REASONS
FOR JUDGMENT
Owen J.
I. Introduction
[1]
These reasons address one issue raised in the
appeals by Sifto Canada Corp.[1]
(the “Appellant”) from reassessments dated August 1, 2012 (collectively,
the “Reassessments”) of its taxation years ending December 31, 2004,
November 23, 2005, December 31, 2005 and December 31, 2006
(collectively, the “Taxation Years”). The appeals in respect of this single
issue were heard on common evidence. The nature of the issue is such that if I
find in favour of the Appellants on the issue, the appeals from the
Reassessments must be allowed.
II. The Issue
[2]
The appeals raise three issues in respect of the
Taxation Years: (1) whether the Minister of National Revenue (the “Minister”)
was entitled to issue the Reassessments; if she was, (2) whether the transfer
price reflected in the Reassessments was correct and (3) whether the Minister
was entitled to assess penalties under subsection 247(3) of the Income Tax
Act (the “ITA”).
[3]
At the written request of the parties, the Court
ordered that these issues be bifurcated pursuant to subsection 171(2) of the
ITA and that the first issue be addressed in a separate hearing. The first
issue is framed by the parties as follows:
[W]hether the
Minister was precluded from issuing the August 1, 2012 reassessments by virtue
of any agreement (the existence of which is in dispute), the Canada-United
States Tax Convention or the Income Tax Act?[2]
[4]
The circumstances giving rise to this issue can
be briefly summarized as follows. The Appellant determined that for 2002 to
2006, it had understated its income from the sale of rock salt to a related
corporation resident in the United States. To correct the situation, the
Appellant made a voluntary disclosure to the Canada Revenue Agency (the “CRA”) that adjusted its income upward for those years.
The upward adjustment of income requested in the voluntary disclosure was
accepted by the CRA and the Appellant was reassessed accordingly for its 2002
through 2006 taxation years. The Appellant and a related US corporation then
applied to their respective competent authorities to request a commensurate
reduction in the income recognized in the United States. The competent
authorities reached two agreements which were memorialized in two separate
letters and the Canadian Competent Authority asked the Appellant to accept the
terms of these letters, which it did. The CRA subsequently audited the
Appellant and reassessed the Taxation Years to further increase the income of
the Appellant from the sale of rock salt to the related United States
corporation.
III. The Facts
A. The Statement of Agreed
Facts (Partial)
[5]
At the commencement of the hearing, the parties
tendered a Statement of Agreed Facts (Partial) (the “SAF”)
and a Joint Book of Documents consisting of two spiral-bound volumes
(collectively, the “JBD”). The facts recited in
the SAF are set out in Appendix A to these reasons.
[6]
The JBD included only the documents cited in the
SAF. The SAF states:
The parties to
this proceeding admit, for the purposes of this proceeding only, the truth of
the following facts and to [sic] the authenticity of the documents
referred to in the Statement of Agreed Facts (Partial) as that term is defined
in the Tax Court of Canada Rules (General Procedure).
The parties do
not admit the truth of the contents of the documents referred to in the
Statement of Agreed Facts (Partial) and may challenge the accuracy of any
statements contained in those documents.
B. The Witnesses
[7]
At the commencement of the hearing, the
Appellant tendered an expert report addressing two questions. I rejected the
expert report on the grounds that the content of the report was neither
relevant nor necessary.[3]
The Appellant did not call any witnesses.
[8]
The Respondent called four witnesses. The first
witness was Mr. Timothy R. Mertz, who is the vice-president of
tax at Compass Minerals International Inc. (“Compass”),
the indirect parent of the Appellant and a publicly traded U.S. corporation.[4]
[9]
The other three witnesses were
Mr. Daniel Quinn, who is a manager in a Mutual Agreement Procedure –
Advance Pricing Arrangements Section of the Competent Authority Services
Division (the “CASD”) of the CRA; Mr. Shaun Harkin, who is a senior
international auditor in a Mutual Agreement Procedure – Advance Pricing
Arrangements Section of the CASD; and, Mr. Darryl Boychuk, who is the
manager of the Mutual Agreement Procedure – Technical Cases Section of the
CASD. I will sometimes refer to these three witnesses as the “CRA witnesses”.
[10]
Mr. Quinn and Mr. Harkin had direct
knowledge of the Appellant’s file with the CASD and testified accordingly.
Mr. Boychuk had no such knowledge and only testified as to the practices
and procedures of his group within the CASD.
[11]
Shortly after Mr. Quinn started to testify,
the Appellant’s counsel objected to the testimony of the CRA witnesses on the
basis that any evidence of the subjective intent of the CASD/CRA or its
employees in respect of its dealings with the United States Internal Revenue
Service (the “IRS”) and with the Appellant was not relevant to the determination of
whether agreements existed and, if so, to the interpretation of those
agreements. Counsel suggested that for this reason the CRA witnesses should not
be allowed to testify.
[12]
I allowed the CRA witnesses to testify on the
basis that I could not determine materiality and relevance before hearing the
evidence of the CRA witnesses and that I would address in the context of my
analysis of the applicable law any issue with respect to the materiality and
relevance of any permitted testimony describing subjective intent. I also
advised the Appellant’s counsel that he was free to object to specific
testimony as he saw fit.
[13]
The Appellant’s counsel objected to Mr. Boychuk
testifying on the grounds that he had no personal knowledge of the Appellant’s
file with the CASD and that the practices and procedures of the Mutual
Agreement Procedure – Technical Cases Section of the CASD were not material or
relevant to the issue as that group had no involvement in the Appellant’s file.
[14]
I allowed Mr. Boychuk to testify because
the issue defined by the parties involves, among other things, whether the
Minister and the Appellant entered into agreements, and Mr. Boychuk’s
testimony could conceivably provide further context to the circumstances
described by the first two CRA witnesses. The Appellant’s counsel renewed his
objection on several occasions during Mr. Boychuk’s testimony. I address
the import of Mr. Boychuk’s testimony in Section: IV. Analysis.
C. Summary of the Facts
(1) Background
[15]
The Appellant is a Canadian corporation resident
in Canada and is an indirect subsidiary of Compass. The Appellant owns and
operates a salt mine in Goderich, Ontario.
[16]
During the Taxation Years, the Appellant sold
approximately 50% of its annual rock salt production to North American Salt
Company (“NASC”), a United States corporation resident in the United States for the
purposes of the Canada-United States Tax Convention (the “Convention”).
At the time of the rock salt sales, NASC was an indirect subsidiary of Compass
with the result that, for the purposes of Article IX of the Convention, the
Appellant and Compass were related under paragraph (2) of Article IX of the
Convention.
[17]
The sales of rock salt by the Appellant to NASC
were reported by the Appellant in its T2 income tax returns filed for the
Taxation Years. Compass reported the purchases of the salt by NASC in its
consolidated U.S. income tax returns filed for the period covered by the
Taxation Years.
(2) The Voluntary Disclosure
[18]
In 2006, Mr. Gary Gose was hired by
Compass as Director, International Tax, a position subordinate to that of
Mr. Mertz.[5]
Mr. Gose and others raised concerns regarding the transfer price of the
rock salt sold by the Appellant to NASC. It appears this price was based on a
transfer pricing report and that the methodologies used in that report were
called into question.[6]
At some point after 2006, KPMG prepared a new transfer pricing report (the “2002-2006 TPR”) that addressed the Appellant’s sales
of rock salt to NASC for 2002 through 2006. Mr. Mertz referred to the
2002-2006 TPR as the 2002 to 2006 report.[7]
[19]
Because of the 2002-2006 TPR, the Appellant and
NASC reached the conclusion that the transfer price used to determine the
Appellant’s income from its sales of rock salt to NASC during its taxation
years ending in 2002 through 2006 was less than an arm’s length price.
[20]
By letter dated April 11 2007, the Appellant
made a no-names application to the CRA’s voluntary disclosure program (the “VDP”). The
CRA acknowledged this application in a letter dated April 19, 2007. The
Appellant subsequently made a named application to the VDP by letter dated August 13, 2007
with an enclosure (the “VDP
Application”).[8]
[21]
In the VDP Application, the Appellant disclosed
an accounting error of $2,470,272 for its 2006 taxation year and the following
additional amounts of income in respect of its sales of rock salt to NASC for
its taxation years ending in 2002 through 2006 (the “VDP Period”):
|
Taxation year ended
|
Additional income disclosed
|
|
December
31, 2002
|
$1,899,577
|
|
December
31, 2003
|
$4,206,408
|
|
December
31, 2004
|
$4,306,553
|
|
November
23, 2005 and December 31, 2005 combined
|
$841,745
|
|
|
|
[22]
The enclosure with the VDP Application letter is
a 51-page document with the following on the cover page: “Transfer Pricing Sifto Canada Inc. Voluntary Disclosure
Program Submission Fiscal Years 2002 to 2006” (the “VDP Document”). Section 2.3 of the VDP Document
states:
There is
essentially only one transaction to be included under the VDP: during the VDP
period, Sifto acted as a simple extractor of raw material (i.e. salt) from its
Goderich salt mine and sold that salt to NASC. The issue is whether Sifto sold
that salt to NASC at an arm’s length price, and if not, how much the price of
the salt must be adjusted in order to reflect arm’s length pricing.
[23]
Sections 3 to 9 of the VDP Document and its
three appendices (approximately 39 pages in total) address the arm’s length
price, section 10 addresses penalties, section 11 addresses the accounting
error for 2006, section 12 describes the requirements for a voluntary
disclosure, and section 14 is titled “Conclusion”.
Section 13 describes the relief requested as follows:
Sifto requests
the following:
1 The CRA accept
the proposed adjustments to its income in each of the years under the VDP
period.
2 The CRA waive
or eliminate all applicable penalties in respect of the transactions discussed
above.
[24]
As part of the VDP process, the Appellant filed
amended T2 income tax returns for its taxation years ending in the VDP Period
(the “VDP Taxation Years”) to reflect the
adjustments to income set out in the VDP Application.
[25]
By letter dated March 13, 2008, the Minister
advised the Appellant that the VDP Application had been accepted and that
reassessments would be issued for the VDP Taxation Years to reflect the
additional income disclosed in the VDP Application.
[26]
On April 21 and 22, 2008, the Minister issued
notices of reassessment to the Appellant for the VDP Taxation Years (the “2008 Reassessments”). The 2008 Reassessments reflected the additional income disclosed
by the Appellant in the VDP Application and reported by the Appellant in the
amended T2 income tax returns filed for the VDP Taxation Years. The CRA did not
audit the Appellant prior to issuing the 2008 Reassessments.
(3) The Application to the Canadian Competent Authority
[27]
Because of the 2008 Reassessments, the income
resulting from the adjustment to the transfer price of the rock salt sold by
the Appellant to NASC during the VDP Period was taxed twice: once in Canada and
once in the United States. This incidence of economic double taxation could
only be eliminated by a commensurate increase in the cost to NASC for U.S. tax
purposes of the salt sold by the Appellant to NASC during the VDP Period.
