) and marketing (including strategy, pricing and
invoicing).
l) Except for re-typing the invoices for the
customers in the United States
and banking the receipts, Barco did not perform any business functions,
whatsoever, and did not add any value to the Appellant’s operations.
m) Barco claimed minimal operating and overhead
expenses, and did not compensate either the Appellant or Swales for any
services that they performed.
n) The Appellant assumed the following business
risks: product, credit, foreign exchange, inventory and market.
o) Barco did not assume any business risks
whatsoever.
p) Barco had no employees. It had two Barbadian
directors who were inactive in the business and were paid $1,500 per year. It
used agents to perform the invoicing and banking functions.
q) The sole purpose for incorporating Barco and
channeling the Appellant’s sales to the customers in the United States through Barco as an
intermediary was to obtain a tax benefit.
r) The tax benefit referred to in the previous
paragraph was that Barco would earn profits in Barbados which, because it was an IBC, would be taxed at the rate of
2.5 percent, and which would then be paid to the Appellant as tax-free
dividends.
s) For the 1999, 2000, 2001, 2002 and 2003 taxation
years, Barco reported net income in Barbados in the following amounts: US$ 117,077, US$ 93,683,
US$ 149,731, US$ 157,777 and US$ 51,204, respectively.
t) During the 1999, 2000, 2001, 2002 and 2003
taxation years, Barco paid dividends to the Appellant in the following amounts:
$170,000, $150,000, $230,000, $230,000 and $105,360, respectively.
u) The terms of the transactions between the
Appellant and Barco differed from those that would have been made between
persons dealing at arm’s length.
v) Had the Appellant and Barco been dealing at
arm’s length, either none of the Appellant’s sales to the customers in the United States would have been channeled
through Barco as an intermediary, or the transfer price between the Appellant
and Barco would have been substantially higher.
w) The transfer price for the “sales” from the
Appellant to Barco was understated, and the “profit” earned by Barco from the
“sales” to the customers in the United States was overstated.
x) The Appellant did not prepare a transfer pricing
study.
y) The best indication of the appropriate transfer
price for any particular “sale” from the Appellant to Barco is the price for
that particular sale that was negotiated at arm’s length between the Appellant
and the customer in the United States.
z)
The transfer pricing adjustment results in the
quantum of profit for the Appellant that would have been determined if the
Appellant and Barco had been dealing at arm’s length.
[8]
It is not in dispute
that the reassessments of the 1999 to 2002 taxation years were made after the
normal reassessment period, but within the additional reassessment period
provided for under subparagraph 152(4)(b)(iii).
[9]
It is also relevant to
note that in its notice of appeal the Appellant gave the following reasons for
its appeal:
C. Reasons
For Appeal and Relief Sought
1. The Appellant maintains that in all cases its sales, including
its sales to Pro‑Tect Plastics International Corp. were made on the basis of arms-length
pricing in similar circumstances. Accordingly, the transfer pricing adjustment
made by the Minister of National Revenue is not appropriate for the
circumstances.
2. The Appellant further submits that the reassessments of it with
respect to the 1999 to 2002 taxation years inclusive were issued beyond the
three year time limit prescribed for reassessments under the Act.
3. The Appellant accordingly submits that its appeal ought to be
allowed and the reassessments vacated.
. . .
ANALYSIS
Statutory provisions
[10]
Subsection 152(4) of
the ITA reads in part:
152(4) The Minister may at any time make an assessment, reassessment
or additional assessment of tax for a taxation year, . . ., except
that an assessment, reassessment or additional assessment may be made after the
taxpayer’s normal reassessment period in respect of the year only if
. . .
(b) the assessment, reassessment or additional
assessment is made before the day that is 3 years after the end of the normal
reassessment period for the taxpayer in respect of the year and
. . .
(iii) is made as a consequence of a transaction involving the
taxpayer and a non-resident person with whom the taxpayer was not dealing at
arm’s length,
. . .