Because NASC was part of a consolidated group for U.S. income tax purposes, the
resulting downward adjustment to income would be reflected in the consolidated
income tax return of Compass. As a result, Compass was the relevant U.S.
taxpayer.
[28]
The Appellant applied to the Canadian Competent
Authority (the “CCA”) and Compass applied to the United States Competent Authority (the
“USCA”) for relief from double taxation under Articles IX and XXVI of the
Convention. The IRS is the USCA[9] and the Minister is the CCA. At the time of the applications, Ms.
Patricia Spice was the Minister’s authorized representative.[10]
[29]
The Appellant’s application to the CCA (the “CCA Application”)[11] was made by letter dated April 30, 2008. A copy of the VDP Document
was enclosed with the CCA Application. The CCA Application stated, in part:
We are writing to
request Competent Authority assistance on behalf of our client, Sifto Canada
Inc. (“Sifto”), regarding Notices of
Reassessment mailed April 21, 2008 for Sifto’s taxation year ended December 31,
2006, and April 22, 2008 for Sifto’s taxation years ended December 31,
2002, 2003, and 2004, and November 23, 2005. In accordance with paragraph 19 of
Information Circular IC71-17R5 (“the IC”), we
have provided the relevant information of Sifto in italics below:
. . .
q) the taxpayer’s
views on any possible bases on which to resolve the issues.
As a result of the Notices of Reassessment mentioned above, Sifto is
requesting the Canadian Competent Authority to request the US Competent
Authority to allow a corresponding deduction in the taxable income of NASC in
order to prevent double taxation.[12]
[Italics in original.]
[30]
At the time of the application, Mr. Quinn
was a manager in the CASD. He assigned the file to Mr. David Dougherty,
who was an analyst in the CASD. After Mr. Dougherty left the CASD around
February 16, 2009,[13]
the file was assigned to Mr. Harkin, who was also an analyst in the CASD.
[31]
Mr. Quinn described his role with respect
to the Appellant’s CCA file and the role of the CCA in general as follows:
My role was to
oversee the decision–making, to sign letters, to sit in on conversations with
the taxpayer and with the IRS, and just to be involved on a regular basis as to
the progress of the file.[14]
. . .
Competent
Authority endeavours to resolve issues of tax contrary to our Tax Treaties, so,
for example, double taxation. We engage with other tax authorities under the
Mutual Agreement Procedure Article and endeavour to resolve double tax with
other tax authorities on behalf of taxpayers.[15]
[32]
Mr. Quinn explained that the CCA would
become involved with a taxpayer’s file once the taxpayer initiated a mutual
agreement procedure (“MAP”) request under one of
Canada’s bilateral income tax conventions. Mr. Quinn confirmed that the
CCA Application was made under Article XXVI of the Convention. He described in
general terms the steps taken by the CASD in response to a MAP request from a taxpayer:
When we receive a
MAP request, we log it in our inventory system, and it gets assigned to a
group, and then it gets assigned to an analyst. And that analyst then
determines if there’s tax contrary to the Convention and initiates work to
acknowledge the request to the taxpayer and engage the other tax authority and
work towards resolving the issue.[16]
[33]
Mr. Quinn described the process with the
competent authority of the other country in the following exchange with
Respondent’s counsel:
Q. Mr. Quinn,
continuing on, can you tell us how Competent Authority cases are discussed
between countries?
A. Yes. They’re
discussed by telephone, by letter, and in-person meetings. Regular meetings are
held with tax authorities that we have a lot of work with. So, with the U.S.,
we would meet the IRS on a regular basis, two to three times a year. And,
besides that, we would converse with them via telephone on a regular basis.
Q. And who
is involved in these discussions?
A. For
Sifto or in general?
Q. Generally,
and then for Sifto.
A. Well,
generally, the analyst that has the case would be involved via telephone. If
there’s a meeting, then both the analyst and myself, as manager, would normally
be present at the meeting. Sometimes I would be involved in conference calls. And,
on the U.S. side, it would be the same. It would be the analyst and manager
involved in meetings, and telephone conversations would normally just be
between the analysts.
Q. And are
taxpayers involved in these discussions?
A. Taxpayers
are not directly involved. They are involved to the extent that they are to
provide information, as they would in their initial request. And if the tax
authorities have any additional requests for information, then, again, they’re
obligated to provide that to both tax authorities. And they are kept informed
as to the progress of the discussions.
Q. What
happens if the Competent Authorities come to an agreement?
A. If we
come to an agreement, then we would generally memorialize that agreement in a
letter or an exchange of letters. We would advise the taxpayer of the
agreement, the terms of the agreement. Normally we would do that verbally, and
we would also normally follow that up with a letter outlining what the
agreement is. And then we would notify our local offices. If there’s an
objection in play, then we would notify our appeals office, and we would also
notify our Tax Services Office, our Audit division normally.
[34]
Compass’s application to the USCA (the “USCA Application”)[17]
was made by letter dated May 13, 2008. Various documents were enclosed with the
USCA Application, including copies of the 2008 Reassessments and a copy of the
VDP Document.
[35]
By letter dated August 12, 2008 received by the
CASD on August 29, 2008,[18] Mr. Barry Shott asked Ms. Spice to provide “us with the details of your position
concerning the adjustments so that we can evaluate the issue for purposes of
considering relief from economic double taxation”.
At the time, Mr. Shott was the United States Competent Authority, Deputy
Commissioner (International), Large and Mid-size Business. The letter was on
the letterhead of the Department of the Treasury, IRS.
[36]
In cross-examination, Mr. Quinn conceded
that the CCA knew that the IRS would conduct an evaluation. However, he avoided
the suggestion that the evaluation was of Canada’s position on the transfer
price of the rock salt sold by the Appellant to NASC during the VDP Period. He
instead suggested that the USCA needed to confirm that the Appellant had been
reassessed by the CRA as indicated in Compass’s application to the USCA.[19]
[37]
In two letters from Ms. Spice to Mr. Shott
dated November 20, 2008 and February 16, 2009[20] respectively, Ms. Spice describes in general terms the
circumstances giving rise to the Appellant’s request for competent authority
relief under the MAP provision of the Convention:
The request arose
as a result of Sifto’s acceptance into Canada’s voluntary disclosure program. The
adjustment relates to Sifto’s intercompany transactions with a related party,
the North American Salt Company, located in Overland Park, Kansas, for the
taxation years ending 2002 through to 2006.
[38]
Ms. Spice then states:
[November 20, 2008 letter]
We will provide
you with details of our position concerning these adjustments in the near
future, for purposes of providing correlative relief from economic double
taxation.
[February 16, 2009 letter]
. . . Please find
attached our position paper regarding the CRA reassessments resulting from the
voluntary disclosure.
Once you have had
the opportunity to review this position paper, please contact Dan Quinn, who
may be reached at . . . .
[39]
Mr. Dougherty wrote the letter dated
November 20, 2008 and Mr. Quinn reviewed that letter.[21]
Mr. Quinn wrote the letter dated February 16, 2009 and Mr. Dougherty
wrote the enclosed position paper,[22]
which described the position taken by the Appellant in the VDP Document.
[40]
Mr. Quinn testified that the CRA did not
audit the Appellant regarding the transfer price and that the position paper
was “basically a summary of the
taxpayer’s voluntary disclosure” and was “based on the taxpayer’s voluntary disclosure”.[23] Mr. Harkin testified that the position paper was not “typical” and that
it “puts forth the taxpayer’s
position for consideration to the IRS”.[24] Mr. Harkin explained:
A typical
Competent Authority position would have normally come through the audit
background and have extensive analysis done by its CRA audit. And the position
paper would be more, “This is our view,” meaning
in our view, in Competent Authority’s view. “This is
what the adjustment should be.”[25]
[41]
Mr. Harkin met with the USCA on October 22,
2009 and was prepared to present and explain the position paper at that
meeting.[26]
However, the USCA initiated a discussion on the nature of voluntary disclosures
and taxpayer-initiated adjustments, and as a result the CCA “never really
discussed the details of the position paper” with the USCA.[27] The CCA did not
express an opinion on taxpayer-initiated adjustments at the meeting.[28]
The meeting concluded with an indication that the USCA would get back to the
CCA regarding how taxpayer‑initiated adjustments should be handled.[29]
[42]
The USCA did get back to the CCA on May 11, 2010
when Ms. Indu Subbiah, an analyst with the USCA[30], called Mr. Harkin to advise that the USCA would provide
relief from double taxation, subject to further evaluation of the comparable
set.[31] Mr. Harkin was asked about the extent of the negotiations with
the USCA:
Q. What
was the extent of the negotiations that you had with the IRS regarding Sifto’s
MAP request?
A. There
were no negotiations. I did use the word “negotiated” in that entry, in the
CATS entry, but it is -- in Competent Authority, typically any time we meet
with another Competent Authority, we consider it a negotiation. We just use
that term, “negotiation,” but a better word -- often we meet with them and don’t
negotiate, and we might just be talking about status of the files. Or in some
situations, like this situation, we’re just presenting a position. So, in this
file, there was no real negotiation at all.[32]
[43]
The USCA subsequently agreed with Canada’s
adjustments to the Appellant’s income for all but the 2002 taxation year. On
November 10, 2010, Ms. Spice wrote to Mr. Shott’s
successor, Mr. Michael Danilack, describing the terms of the
settlement.[33]
The letter states, in part:
This letter is to
confirm the settlement recently negotiated by our representatives on the
above-mentioned case.
The double
taxation arose from the Canada Revenue Agency (“CRA”) initiated adjustments
relating to the sale of tangible goods by Sifto to its U.S. parent company,
North American Salt Company (“NASC”) for the taxation years 2002 through 2006.
The adjustments
made by the CRA were as follows:
1)
Adjustment to Sifto’s operating income to obtain
a return on total cost equal to the low point of the weighted average
observations obtained from the comparable company data:
. . .
Under the terms of the competent authority settlement:
1.
The Internal Revenue Service (“IRS”) will grant
correlative relief by allowing NASC to decrease its income for the taxation
years 2003 through 2006 as follows:
. . .
2. The IRS has allowed NASC to repay
US$11,090,756 to Sifto free of any U.S. withholding taxes . . . .
3. It is understood that this settlement is
not intended to create a precedent for any subsequent years involving these
taxpayers or for any other case.
We now consider this case closed and will advise Sifto of the terms
of this settlement. . . .
[44]
By letter dated January 25, 2011
received by the CASD on February 11, 2011, Mr. Danilack responded
to Ms. Spice as follows: [34]
We are writing in
furtherance of the mutual agreement procedure concerning Compass Minerals
International, Inc. and its Canadian subsidiary, Sifto Canada Inc. As U.S.
Competent Authority, I hereby confirm, on behalf of the U.S. Internal Revenue
Service, the terms of the agreement memorialized by your letter of November 23
[sic], 2010.[35]
This exchange of letters constitutes a mutual agreement under Article 26 of the
U.S.-Canada Income Tax Treaty.
We are notifying
Compass Minerals International, Inc. of our determination and are providing our
Natural Resources and Construction Industry Director instructions for
implementing our agreement. We now consider this case closed.
[45]
On the same day, Mr. Danilack wrote a
letter to Compass stating in the second paragraph:
A mutual
agreement has been reached regarding the transfer price of the transaction
between Compass and Sifto Canada Inc. (“Sifto”). As a result of our
discussions, the US Competent Authority has agreed to provide full correlative
relief in the amounts shown in the table below.[36]
[46]
Mr. Quinn testified that the CCA viewed the
exchange of the November 10, 2010 and January 25, 2011
letters as a mutual agreement under Article XXVI of the Convention.[37]
[47]
Ms. Spice advised the Appellant’s counsel
of the CCA agreement with the USCA by letter dated November 10, 2010.[38] The letter describes the terms of the competent authority
settlement as described in the November 10, 2010 letter to Mr. Danilack
and then states:
We would
appreciate your advising this office within 30 days of the date of this letter
whether Sifto is prepared to accept the terms of the competent authority
settlement as outlined above. Once we receive your acceptance, we will instruct
our Toronto West Tax Services Office to adjust your tax returns in accordance
with this settlement.
[48]
Mr. Quinn testified that Mr. Harkin
wrote the letter, that this paragraph was “standard wording in our closing letters” and that it was “actually
wrong”.[39] He also stated that he reviewed this letter before it was sent to
the Appellant’s counsel.[40]
[49]
The Appellant responded to this letter by a
letter dated December 1, 2010,[41] with which was enclosed a “signed acceptance of the terms contained in the letter from your
office dated November 10, 2010 for Sifto Canada Corp. (formerly, Sifto Canada
Inc.)”. The enclosure is a copy of Ms. Spice’s
November 10, 2010 letter to the Appellant’s counsel with “agreed & accepted by” written in capitals below Ms. Spice’s title at the end of
letter. Below that statement is the signature of Mr. Rodney L. Underdown
and the title “vice president
& chief financial officer”.
[50]
On December 2, 2010 at 1:56 p.m.,
Mr. Craig Reeder of KPMG sent an e-mail to Mr. Quinn which
reads:
We understand
that Shaun is out of the office this week and thought we would also provide you
with a copy of the acceptance of the Competent Authority settlement by Sifto
Canada Corp. Please confirm that you have received this document and are
satisfied with its contents as acceptance of the Competent Authority settlement
by Sifto Canada Corp.[42]
[51]
On the same day at 1:59 p.m., Mr. Quinn
responded to this email as follows:
Received in good
order Craig, and it is exactly what we need. Thank you.[43]
[52]
In cross-examination, Mr. Quinn
acknowledged that he did not advise the Appellant that there was no agreement
between the Appellant and the CCA.[44]
[53]
The CASD advised Mr. Kamlesh Kumar,
the Assistant Director, Audit at the Toronto West Tax Services Office, and
Mr. Arun Khanna, Chief of Appeals at the Toronto West Tax Services Office,
of the agreement with the IRS by memoranda dated December 17, 2010 from Mr. Harkin.[45] The memoranda were each signed by Mr. Quinn.
[54]
Enclosed with the memorandum to Mr. Kumar was
a copy of an “internal decision
summary” and of Ms. Spice’s November 10,
2010 letter to the Appellant’s counsel with Mr. Underdown’s acceptance at
the end. The last paragraph of the internal decision summary states under the
heading “RATIONALE”:
After numerous
negotiations, the IRS agreed to the adjustments presented in the voluntary
disclosure. The IRS agreed the adjustments conform to the arm’s length
principle. The adjustments adjust Sifto’s operating income to obtain a return
on total cost equal to the low point of the weighted average observations
obtained from the comparable company data.
[55]
The first MAP agreement reached by the CCA and
the USCA did not address the 2002 fiscal period of the Appellant because the
USCA took the position that NASC’s MAP request was made too late to apply to
that year.[46]
However, the USCA reconsidered this position and a second MAP agreement that
included 2002 was reached in April 2011.[47]
[56]
A letter from Ms. Spice’s successor,
Mr. André Lamarche,[48] to Mr. Danilack, dated April 7, 2011,[49] states in the introductory paragraph:
This letter is to
confirm the settlement recently negotiated by our representatives on the
above-mentioned case and is subsequent to our letter of November 10, 2010
as a result of the Internal Revenue Service (“IRS”) now granting correlative relief
with respect to the 2002 year.
[57]
The letter goes on to describe the details of
the settlement and concludes:
We now consider
this case closed and will advise Sifto of the terms of this settlement.
[58]
Mr. Quinn testified that Mr. Harkin
wrote the April 7, 2011 letter to the IRS, that he himself reviewed the letter,
and that Mr. Lamarche signed the letter.[50]
He described the letter as a “standard closing letter”.[51]
[59]
Mr. Lamarche advised the Appellant’s
counsel of the second MAP agreement by letter dated April 7, 2011,[52] and the Appellant accepted the terms of the agreement in the same
manner as the first settlement, by a letter to the attention of
Mr. Lamarche dated April 19, 2011.[53]
[60]
The CASD advised Mr. Khanna and Mr. Paul
Kohut, International Tax Auditor with the Toronto West Tax Services Office, of
the second MAP agreement by memoranda dated April 7, 2011 from Mr. Harkin
but signed by Mr. Quinn. The memorandum to Mr. Khanna included a copy
of the CASD’s “internal
decision summary” and a copy of the letter sent
by Mr. Lamarche to the Appellant’s counsel. The internal decision summary
included the same last paragraph under the heading “RATIONALE” as
that reproduced above.
[61]
Mr. Quinn described these memoranda and
attachments as follows:
These are final
letters, memos from Competent Authority to our Toronto West TSO and to Toronto
West Appeals Division, and they summarize the result of our discussions with
the IRS. And there are some letters attached. The final letters that we
discussed already are attached.[54]
[62]
Mr. Quinn described the paragraph following
the heading RATIONALE as “[s]tandard wording in our
decision summaries”.[55]
Mr. Quinn also stated repeatedly that at that time a MAP negotiation
following a voluntary disclosure was unique.[56]
With respect to the reference in the paragraph to an arm’s length price, the
following exchange with the Respondent’s counsel took place:
Q. And the
next spot I would like to take you to is the decision summary that we were just
speaking about.
Did the Canadian
Competent Authority have a view on the arm’s-length transfer price?
A. No, we
didn’t. We had no idea whether or not the transfer price was arm’s length,
because we're not mandated to audit, and there was no audit in this case that
existed. The Mutual Agreement was that the IRS would provide relief for the
adjustments that were initiated by the taxpayer and CRA processed under our
voluntary disclosure program. But in terms of the transfer price, we didn’t
have any view on it. We simply presented the adjustments to the IRS for relief
from double taxation.
(4) The Transfer Pricing Audit of the Appellant
[63]
A chain of e-mails dated between May 20 and 25,
2010[58]
indicates that as of May 20, 2010, Mr. Quinn and Mr. Harkin were
aware of a possible transfer pricing audit of the Appellant’s taxation years
ending in 2004 through 2008 (the “Audit Taxation Years”).
[64]
In an e-mail from Mr. Quinn to
Ms. Tiina Wainman sent May 25, 2010 at 2:50 p.m.,[59] Mr. Quinn states:
I just want to
clarify that the taxpayer’s request to competent authority was inclusive of the
2002 through 2006 taxation years. The taxpayer has been reassessed by CRA for
all of these years, and are [sic] in a double tax situation. We
presented the adjustments to the IRS for their consideration to provide relief.
If you are proceeding with an audit which includes 2004 through 2006 we will
advise the IRS accordingly. We don’t know what the IRS reaction will be (ie. we
don’t know if the IRS will terminate discussions for some years or all years
and we don’t know if they will accept the same case a second time under the MAP
article, should CRA raise more adjustments). We wanted you to be aware of the
increased risk to the taxpayer of being subject to double tax for a longer
period of time (the time it takes to finalize your audit) and potentially
permanently (depending on the IRS reaction).
[65]
Mr. Harkin testified that he had a telephone
conversation with Ms. Indu Subbiah on May 28, 2010 during which
he advised her of the taxation years of the Appellant that would be under
audit.[60]
Mr. Harkin had a further telephone conversation with Ms. Subbiah on
June 7, 2010. He described the content of the conversation as
follows:
This is a follow-up
phone call with Indu approximately 10 days after the prior one, after we had
informed them of the years that would be under audit.
And Indu
indicated that we should proceed, basically, with resolving the double tax. She
was concerned that the arbitration date was getting close, and she was also
concerned with the fact that the audit could be prolonged, and the taxpayer
would be facing double tax for a prolonged period of time.
She also
indicated that, if another MAP were to come in as a result of the CRA audit,
that the IRS would not be receptive to another transfer pricing method. They
would more or less -- their transfer pricing method would be what was presented
in the taxpayer’s voluntary disclosure.[61]
. . .
Well, in the
subsequent phone call with Indu, she indicated that, if a second MAP request
were to come in, the transfer pricing method that they would put forth would be
the method that’s described in the voluntary disclosure. I guess they didn’t
comment directly on whether they would accept a second case, but they said
that, if it were to come in, that would be their position, their transfer
pricing method.[62]
[66]
In cross-examination, Mr. Quinn
acknowledged that further adjustments to the transfer price because of an audit
could have placed the Appellant at risk for permanent double taxation if the
USCA did not agree to a second MAP agreement.[63]
Mr. Quinn was asked about the CCA’s specific actions regarding the pending
audit:
Q. . . .
What do you do at that point? Did you consider a number of options to put your
current review in abeyance?
A. What we
did is we consulted the IRS first and advised them of the situation. Putting
the request in abeyance wasn’t a viable option because this file was becoming
eligible for arbitration as of December 2010, and they could have invoked
arbitration at that time. And there was no guarantee that the audit would be
finished at that time. So that’s the problem with involving Audit when we have
a current case in Competent Authority.[64]
. . .
Q. I appreciate
the file was resolved. But did you ever advise the IRS that you wanted to hold
off further discussions?
A. We
didn’t advise them that we wanted to. What we advised them was our auditors
were auditing those years, and we wanted to know what they felt was the best
way to proceed, given that fact, given the fact that there would potentially be
further reassessments. And their view was they wanted to close the case as it
was.[65]
. . .
Q. Did
anyone from Canada ever pick up the phone and say to the IRS, “We have to hold
off this file. That’s what Canada wants to do. We have to hold it off”?
A. No.[66]
. . .
Q. All
right. 2011. So let’s go back to 2010. Did you ever get confirmation from the
IRS that they would accept another MAP at this stage?
A. No.[67]
[67]
In an e-mail from Ms. Wainman to
Mr. Quinn sent on December 17, 2010 at 10:39 a.m., Ms. Wainman
states:
We had a bit of a
frantic call from the auditor on the file I had discussed with you several
months ago. [It’s] the file which involved the voluntary disclosure - my
recollection is that, although CA was about to embark on a discussion with the
IRS to resolve the double tax issue, you were going to hold off as you became
aware of the ongoing audit, which included some of the VD years. I believe CA
was going to advise the IRS of that decision.[68]
[68]
Mr. Quinn responded at 10:43 a.m. as
follows:
Yes, we advised
the IRS of the ongoing audit, and the potential for further adjustments.