[11]
Subsection 247(2)
says:
247(2) Where a taxpayer . . . and a non-resident person
with whom the taxpayer . . . does not deal at arm’s length . . .
are participants in a transaction or a series of transactions and
(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, or
(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,
any amounts that, but for this section and section 245, would be
determined for the purposes of this Act in respect of the taxpayer . . .
for a taxation year or fiscal period shall be adjusted (in this section
referred to as an “adjustment”) to the quantum or nature of the amounts that
would have been determined if,
(c) where only paragraph 247(2)(a) applies, the terms
and conditions made or imposed, in respect of the transaction or series,
between the participants in the transaction or series had been those that would
have been made between persons dealing at arm’s length, or
(d) where paragraph 247(2)(b) applies, the
transaction or series entered into between the participants had been the
transaction or series that would have been entered into between persons dealing
at arm’s length, under terms and conditions that would have been made between
persons dealing at arm’s length.
Arguments, issues[2]
[12]
The Appellant says that
one of the essential elements of both of the above provisions is that there
must be a transaction between the Appellant and a non‑resident
person with whom the Appellant does not deal at arm’s length. The Appellant’s
focus was on the non-resident character of the other party.[3]
[13]
The Appellant argued that
the central management and control of Barco was in Canada.
Relying on the admitted facts, the Appellant argued:
. . . The appellant manufactured the product
(inaudible) in Canada to the U.S. The appellant sold the products. The appellant
performed the following business functions: management, corporate
strategy, treasur[y], legal, regulatory, personnel, manufacturing,
marketing. Dealt with all the business risks. [Barco] assumed no
business risks. [Barco] had no employees and the two Barbadian directors
who were inactive and it used agents. The sole purpose of [Barco] was to
channel funds.
Applying the law that we have just been through to those
facts, your honour, I believe the inescapable conclusion is central management
and control was exercised by the appellant, a Canadian resident, and when I say
the appellant is a Canadian resident, that is quite a (inaudible) yes, but we
will see in the effect of the facts that it was incorporated -- the
appellant was incorporated in Ontario on September 20th, 1995, and by virtue of
the Income Tax Act it is deemed to be a resident of Canada. I don't think
there is any dispute about that.
The appellant, a Canadian resident, exercised central
management and control over [Barco]. [Barco] is therefore a resident of Canada, and therefore not
a non‑resident . . . .
Consequently, the Appellant argued that Barco was a
resident and that subsection 247(2) could have no application. For the same
reason the Appellant took the position that subparagraph 152(4)(b)(iii)
is inapplicable to the 1999 to 2002 taxation years.
[14]
The Respondent’s
position was that on the admitted facts Barco was a non‑resident, that the
Appellant’s argument took the Respondent by surprise and that it was too late
to be raising something which should have been pleaded earlier.
[15]
The issues to be
determined are:
(a) whether the issue of
Barco being a resident of Canada was properly raised by the Appellant and
the Appellant should be precluded from making the argument; and
(b) whether Barco was a
resident of Canada.
Was the issue of Barco’s residence properly raised?
[16]
The purpose of
pleadings and pretrial procedures is to clarify and narrow the issues.[6] Among other objectives it seeks to promote
more efficient proceedings by eliminating surprise.
[17]
The Appellant has
certainly not conformed with that objective here. There is absolutely nothing
in the notice of appeal to suggest that the residence of Barco is in issue.
[18]
The failure to raise the issue in
the notice of appeal is compounded by the Appellant having accepted the notice
to admit thereby reinforcing the impression that there was no dispute that “Pro-Tect Plastic Fabricators International
Corp. (“Barco”) was incorporated in Barbados . . .
and was a non-resident of Canada.”
[19]
In the circumstances it
is not surprising that the Respondent did not foresee the issue of Barco’s
residence.
[20]
The Appellant could
have sought leave to amend its pleadings, but did not do so.,
[21]
The issue of Barco’s
residence was not properly raised. This would be reason enough to dismiss the appeal
given that the Respondent might have conducted its case quite differently had
it known that Barco’s residence was in issue.
[22]
If this were the only reason for
dismissing the appeal I would have to consider whether or not the Appellant ought
to have the opportunity to amend its notice of appeal. Given that this is not
my only reason for dismissing the appeal, it is unnecessary for me to decide
this.
Is Barco resident in Canada?
[23]
The Appellant first
argues that whether or not Barco is resident is a question of law which cannot
be admitted and argues that as a result there is no admission that Barco is a
non-resident.