However, I recall that the IRS had already agreed to provide full relief, and
they didn’t retract that when we informed them of the audit, and potential
additional adjustments.[69]
[69]
Mr. Quinn responded again at 10:48 a.m. as
follows:
And I just (a
second ago) signed the closing memo to the field, directed to Kamlesh Kumar
(ADA)… It summarizes situation.[70]
[70]
A subsequent chain of e-mails between Ms. Spice
and Mr. Harkin dated May 31, 2011[71] indicates that
Ms. Spice was concerned about the audit of the Audit Taxation Years
following the MAP agreement. In the first e-mail in the chain, from
Mr. Harkin to Ms. Spice, sent on May 31, 2011 at 11:00 a.m.,
Mr. Harkin states:
It was at the May
28/10 discussions where I advised the IRS of the possible intention of CRA
auditing the 2004-08 years. The possibility of a CRA audit had just recently
been brought to our attention prior the May 28 phone call. This was late in the
negotiation process where an agreement was imminent. The IRS felt that since
the t/p is currently facing double tax we should endeavor to resolve the case.
The IRS did not comment directly on whether they would accept a second case.
They indicated, that if we were to present a second MAP case, their position
would likely be what they were about to agree to. These views were presently [sic]
orally.
[71]
In the second e-mail in the chain, Ms. Spice
asks “At what point did we know an audit was initiated?”
Mr. Harkin responds:
I became aware of
the audit years on May 20/10. It was my understanding that the audit had not
started yet. To clarify, I advised the IRS, on May 28/10, that the 2004-08
would be audited and that possible adjustments could arise regarding the
transfer price of the issue being discussed.
I don’t recall
any discussions with the t/p prior to settlement about being under audit. The
t/p was advised of our agreement with the IRS shortly after the agreement was
reached on June 7/10 by phone and then subsequently with the closing letter.
[72]
The Competent Authority Tracking System (the “CATS”)[72]
shows a telephone conversation between Mr. Harkin and Ms. Indu Subbiah
on May 28, 2010. The log entry states:
Discussed file
again with Indu. She indicated that they would provide relief. I advised our
Audit area intends to audit the years 2004-08. Indu indicated she will consider
this and get back to us.
[73]
In the fourth e-mail in the chain,
Ms. Spice asks Mr. Harkin: “Can I get a copy
of the taxpayer agreement to the settlement please.”[73] Mr. Harkin
responds: “I’ll provide you copies of the taxpayer
agreement to the settlement.”[74]
[74]
A chain of e-mails ending with an e-mail from
Ms. Spice sent on November 22, 2011 at 2:47 p.m. reveals
continued concern regarding the proposed reassessment of the Appellant’s 2004
through 2008 taxation years based on a transfer pricing audit. Ms. Spice
states, in part:
Hi Geri and Tiina
and Jennifer – Shaun suggested we indicate that only some of the years of the
VDP are under audit so that change was made.
I have made more
edits which I think are self-explanatory. . . .
Track changed and
clean versions attached.[75]
[75]
Attached to the chain of e-mails are a
blacklined copy and a clean copy of a document titled “MEMORANDUM
FOR TERRANCE McAULEY SIFTO CANADA CORP. (Information Only)”.[76]
At the time, Mr. McAuley was the Assistant Commissioner of Compliance,
Programs Branch.
[76]
At the end of the document is the name of Lucie Bergevin,
who at the time was the Director General, International and Large Business
Directorate. The body of the clean version of the document states on the first
page:
The purpose of
this memorandum is to provide you with information on a contentious audit and
the issuance of proposal letters on November 16, 2011.
This audit
relates to the above-noted taxpayer for Canada Revenue Agency (CRA) adjustments
that were previously the subject of a mutual agreement procedure (MAP) settlement
with the Internal Revenue Service (IRS). These CRA transfer pricing adjustments
were founded on the taxpayer’s voluntary disclosure under the CRA’s Voluntary
Disclosure Program (VDP). For your information, there is concern, mainly raised
by Competent Authority Services Division (CASD) [Redacted] of possible
consequences that may arise from the proposed (second) reassessment on the same
issue for the same years covered by the voluntary disclosure and the MAP
settlement.
[Redacted]
[Redacted] there is
also a relationship risk. MAP negotiations are concluded on the basis that they
are final and binding on the two treaty partners, and if the taxpayers concur,
on the taxpayers. It has never occurred, to my knowledge, that a treaty partner
has concluded a MAP settlement and then sought to re-open the same case again. It
would be a waste of resources for both countries and would undermine the
credibility of the country raising the second set of adjustments that form the
basis of the second case. [Redacted] The presentation of the second MAP case by
the CRA could negatively affect relations with our treaty partner. [Redacted][77]
[77]
Mr. Quinn acknowledged that he had received
the e-mail from Ms. Spice with the clean and the blacklined versions of
this document attached, and he said that to his knowledge he had not indicated
disagreement with this version.[78]
[78]
In an earlier e-mail in the chain, from
Mr. Quinn to Ms. Spice, sent on November 22, 2011 at 12:00
p.m., Mr. Quinn states:
I’ve read it. It
looks fine to me.
[79]
Mr. Quinn could not recall which version of
the document this comment was in reference to, but he noted that his e-mail to
Ms. Spice preceded Ms. Spice’s e-mail.[79]
(5) The Policy Discussion Regarding Voluntary Disclosures
[80]
In cross-examination, Mr. Quinn was asked
about a policy discussion meeting that took place on January 21, 2009
and two sets of related e-mails: one set dated May 30, 2011 from
Ms. Spice and the other set consisting of emails dated June 15, 2009
and June 23, 2009 from Mr. Quinn.[80]
[81]
The emails and the written summary of the
meeting indicate that the CASD discussed how to address a MAP request following
a voluntary disclosure. In the written summary of the policy discussion, under
the heading “Decision”, the following is stated:
These requests
would fall under the provisions of the MAP article. [Redacted] Accordingly,
CASD will accept requests, and consult the IRS to determine if they concur with
accepting requests and also determine appropriate and reciprocal procedures for
dealing with such cases. CASD will also engage the TSO where appropriate.
[Redacted] In cases of voluntary disclosure in Canada (example 2), CASD will
engage the TSO to obtain the background audit work on the downward adjustment
request, and where substantive audit work to verify the adjustment was not
done, CASD will ask the TSO [to] do such work.
[82]
In one of the two May 30, 2011 e-mails from Ms.
Spice, sent at 2:18 p.m., she states:
Hi all – I was
just checking my files on our position that originated in 2009 and attach the email
and position paper that I understand would still be relevant today. I believe
there was an error in the position paper concerning scenario 2 and suggest the
wording should have been (change is underlined):
In cases of voluntary disclosure in
Canada (example 2), CASD will engage the TSO to obtain the background audit
work on the upward adjustment request, and where substantive audit work
to verify the adjustment was not done, CASD will ask the TSO [to] do such work.
[83]
Mr. Quinn testified that, notwithstanding the
heading of the paragraph which Ms. Spice is correcting, the CASD did not
adopt the policy identified in the paragraph and did not contact the TSO to
have it perform an audit of the transfer price adjustments made by the CRA in
the 2008 Reassessments.[81]
Mr. Quinn stated that instead of the CASD adopting the policy from the
January 21, 2009 policy discussion meeting, the CRA has, within the
past couple of years, amended its voluntary disclosure policy to provide that
transfer pricing voluntary disclosures will not be accepted without their first
being reviewed by audit.[82]
IV. Position of the Appellant
[84]
The Appellant submits that the Appellant and the
Minister entered into a binding agreement that established the transfer price
of the rock salt sold by the Appellant to NASC during the Taxation Years. A
reasonable person looking at the conduct of the parties (including the language
used in the relevant written communications) would conclude that the parties
intended to enter into such an agreement. The Minister’s state of mind and
subjective intention are not relevant as intention must be determined by
reference to conduct, including the language chosen by the parties.
[85]
The Appellant submits that the objective
circumstances establish the existence of the agreement and that the agreement
is enforceable against the Minister as a settlement agreement as well as being
enforceable under the Convention and section 115.1 of the ITA.
V. Position of the Respondent
[86]
The Minister submits that the Appellant has
failed to establish that the Minister is legally barred from issuing the
Reassessments. The letters exchanged by the CCA and USCA, which concluded their
consideration of the Appellant’s and Compass’s competent authority requests, do
not reference a transfer price for the salt sold by the Appellant to NASC
during the Taxation Years and do not represent an agreement between the CCA and
the USCA on the arm’s length transfer price of that salt. The Respondent
submits that the subject matter of the settlement reached by the CCA and USCA
was whether, and on what terms, the competent authorities were willing to
provide the relief from double taxation requested by the Appellant and Compass.
The role of the CCA was advising the USCA on whether, in the particular
circumstances, it believed relief from double taxation was available under the
Convention. The letters exchanged by the CCA and USCA represented a mutual
agreement under the Convention to provide relief from double taxation. The USCA
implemented the agreement by allowing Compass to reduce its income for U.S. tax
purposes.[83]
[87]
The Respondent submits that the Minister did not
enter into a settlement agreement with the Appellant. The CCA accepted the
Appellant’s request for relief from double taxation, presented the Appellant’s
request to the USCA, obtained the agreement of the USCA to provide relief from
double taxation and communicated the result to the Appellant. Nothing in the
facts suggests an intention on the part of the Minister or the Appellant to
create a binding contractual relationship. Specifically, there was no
consideration, no certain terms and no communication of an intention to fix the
transfer price of the salt. Furthermore, even if there was an agreement, it was
not an agreement to fix the transfer price of the salt. This is confirmed by
the factual matrix or surrounding circumstances.
[88]
The Respondent submits that the Minister has a
duty to administer and enforce the ITA, which requires the Minister to apply
the ITA as she understands it to the facts as she finds them. In carrying out
this duty to assess each taxpayer in accordance with the ITA, the Minister is
not bound by the tax returns filed by the taxpayer or by earlier assessments of
the taxpayer. The Minister’s duty is to apply the ITA as it stands subject only
to the time limits imposed by the ITA. The Minister issued the Reassessments
following an audit of the Appellant in which the Minister determined that the
facts showed an arm’s length transfer price different from the price used in
the 2008 Reassessments. In the circumstances, the Minister was duty-bound to
issue the Reassessments.
VI. Statutory and Treaty Provisions
[89]
The provisions of the ITA and the Convention
relevant to the issue under consideration are set out in full in Appendix B to
these reasons. For ease of reference, I have also reproduced some of the
relevant language here:
Section 115.1 of the ITA
115.1(1)
Competent authority [tax treaty] agreements — Notwithstanding any other
provision of this Act, where the Minister and another person have, under a
provision contained in a tax convention or agreement with another country that
has the force of law in Canada, entered into an agreement with respect to the
taxation of the other person, all determinations made in accordance with the
terms and conditions of the agreement shall be deemed to be in accordance with
this Act.