[24]
While I agree that the
Appellant cannot admit a question of law, the question of residence is a mixed
question of fact and law. The question arises: what exactly is the effect of an
admission of something that is a mixed question of fact and law? For the
purposes of this proceeding it is not necessary to decide that question and I
will proceed, without deciding the question, on the basis that there was no admission
that Barco was a non-resident.
[25]
The Appellant then
argues that the common law test as to whether a company is resident in Canada is the central management and control test. I agree.
[26]
The Appellant argues
that Barco is a resident of Canada based on the admitted facts, notably:
(a) The Appellant did all
the manufacturing of products in Canada and drop shipped them directly to U.S. customers.
(b) The Appellant sold the products.
(c) The Appellant performed the following
business functions: management, corporate strategy, treasury, legal,
regulatory, personnel, manufacturing and marketing.
(d) The Appellant took all
the business risks.
(e) Barco assumed no
business risks.
(f) Barco had no
employees.
(g) Barco had two
Barbadian directors who were inactive and it used agents.
(h) The sole purpose of
Barco was to channel funds.
(i) Barco did not really do much of anything.
[27]
I disagree. The
Appellant’s argument fails to distinguish between the division of roles between
the companies and who has central management and control of Barco.
[28]
Barco’s role was very
limited indeed. On the evidence admitted it did little more than send bills and
collect payments. That is its function. It had no employees and used agents to
carry out these functions.
[29]
The question is “where
is the central management and control of Barco?” not whether, or not, as
between Barco and its parent, the Appellant, Barco does most of the functions
done by the two companies.
[30]
The following facts are
relevant to the issue of management and control:
(a) Barco was incorporated
in Barbados as an international business corporation
(“IBC”) on March 14, 1996.
(b) It had two Barbadian
directors who were inactive in the business and were paid $1,500 per year. It
used agents to perform the invoicing and banking functions.
(c) At all material times,
the shares of Barco were owned 100% by the Appellant.
(d) The Appellant sold its
products at profit to Barco, and Barco then sold them at profit to the
customers in the U.S., with the result that approximately 60% of
the overall profit from these sales was earned by the Appellant, and 40% by
Barco.
(e) The sole purpose for
incorporating Barco and channeling the Appellant’s sales to the customers in
the U.S. through Barco as an intermediary was to
obtain a tax benefit.
(f) The tax benefit
referred to in the previous paragraph was that Barco would earn profits in Barbados which, because it was an IBC, would be taxed at the
rate of 2.5%, and which would then be paid to the Appellant as tax-free dividends.
[31]
Thus there is no reason
to give weight to the ownership of Barco as pointing to management being in Canada. It is well accepted that it is the role of directors
to manage a corporation
and, in the absence of any evidence to the contrary, I must proceed on the
basis that it was the directors who managed the company.
[32]
We know that the
directors were Barbadian and that the company was incorporated in Barbados. They are factors pointing towards management and
control outside of Canada.
[33]
Given the very limited
functions of Barco, functions which would run almost automatically once set up,
one would not expect the directors to have to do much more than the bare
minimum. Accordingly, I do not ascribe much significance to the directors being
inactive. A $1,500 annual payment is consistent with the directors playing a
role even if that role does not take much time.
[34]
In addition facts (d),
(e) and (f) set out in paragraph 30 above show that the sole purpose of Barco
was to make sales through Barco and obtain a significant tax benefit. Such a
benefit would evaporate if Barco were a resident of Canada.
Barco had major incentives to make sure that its central management and control
was not in Canada.
[35]
There are no
indications of management and control being exercised in Canada.
[36]
While one might like to
have more facts, on the facts before me I can only infer that the central
management and control of Barco was outside of Canada
and that, as a result, Barco was a non-resident.
[37]
If there were evidence
to show that the central management and control was in Canada,
the Appellant, who was the sole owner of Barco, was well placed to bring
forward any such evidence. It chose not to do so.
CONCLUSION
[38]
Having concluded that
Barco was a non-resident, it follows that the appeal will be dismissed with
costs to the Respondent.
Signed at Ottawa, Canada, this 25th day of September
2009.
"Gaston Jorré"
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