Article IX of the Convention, titled “Related Persons”
1. Where a person
in a Contracting State and a person in the other Contracting State are related
and where the arrangements between them differ from those which would be made
between unrelated persons, each State may adjust the amount of the income, loss
or tax payable to reflect the income, deductions, credits or allowances which
would, but for those arrangements, have been taken into account in computing
such income, loss or tax.
2. For the
purposes of this Article, a person shall be deemed to be related to another
person if either person participates directly or indirectly in the management
or control of the other, or if any third person or persons participate directly
or indirectly in the management or control of both.
3. Where an
adjustment is made or to be made by a Contracting State in accordance with
paragraph 1, the other Contracting State shall (notwithstanding any time or
procedural limitations in the domestic law of that other State) make a
corresponding adjustment to the income, loss or tax of the related person in
that other State if:
(a) It agrees with the first-mentioned adjustment; and
(b) Within six years from the end of the taxable year to
which the first‑mentioned adjustment relates, the competent authority of
the other State has been notified of the first-mentioned adjustment. The
competent authorities, however, may agree to consider cases where the
corresponding adjustment would not otherwise be barred by any time or
procedural limitations in the other State, even if the notification is not made
within the six-year period.
4. In the event
that the notification referred to in paragraph 3 is not given within the time
period referred to therein, and the competent authorities have not agreed to
otherwise consider the case in accordance with paragraph 3(b), the
competent authority of the Contracting State which has made or is to make the
first-mentioned adjustment may provide relief from double taxation where
appropriate.
5. The provisions
of paragraphs 3 and 4 shall not apply in the case of fraud, willful default or
neglect or gross negligence.
Article XXVI of the Convention, titled “Mutual Agreement Procedure”
1. Where a person
considers that the actions of one or both of the Contracting States result or
will result for him in taxation not in accordance with the provisions of this
Convention, he may, irrespective of the remedies provided by the domestic law
of those States, present his case in writing to the competent authority of the
Contracting State of which he is a resident or, if he is a resident of neither
Contracting State, of which he is a national.
2. The competent
authority of the Contracting State to which the case has been presented shall
endeavor, if the objection appears to it to be justified and if it is not
itself able to arrive at a satisfactory solution, to resolve the case by mutual
agreement with the competent authority of the other Contracting State, with a
view to the avoidance of taxation which is not in accordance with the
Convention. Except where the provisions of Article IX (Related Persons) apply,
any agreement reached shall be implemented notwithstanding any time or other
procedural limitations in the domestic law of the Contracting States, provided
that the competent authority of the other Contracting State has received
notification that such a case exists within six years from the end of the
taxable year to which the case relates.
. . .
5. The competent
authorities of the Contracting States may communicate with each other directly
for the purpose of reaching an agreement in the sense of the preceding
paragraphs.
VII. Analysis
A. Introduction
[90]
The Appellant and the Respondent put forward two
entirely different interpretations of the facts. The Appellant says that the
competent authority proceedings resulted in a binding agreement between the
Appellant and the Minister that fixed the arm’s length transfer price of rock
salt sold by the Appellant to NASC during the Taxation years (the “Salt”). The Respondent says that there is no such
agreement and that, even if there is an agreement between the Appellant and the
Minister, it does not fix the arm’s length transfer price of the Salt. In the
circumstances, the Minister was not only authorized, but was required, by the
ITA to issue the Reassessments once in possession of the facts revealed by her
audit of the Appellant.
B. The Factual Matrix
[91]
To resolve the question posed by the parties, I
must first consider the relevant terms of the Convention, as it is under the
Convention that the competent authority proceedings took place and the two
consecutive MAP agreements were concluded. This information is part of the
factual matrix relevant to understanding the terms of the MAP agreements
reached by the CCA and the USCA. In Sattva Capital Corp. v. Creston Moly
Corp., 2014 SCC 53, [2014] 2 S.C.R. 633 (“Sattva”), the Supreme Court of
Canada described the significance of the factual matrix as follows:
The shift away
from the historical approach in Canada appears to be based on two developments.
The first is the adoption of an approach to contractual interpretation which
directs courts to have regard for the surrounding circumstances of the contract
— often referred to as the factual matrix — when interpreting a written
contract [citations omitted].
Regarding the
first development, the interpretation of contracts has evolved towards a
practical, common-sense approach not dominated by technical rules of
construction. The overriding concern is to determine “the intent of the parties
and the scope of their understanding” [citations omitted]. To do so, a
decision-maker must read the contract as a whole, giving the words used their
ordinary and grammatical meaning, consistent with the surrounding circumstances
known to the parties at the time of formation of the contract. Consideration of
the surrounding circumstances recognizes that ascertaining contractual
intention can be difficult when looking at words on their own, because words
alone do not have an immutable or absolute meaning:
No contracts are made in a vacuum:
there is always a setting in which they have to be placed. . . . In a
commercial contract it is certainly right that the court should know the
commercial purpose of the contract and this in turn presupposes knowledge of
the genesis of the transaction, the background, the context, the market in
which the parties are operating.
(Reardon Smith
Line, at p. 574, per Lord Wilberforce)[84]
[92]
With respect to the interpretation of the
Convention, in Crown Forest Industries Ltd. v. Canada, [1995] 2 S.C.R.
802 (“Crown Forest”), the Supreme Court
of Canada said that the paramount goal in interpreting a treaty is:
. . . to find the
meaning of the words in question. This process involves looking to the language
used and the intentions of the parties.[85]
[93]
With that in mind, let us turn to paragraph (1)
of Article IX of the Convention, which provides that, where persons are related
and the arrangements between them differ from those which would be made between
unrelated persons, each state may adjust the amount of the income, loss or tax
to reflect the income, deductions, credits or allowances that, but for those
arrangements, would have been taken into account in computing such income, loss
or tax. There is no question that the Appellant and NASC were related during
the Taxation Years.
[94]
Paragraph (3) of Article IX of the Convention
provides that where an adjustment is made by a contracting state, the other
state shall make a corresponding adjustment to the income of the related person
if it agrees with the adjustment and certain notification requirements are met.
[95]
Paragraphs (1) and (2) of Article XXVI of the
Convention together provide that, where a person considers that the actions of
one or both of the contracting states result in taxation of the person that is not
in accordance with the Convention, that person may present his case to the
competent authority of the state of which he is a resident and, if the
objection appears to be justified and cannot be resolved unilaterally by the
competent authority, that contracting state shall endeavour to resolve the case
by mutual agreement with the competent authority of the other state.
[96]
The mutual agreement procedure described in paragraphs
(1) and (2) of Article XXVI of the Convention applies only when a person
believes he is being taxed in a manner not in accordance with the Convention
and the contracting state of which he is a resident is of the view that the
position is justified. The commentary (the “OECD Commentary”) to the OECD Model
Tax Convention on Income and on Capital (the “OECD Model Convention”)
describes this aspect of the nearly identical Article in the OECD Model
Convention as follows:
. . . the mutual
agreement procedure is clearly a special procedure outside the domestic law. It
follows that it can be set in motion solely in cases coming within paragraph 1,
i.e. cases where tax has been charged, or is going to be charged, in
disregard of the provisions of the Convention. So where a charge of tax has been
made contrary both to the Convention and the domestic law, this case is
amenable to the mutual agreement procedure to the extent only that the Convention
is affected, unless a connecting link exists between the rules of the
convention and the rules of the domestic law which have been misapplied.[86]
[Emphasis added.]
[97]
The Appellant and Compass[87] each presented its
case to the competent authority of the country of which it was a resident. The
case presented focussed on the fact that the Minister’s unilateral adjustment
of the Appellant’s income had resulted in economic double taxation and asked
that the economic double taxation be eliminated. The case presented necessarily
raised the question of whether the Minister’s adjustments to the Appellant’s
income were in accordance with paragraph (1) of Article IX of the Convention. Paragraph
(3) of Article IX mandated that the IRS make corresponding adjustments to the
income of Compass only if the IRS agreed that the Minister’s adjustments were
in accordance with paragraph (1) of Article IX of the Convention.
[98]
The focus of the MAP provision in transfer
pricing cases is identified in the 1992 OECD Commentary:
9. Article
25 also provides machinery to enable competent authorities to consult with each
other with a view to resolving, in the context of transfer pricing problems,
not only problems of juridical double taxation but also those of economic
double taxation, and especially those resulting from the inclusion of profits
of associated enterprises under paragraph 1 of Article 9; the corresponding
adjustments to be made in pursuance of paragraph 2 of the same Article [paragraph
(3) of Article IX of the Convention] thus fall within the scope of the mutual
agreement procedure, both as concerns assessing whether they are well-founded
and for determining the amount.
10. This in
fact is implicit in the wording of paragraph 2 of Article 9 when the bilateral
convention in question contains a clause of this type.[88]
[Emphasis added.]
[99]
The 1984 U.S. Treasury Department technical explanation
of paragraph (2) of Article XXVI of the Convention also highlights the
focus of the MAP provision where Article IX applies:
Paragraph 2
provides that the competent authority of the Contracting State to which the
case is presented shall endeavor to resolve the case by mutual agreement with
the competent authority of the other Contracting State, unless he believes that
the objection is not justified or he is able to arrive at a satisfactory
unilateral solution. Any agreement reached between the competent authorities
of Canada and the United States shall be implemented notwithstanding any time
or other procedural limitations in the domestic laws of the Contracting States
. . . . In a case where the provisions of Article IX apply, the provisions of
paragraphs 3, 4, and 5 of that Article are controlling with respect to
adjustments and corresponding adjustments of income, loss, or tax and the
effect of the Convention upon time or procedural limitations of domestic law.
Thus, if relief is not available under Article IX because of fraud, the
provisions of paragraph 2 or Article XXVI do not independently authorize such
relief.[89]
[Emphasis added.]
C. What did the MAP Agreements
Resolve?
[100] Mr. Quinn stated repeatedly, and the Respondent argues, that
all the CCA did in its handling of the Appellant’s competent authority file was
pass on to the USCA the adjustments requested by the Appellant in its voluntary
disclosure and request relief from double taxation. This description echoes the
general purpose of tax treaties – to eliminate double taxation — but fails to
recognize the specific reason why the MAP provision was engaged in this
instance: taxation not in accordance with the Convention.
[101] Under the applicable terms of the Convention, the issue that the two
competent authorities had to resolve was the adjustments permitted by paragraph (1)
of Article IX or required by paragraph (3) of Article IX of the
Convention. The CCA provided the USCA with a position paper which set out the
Appellant’s rationale for the adjustments to its income. These adjustments had
been accepted by the Minister and implemented in the 2008 Reassessments.[90]
[102] In presenting the position paper to the USCA, the CCA was
necessarily taking the position that the adjustments to the Appellant’s income
were in accordance with paragraph (1) of Article IX of the Convention. The USCA
analyzed Canada’s adjustments and concluded that it agreed with those
adjustments. Paragraph (3) of Article IX therefore required the USCA to make a
corresponding adjustment to Compass’s income, which it agreed to do in the MAP
agreements. The MAP agreements resolved the issue of the application of paragraphs
(1) and (3) of Article IX to the Appellant and Compass respectively, and thus
resulted in taxation in accordance with the Convention.
[103] The CCA and the USCA twice reached a MAP agreement, under paragraph
(2) of Article XXVI of the Convention, regarding the adjustments to be made to
the income of the Appellant and Compass under paragraphs (1) and (3) of Article
IX of the Convention.[91] The first agreement covered the adjustments for 2003 through 2006
and the second added an adjustment for 2002. In each case, the Appellant was
asked to advise the CCA whether it accepted the terms of the MAP agreement, and
the Appellant responded in writing that it did accept those terms.
[104] The terms of the MAP agreements are described in the letters from
the CCA to the Appellant dated November 10, 2010[92] and April 7, 2011[93] (together, the “Letters”). The Letters first identify the
adjustments to the Appellant’s income made by the Minister in issuing the 2008
Reassessments. The Letters then describe the corresponding adjustments that the
USCA will make to the income of Compass. The adjustments to Compass’s income
are in the same amounts as the adjustments to the Appellant’s income except
that they are decreases in income rather than increases in income.
[105] Read as a whole within the relevant factual matrix, the Letters
reflect the IRS’s agreement with the Minister’s adjustments to the Appellant’s
income and describe the relief consequent on that agreement to be provided by
the IRS. In other words, the Letters reflect the Minister’s and IRS’s agreement
that the adjustments to the Appellant’s and Compass’s income set out in the
Letters are in accordance with paragraphs (1) and (3) of Article IX of the
Convention respectively. To suggest that the MAP agreements simply addressed
double taxation of Compass ignores the factual context in which the agreements
were reached by the Minister and the IRS through their respective representatives.
D. Did the Appellant’s
Acceptance of the MAP Agreements Constitute a Settlement Agreement?
[106] The Respondent argues that the Appellant’s acceptance of the two MAP
agreements did not create a binding contractual relationship between the
Appellant and the Minister because there was no consideration, no certain terms
and no communication of an intention to fix the transfer price of the Salt. The
Respondent further submits that, even if there was a binding agreement between
the Appellant and the Minister, it was an agreement to the relief from double
taxation to be provided by the USCA. It was not a settlement agreement
regarding the transfer price of the Salt.
(1) The Law on Settlement Agreements
[107] Recently, in Apotex Inc. v. Allergan, Inc., 2016 FCA 155, the
Federal Court of Appeal provided the following legal framework for assessing
whether a settlement agreement exists (citations omitted):
[21] First, the
court must find on the evidence before it that, objectively viewed, the parties
had a mutual intention to create legal relations.
[22] The test is
whether a reasonable bystander observing the parties would conclude that both
parties, in making a settlement offer and in accepting it, intended to enter
into legal relations . . .
. . .
[25] Second, like
all other agreements, a settlement agreement must satisfy the requirement that
there be consideration flowing in return for a promise. In settlement
agreements, this is almost certainly never a problem—by definition, settlements
are compromises, and so there will be consideration flowing both ways.
[26] The Court
must also find, as an objective matter, that the terms of the agreement are
sufficiently certain . . . . Where the parties “express themselves in such
fashion that their intentions cannot be divined by the court…the agreement will
fall for lack of certainty of terms” . . . . Another way of putting this is
that the court must be satisfied that the parties were objectively ad idem
or were objectively of a common mind.
[27] It is not
for the courts to amend the parties’ offer and acceptance and make the terms
certain. The Court will not make “a new agreement for the parties” where they
“were never ad idem” . . . .
[28] That being
said, where the parties were objectively of a common mind and “intended some
legal relationship to exist between them,” often their reasonable expectations
can be discerned and “courts will generally strive to give effect to [them]” .
. . .
[29] Lack of
certainty of terms leading to a finding that there was no agreement is something
quite different from the presence in an agreement of words that have a range of
meaning. For example, words like “disparage” or “scientific” may have a range
of meaning but as long as a court can divine a meaning from those terms in the
circumstances of a particular case, the agreement is not void for uncertainty .
. . .
[30] An agreement
does not arise until there is [a] matching offer and acceptance on all terms
essential to the agreement . . . . Disagreement, objectively assessed, on an
essential term will mean that there is no agreement. . . .
[31] How does a
court decide what terms are essential and what terms are not?
[32] The court is
to view the specific facts of the case objectively in light of the practical
circumstances of the case and ask whether the parties intended to be legally
bound by what was already agreed or, in other words, whether an “honest,
sensible business[person] when objectively considering the parties’ conduct
would reasonably conclude that the parties intended to be bound or not” by the
agreed-to terms. . . Put another way, looking not through the eyes of lawyers,
but through the eyes of reasonable businesspeople stepping into the parties’
shoes, was there something essential left to be worked out? . . . . Another way
of putting it is to ask how “a reasonable [person], versed in the business,
would have understood the exchanges between the parties” . . . .
[33] When courts
find that there has been an agreement on essential terms, they will often imply
non-essential terms into the agreement . . . . The lack of agreement on
non-essential terms will not stand in the way of a finding of an agreement.
(2) Evidence of Mutual Intention
[108] The first question to be addressed is whether there is objective
evidence that the parties had a mutual intention to enter into legal relations.
The Letters each set out the terms of the settlement reached by the CCA and the
USCA regarding the adjustments to be made under paragraphs (1) and (3) of Article
IX of the Convention, and related matters, such as the repatriation of the
profits to Canada. The penultimate paragraph of each of the Letters states:
We would
appreciate your advising this office within 30 days of the date of this letter
whether Sifto is prepared to accept the terms of the competent authority
settlement as outlined above. Once we receive your acceptance, we will instruct
our Toronto West Tax Services Office to adjust your tax returns in accordance
with this settlement.
[109] Mr. Quinn testified that this paragraph was standard wording
and was “wrong” as there was nothing for the Appellant to agree to because the
adjustments resulting from the MAP agreement were being made only to the income
of Compass. Mr. Quinn did not explain why, in reviewing the Letters, he did not
amend or delete the paragraph if it was indeed “wrong” and therefore not
indicative of the intention of the CCA. Mr. Quinn also appears to have overlooked
the fact that the MAP agreement, if implemented, would result in the return to
the Appellant, free of U.S. withholding tax, of the US$11,090,756 profit
originally attributed to NASC and included in the consolidated income of
Compass.
[110] In my view, the standard paragraph was not wrong but accurately
reflected what had been resolved by the CCA and the USCA under paragraph (2) of
Article XXVI of the Convention. The two competent authorities negotiated[94] and ultimately agreed that the adjustments to the income of the
Appellant were in accordance with paragraph (1) of Article IX of the
Convention. This agreement in turn required the USCA to make the corresponding
adjustments to the income of Compass required by paragraph (3) of Article IX of
the Convention. The MAP agreement therefore resolved the issue necessarily
raised by the Appellant and Compass in order to engage the MAP provision in the
first place: i.e., that there was taxation not in accordance with paragraphs
(1) and (3) of Article IX of the Convention.[95]
[111] The Appellant and Compass each benefitted from accepting the MAP
agreement as the Appellant would have certainty regarding the transfer price of
the Salt and would receive US$11,090,756 free of US withholding tax and Compass
would be allowed to reduce its income for U.S. income tax purposes to reflect
the agreed-upon transfer price, thereby eliminating economic double taxation. These
results belie Mr. Quinn’s suggestion that the Appellant had nothing to
agree too.
[112] The inclusion of the penultimate paragraph in the Letters is also
consistent with the CRA’s own description of the competent authority process
and with commentators’ understanding of that process. In his 1994 text on
double taxation conventions, Philip Baker remarks:
. . . The
taxpayer may be asked whether he accepts the results of the agreement; if he
does then it may be binding on him as a contract. In Canada a taxpayer is not
bound by a mutual agreement unless he accepts it.[96]
[113] Mr. Baker cites paragraph 18 of Information Circular 71-17R3
for the last proposition.[97]
The salient paragraphs of current Information Circular 71-17R5 state:
53. Competent
authority agreements are not considered precedents for either the taxpayer or
the CRA in regard to (re)assessments relating to subsequent years or for
competent authority negotiations on the same issues. This is because the
competent authorities have negotiated an agreement that takes into account the
facts of the particular taxpayer, as well as differences in the provisions of
the tax law in each country and effects of the economic indicators on the
particular transactions at the relevant time. (Re)assessments of subsequent
years should be based on the particular circumstances, facts and documentary
evidence existing for those years.
54. A taxpayer
cannot accept the terms of an agreement for only some issues or taxation years
involved, since the original request by the taxpayer would have asked for
assistance in respect of all issues and taxation years involved and the
competent authorities would have considered all issues and years in the
negotiations.
55. If a taxpayer
is not satisfied with the agreement negotiated by the competent authorities,
the taxpayer may reject it. If this occurs, the competent authorities will
consider the case closed and advise the taxpayer accordingly. Assuming a valid
notice of objection or an appeal has been filed, the taxpayer will still have
the right to proceed through the appeals process and/or to the Tax Court for
Canadian (re)assessments. If the Appeals Branch or the Court does not reverse
the adjustment in its entirety, double taxation may remain. The Canadian
Competent Authority will accept another request by the same taxpayer on the
issue but will only present it to the other competent authority and will not
negotiate the issue a second time.
[114] The CRA’s own Information Circular clearly contemplates the
taxpayer’s acceptance or rejection of a competent authority agreement. Ms. Spice appears to have
understood the general approach set out in the Information Circular because she
asked Mr. Harkin for “a copy of the taxpayer agreement to the settlement”
in an e-mail to Mr. Harkin sent on May 31, 2011.[99] Mr. Harkin
appears to have had a similar understanding since he responded that he would
provide Ms. Spice with “copies of the taxpayer agreement to the
settlement”. While neither statement is relevant to contractual intent at the
time the Letters were sent and signed back, it may be inferred from these statements
that Ms. Spice and Mr. Harkin did not consider the penultimate
paragraphs of the Letters to be wrong.[100]
[115] The CCA had complete control over the wording of the Letters, which
were put to the Appellant on a take it or leave it basis. The wording of the
Letters was not ambiguous. The language used clearly described the terms of the
MAP agreement reached by the CCA and USCA and asked the Appellant to accept or
reject those terms.[101] The Appellant accepted each of the offers in writing and even
followed up with Mr. Quinn, after responding to the first Letter, to
determine if its response had been received and if anything further was
required. Mr. Quinn responded “Received in good order Craig, and it is
exactly what we need. Thank you.”[102] This response is at odds with Mr. Quinn’s suggestion that the
penultimate paragraph of the Letters was wrong and meaningless in the
circumstances.
[116] There is no doubt in my mind that a reasonable person reading the
CCA Letters to the Appellant and the Appellant’s acceptance of the terms of the
Letters would conclude that the CCA made an offer to the Appellant to accept
the terms of the CCA’s MAP agreement with the USCA and that the Appellant
accepted that offer. The relevant factual matrix, including the mutual
agreement process prescribed by the Convention and the CRA’s own public
explanation of the competent authority process, only serves to reinforce this
conclusion. Mr. Quinn’s subjective after-the-fact description of the
Letters is neither relevant nor persuasive in terms of providing a basis for a different
conclusion.
(3) Mutual Consideration
[117] The second requirement is that there must be consideration passing
between the parties. The consideration flowing from the Appellant is the implicit
agreement not to pursue the issue further through any other available avenues.
This consideration is no different than that which exists in any case where a
taxpayer agrees with the Minister to settle an outstanding income tax issue. While
in some cases, such as those addressed by subsection 169(2.2), the agreement of
the taxpayer not to object or appeal would be more explicit, the failure of the
CCA to include in the Letters more explicit language does not mean that the
Appellant gave no consideration in accepting the terms set out in the Letters. Subsection
169(2.2) itself is “for greater
certainty” and does not mean that consideration
only passes if there is a written waiver.
[118] The consideration from the CCA is the agreement to implement the
competent authority settlement if the Appellant concurs. Specifically, the
penultimate paragraph of the Letters states: “Once we receive your acceptance, we will instruct our Toronto West
Tax Services Office to adjust your tax returns in accordance with this settlement”. This statement is consistent with paragraph 55 of Information
Circular 71-17R5, which indicates that if the taxpayer does not accept the
settlement the competent authorities will consider the case closed and will
take no further action.
[119] Upon receipt of the Appellant’s acceptance of the first MAP agreement,
the CASD advised Mr. Kamlesh Kumar, the Assistant Director, Audit at
the Toronto West Tax Services Office, and Mr. Arun Khanna, Chief of
Appeals at the Toronto West Tax Services Office, of the settlement with the IRS
by memoranda dated December 17, 2010 (the “Memoranda”). The
Memoranda fulfil the promise of the CCA described in the last sentence of the
penultimate paragraphs of the Letters. For its part, the Appellant took no
further action until the Reassessments departing from the MAP agreement were
issued. A similar process occurred with the second MAP agreement.
(4) Sufficiently Certain Terms
[120] The third requirement is that the terms of the agreement be
sufficiently certain. Here, as already stated, the terms of the MAP agreements
are clearly stated in the Letters. The Appellant’s acceptance of those terms is
also clearly stated in the sign-back of the Letters to the CCA.[103]
E. Did the Settlement Agreements
Fix the Transfer Price of the Salt?
[121] The Respondent submits that, even if there is an agreement between
the Minister and the Appellant, that agreement does not fix the transfer price
of the Salt.
[122] The Letters describe in detail the adjustments made or to be made in
compliance with paragraphs (1) and (3) of Article IX of the Convention. The
evidence of Mr. Harkin regarding one of his conversations with the USCA
indicates that the USCA was focussing on whether the adjustment of the
Appellant’s income was in accordance with paragraph (1) of Article IX. Specifically,
according to the excerpt from the CATS entered as Exhibit R-3,
Ms. Indu Subbiah stated in a telephone conversation with Mr. Harkin
on May 11, 2010 that she wanted “to analyze the effect of some of the large revenue companies in the
comparable set”. In Mr. Harkin’s
handwritten notes on the same call, he writes under the heading “Indu”:
- feels in
general relief is ok but wants to analyze effect of some of the large companies
in the comparable set
- wants to see if
adj[ustments] are needed.[104]
[123] Mr. Harkin testified to much the same effect.[105] Although if
presented for their truth the statements attributed to Ms. Subbiah are
hearsay, Mr. Harkin’s recording of the statements in his notes and in
summary form in the CATS indicates that he accepted them at face value. Given
the circumstances in which these communications took place (i.e., an official
dialogue between the CCA and the USCA), there is in my view no reason to doubt
that the USCA was doing precisely what Ms. Subbiah suggested in her conversation
with Mr. Harkin – vetting the transfer pricing methodology used to
determine the adjustments to the income of the Appellant.[106]
[124] The Appellant had adopted the transactional net margin method
(“TNMM”), which, in general terms, determines an appropriate profit level for a
taxpayer based on comparable arm’s length data. Unlike, for example, the
comparable uncontrolled price (“CUP”) method, this approach does not rely on a
specific sale price for the Salt. However, an implicit transfer price can be
determined that is based on the profit earned on the sale of the Salt. Thus, by
vetting the methodology, the USCA was in effect determining whether it agreed
with the implicit transfer price yielded by the methodology. This is not
surprising since the adjustments allowed by paragraph (1) of Article IX of the
Convention and the transfer price that gave rise to the adjustments were
inextricably linked such that an agreement to the adjustments was also an
agreement to the implicit transfer price that yielded those adjustments.
[125] The direct relationship of the transfer price of the transactions
between the Appellant and NASC and the adjustments to the Appellant’s income is
highlighted in a letter from the USCA to Compass dated January 25, 2011[107] in which the USCA states:
We have concluded
our discussions with the Canadian Competent Authority with respect to Compass
Minerals International, Inc. (“Compass”) request for competent authority
consideration for the taxable year ended February 28, 2002 - February 28, 2007.
A mutual agreement has been reached regarding the
transfer price of the transaction between Compass and Sifto Canada Inc. (“Sifto”). As a result of our
discussions, the US competent authority has agreed to provide full
correlative relief in the amounts shown in the table below.
[Emphasis added.]
[126] The USCA is informing Compass that a mutual agreement has been
reached regarding the transfer price of the transactions during the identified
period. This correctly recognizes that the adjustments to income allowed by paragraph
(1) of Article IX of the Convention are the result of a transfer price and that
it is impossible to agree to the adjustments to the Appellant’s income without
also agreeing to the implicit transfer price that yields those adjustments.
[127] Similarly, the RATIONALE section of the CASD’s internal decision
summary states:
After numerous
negotiations, the IRS agreed to the adjustments presented in the voluntary
disclosure. The IRS agreed the adjustments conform to the arm’s length
principle. The adjustments adjust Sifto’s operating income to obtain a return
on total cost equal to the low point of the weighted average observations
obtained from the comparable company data.[108]
[128] This description recognizes that the adjustments to the Appellant’s
income implemented by the 2008 Reassessments were in conformity with paragraph (1)
of Article IX of the Convention because they conformed to the arm’s length
principle. In Marzen Artistic Aluminum Ltd. v. The Queen, 2016 FCA 34 (“Marzen Artistic Aluminum”), the Federal Court
of Appeal described this principle in the context of Canada’s domestic transfer
pricing rule:
[15] Since
1939, the Act has included provisions under which a Canadian taxpayer may be
reassessed to include in his Canadian income the difference between the price paid
for a property or service to a non-resident with whom he does not deal at arm’s
length and the price he would have paid had he be [sic] dealing at arm’s
length. Section 247(2) of the Act is the successor provision to section 69(2)
which was repealed in 1998 (Repealed, 1998, c. 19, s. 107(1)).
[16] A
multinational enterprise is free to set a price for a transaction between two
corporations it controls under different tax jurisdictions. Transfer pricing is
the setting of the price between related corporations. Identifying the fair
market value of a transaction between related corporations is the underlying
principle in transfer pricing. It entails a comparative exercise with what
parties dealing at arm’s length would have considered.
[17] The
language in section 247 does not contain criteria nor does it specify a
methodology to determine the reasonable amount parties dealing at arm’s length
would have paid in any given transaction where transfer pricing principles
apply. Consequently, Canadian courts have relied on the OECD Guidelines 1995
(the Guidelines) as being of assistance in that respect.
[18] The
Supreme Court stated in Canada v. GlaxoSmithKline Inc. 2012 SCC
52, [2012] 3 S.C.R. 3 [Glaxo], at paragraphs 20 and 21 that the
Guidelines are not controlling as if they were a Canadian statute but they are
useful in determining the amount a reasonable business person, who was party to
the transaction, would have paid if it [sic] had been dealing at arm’s
length. The Court also affirmed that a transfer pricing analysis is inherently
fact driven.
[129] A similar description is found in Information Circular 87-2R dated
September 27, 1999 (“IC 87-2R”):
7. Canada’s
transfer pricing legislation:
• embodies
the arm’s length principle; and
• requires
that, for tax purposes, the terms and conditions agreed to between non-arm’s
length parties in their commercial or financial relations be those that one
would have expected had the parties been dealing with each other at arm’s
length.
This ensures that
taxpayers, who are non-arm’s length members of a group and engage in
transactions with other members of the group, report substantially the same
amount of income as they would if they had been dealing with each other at arm’s
length.
8. The OECD and
Canada continue to endorse the arm’s length principle as the basic rule governing
the tax treatment of non-arm’s length cross-border transactions.
9. The arm’s
length principle:
• treats
a group of parties not dealing at arm’s length as if they operate as separate
entities rather than as inseparable parts of a single unified business; and
• is
generally based on a comparison of:
-
prices or margins between non-arm’s length
parties on cross-border transactions (“controlled transactions”); with
-
prices or margins on similar transactions
between arm’s length parties (“uncontrolled transactions”).
[130] Accordingly, the determination of whether an adjustment to the
Appellant’s income reflected the arm’s length principle embodied in paragraph
(1) of Article IX of the Convention requires the same general approach as
that imposed by Canada’s domestic transfer pricing rule. Simply stated, the
arm’s length principle requires a transfer pricing analysis. Therefore, it is
not surprising that the USCA focussed on the transfer pricing analysis in the
VDP Document and the CCA’s position paper in determining whether to agree to
the Minister’s adjustments to the Appellant’s income.
[131] Mr. Quinn repeatedly stated that the adjustments put to the
USCA by the CCA were unusual because they resulted from a voluntary disclosure
and that the CCA took no position regarding the adjustments. The Respondent
argues that the CCA did nothing more than accept the Appellant’s request for
relief from double taxation, present the Appellant’s request to the USCA,
obtain the agreement of the USCA to provide relief from double taxation and
communicate the result to the Appellant.
[132] The fact that the adjustments to the Appellant’s income in the 2008 Reassessments
resulted from a voluntary disclosure by the Appellant and the fact that the CRA
chose not to audit those adjustments before issuing the 2008 Reassessments do not alter the fact
that the MAP agreement between the CCA and the USCA necessarily determined the
transfer price of the relevant transactions reflected in the adjustments to the
Appellant’s and Compass’s income.
[133] If the CRA had an issue with the adjustments suggested by the
Appellant in its voluntary disclosure it could easily have audited the
Appellant before issuing reassessments of the VDP Taxation Years. Instead, the CRA
chose to issue the 2008 Reassessments without an audit. Similarly, upon
learning of the pending audit of some of the years under negotiation with the
USCA, the CCA could have chosen to defer or even discontinue those
negotiations. Instead, the CCA chose to continue its MAP negotiations with the
USCA and concluded those negotiations with two MAP agreements. It appears the
latter decision resulted from a concern that the file would be eligible for
arbitration in December 2010.[109]
F. The Form of the Settlement Agreements
[134] The Respondent suggested that the Letters do not conform to a
typical settlement agreement. However, as stated in Apotex, a settlement
agreement does not have to be in any particular form:
[23] The
requirement of an objective, mutual intention to create legal relations does
not mean that there must be formality. Settlements need not be reached through
counsel or in pre-planned, formal discussions.
[24] Indeed, many
cases show that—sometimes much to the surprise of clients and lawyers
alike—seemingly idle conversations can have binding, legal consequences.
Binding settlements can arise from impromptu, informal communications in
relaxed, non-business settings.
[135] In this case, the format of the settlement agreement with the
Appellant was entirely within the control of the CCA. The CCA chose to write to
the Appellant describing the terms of the MAP agreement reached with the USCA
and asking the Appellant whether it accepted the terms of that agreement. As
already stated, there was no ambiguity in the wording of the Letters and the
Appellant clearly accepted their terms. I can see no reason why in such circumstances
the Letters and the sign-back of the Letters should not be considered a
settlement agreement as to the issue resolved by the CCA and the USCA: namely,
the issue of the adjustments to income under paragraphs (1) and (3) of Article
IX of the Convention and the transfer price of the Salt implicit in those
adjustments. The USCA correctly characterized the subject of the MAP agreement
as the determination of the transfer price, as evidenced by its January 25,
2011 letter to Compass.
G. Is the Minister Required to
Reassess the Appellants notwithstanding the Settlement Agreements?
[136] The Respondent argues that, regardless of any agreement that may
exist between the Minister and the Appellant, the Minister was required by the
provisions of the ITA to reassess the Appellant for the Taxation Years once the
Minister determined through an audit that the transfer price used by the CCA
and USCA to determine the correct adjustments under paragraph (1) of Article IX
of the Convention was not correct.
[137] This position raises three issues. First, is the settlement
agreement binding on the Minister such that the Minister cannot reassess
contrary to the agreement? Second, if the settlement agreement is not binding
on the Minister vis-à-vis the Appellant, is the Minister nevertheless bound by
the Convention to give effect to the MAP agreement in assessing the Appellant? Third,
if the Convention alone does not require the Minister to assess the Appellant
in accordance with the MAP agreement, what effect does section 115.1 have on
the Minister’s right to override the MAP agreement?
(1) Are the Settlement Agreements Binding on the Minister?
[138] The crux of the Respondent’s argument is that the Minister is
required to base the assessment of the Appellant on the application of the law
to the facts and that an agreement with the Appellant cannot affect that duty. In
Galway v. M.N.R., [1974] 1 F.C. 600, the Federal Court of Appeal
stated:
. . . the
Minister has a statutory duty to assess the amount of tax payable on the facts
as he finds them in accordance with the law as he understands it. It follows
that he cannot assess for some amount designed to implement a compromise
settlement and that, when the Trial Division, or this Court on appeal, refers
an assessment back to the Minister for re-assessment, it must be for re-assessment
on the facts in accordance with the law and not to implement a compromise
settlement.[110]
[139] Importantly, Galway does not preclude the possibility that
the Minister may agree with a taxpayer to settle a tax case. The Court states
(at page 603):
. . . In the
circumstances, there is no reason why the parties cannot re-apply on the basis
of a consent to a judgment designed to implement an agreement of the parties as
to how the assessment should have been made by application of the law to the
true facts. . . .
[140] Nor does Galway suggest that every settlement is
unenforceable against the Minister because of the Minister’s duty to apply the
law to the facts. The Court in Galway simply acknowledges that the terms
of the settlement must be such that a court could give a judgment on the
same basis as the settlement. If the court could not give such a judgment in
the circumstances, then the settlement is illegal and does not bind the
Minister.[111]
[141] In CIBC World Markets Inc. v. The Queen, 2012 FCA 3, the
Federal Court of Appeal amplifies these points as follows:
CIBC World
Markets cites 1390758 Ontario Corporation v. The Queen (2010), 2010 TCC
572 at paragraph 36 and Smerchanski v. Minister of National Revenue,
[1977] 2 S.C.R. 23 for the proposition that courts have enforced settlements
that apply tax law to agreed facts. That is true. But the Minister’s
power to agree to facts is limited by the Galway principle — the
Minister cannot agree to an assessment that is indefensible on the facts
and the law. Nothing in 1390758 Ontario and Smerchanski
undercuts the Galway principle.
At present, the Excise
Tax Act does not contain a provision allowing the Minister to make
settlements solely on the basis of compromise, rather than following the
facts and the law as the Minister views them or might reasonably defend them.
Put another way and more succinctly, there is no legislative provision that
repeals Galway.
. . .
. . . despite Galway,
a high proportion of cases are not litigated to judgment. Often negotiations
and discussions bring to light new facts, better characterizations of the
overall situation, and richer appreciations of the applicable law. These
negotiations and discussions can culminate in a settlement that the Minister
can implement by reassessing on the basis of defensible views of the facts
and the law.[112]
[Emphasis and double emphasis added.]
[142] In this case, the Minister and the IRS agreed that the adjustments
were in accordance with the arm’s length principle used in paragraph (1) of
Article IX of the Convention and in Canada’s domestic transfer pricing rule.[113]
The Appellant accepted the agreement between the Minister and the IRS. I can see
no basis on which to conclude that the agreement reached by the Minister and
the IRS was indefensible on the facts and the law. The CCA presented the
Appellant’s transfer pricing report to the USCA and the USCA reviewed the data
and apparently concluded that the price for the transactions adopted by the
Appellant satisfied the arm’s length principle. This conclusion was reported by
the CCA to the Toronto West Tax Services Office in the RATIONALE section of the
two decision summaries.[114]
The USCA also indicated that it would not deviate from its transfer pricing
position even if the Minister chose to reassess the Appellant.[115]
[143] Although I do not have the benefit of expert evidence on the
transfer price fixed by the MAP agreements, the TNMM method applied by the Appellant
and accepted by the Minister and the USCA is certainly one reasonable way in
which to determine an arm’s length transfer price. The fact that the net margin
chosen by the Appellant and reassessed by the Minister was at the lower end of
the comparable range is certainly no basis on which to conclude that the price
was indefensible on the facts and the law.
[144] The Minister’s adjustments to the Appellant’s income were accepted
by the IRS even though they reduced the tax payable in the United States. It is
reasonable to assume that the IRS would not accept such adjustments unless it
viewed the adjustments as reflective of the arm’s length principle. This
assumption is consistent with the general approach to paragraph (3) of
Article IX of the Convention (Article 9(2) of the OECD Model Convention)
described in Part II of the 1995 OECD Transfer Pricing Guidelines at paragraph
151:
151. Corresponding adjustments are not mandatory, mirroring the rule
that tax administrations are not required to reach agreement under the mutual
agreement procedure. Under Article 9(2), a tax administration should make a
corresponding adjustment only insofar as it considers the primary adjustment to
be justified both in principle and in amount. The non-mandatory
nature of corresponding adjustments is necessary so that one tax administration
is not forced to accept the consequences of an arbitrary or capricious
adjustment by another State. It also is important to maintaining the fiscal
sovereignty of each Member country.
[Emphasis and double emphasis added.]
[145] In the circumstances, I can find no basis on which to conclude that
the agreement reached by the CCA and the USCA and accepted by the Appellant and
Compass was indefensible on the facts and the law. The fact that the CRA
unilaterally chose to further reassess the Appellant to alter the transfer
price is not evidence that the adjustments in the MAP agreements were indefensible
on the facts and the law. On the other hand, that two arm’s length tax
administrations agreed to the adjustments in the Letters is in my view
indicative of the fact that the adjustments in the Letters are indeed
defensible on the facts and the law. Accordingly, the terms of the April 7,
2011 Letter to the Appellant are binding on the Minister and the Appellant as a
settlement agreement. Those terms fix the income of the Appellant from the
transactions with NASC during the Taxation Years.
(2) Are the MAP Agreements Binding on the Minister?
[146] If I am wrong in this conclusion, I also find that the agreements
between the CCA and the USCA were binding on the Minister as mutual agreements
reached under paragraph (2) of Article XXVI of the Convention and that the
Minister is not permitted to assess in a manner inconsistent with the
agreements.
[147] Articles 26 and 27 of the Vienna Convention (citation at footnote 85
supra) state:
Article 26
Pacta sunt
servanda
Every treaty in
force is binding upon the parties to it and must be performed by them in good
faith.
Article 27
Internal law and
observance of treaties
A party may not
invoke the provisions of its internal law as justification for its failure to
perform a treaty. This rule is without prejudice to article 46.
[148] Canada ratified the Vienna Convention by accession on
October 14, 1970 and the treaty came into force on January 27, 1980.
The United States signed the Vienna Convention on April 24, 1970 but never
ratified the treaty. However, that does not alter Canada’s obligations under
the terms of the Vienna Convention or under the Convention.
[149] In Divito v. Canada (Public Safety and Emergency Preparedness),
2013 SCC 47, [2013] 3 S.C.R. 157, the Supreme Court recognized that
international treaties ratified by Canada are binding:
The international
law inspiration for s. 6(1) of the Charter is generally considered to be
art. 12 of the International Covenant on Civil and Political Rights,
Can. T.S. 1976 No. 47 (“ICCPR”), which has been ratified by 167 states,
including Canada . . . .
As a treaty to
which Canada is a signatory, the ICCPR is binding.[116]
[150] The Convention and the Vienna Convention are each a treaty ratified
by Canada. Moreover, the Convention was given the force of law in Canada by the
Canada-United States Tax Convention Act, 1984, S.C. 1984, c. 20
(the “CUSTCA”). Subsections 3(1) to (2.1) of the CUSTCA state:
3 (1) The Convention is approved and declared to have the
force of law in Canada during such period as, by its terms, the Convention is
in force.
(2) In the event of any
inconsistency between the provisions of this Act, or the Convention, and the
provisions of any other law, the provisions of this Act and the Convention
prevail to the extent of the inconsistency.
(2.1) In the event of any
inconsistency between the provisions of the Income Tax Conventions Interpretation Act and the provisions of the Convention, the
provisions of that Act prevail to the extent of the inconsistency.
[151] Subsection 3(2) of the CUSTCA gives domestic legal effect to Article
27 of the Vienna Convention by ensuring that any conflict between the provisions
of domestic law and the provisions of the Convention is resolved in favour of
the provisions of the Convention. An exception is made for the provisions of
the Income Tax Conventions
Interpretation Act (the
“ITCIA”), but no provision of the ITCIA is relevant to the issue being
addressed in these reasons.
[152] In this case, the Minister entered into two MAP agreements with the
IRS under paragraph (2) of Article XXVI of the Convention. These agreements
determined the income of the Appellant and Compass from transactions involving
the sale and purchase of rock salt. The determinations of income were made in
accordance with paragraphs (1) and (3) of Article IX of the Convention.
[153] The Minister has subsequently chosen not to honour the MAP agreements
by reassessing the Appellant to increase its income from the relevant
transactions with NASC. The Respondent takes the position that there is nothing
in the Convention or Canada’s domestic law to stop the Minister from issuing
the Reassessments.
[154] I disagree. By reassessing the Appellant to increase the income
attributed to Canada from the relevant transactions, the Minister has breached
Canada’s obligations under the Convention by failing to give continuing effect
to MAP agreements reached with the United States under paragraph (2) of Article
XXVI of the Convention.
[155] The Minister relies on her assessing powers under the ITA to justify
this departure. It is true that the provisions of the ITA do not limit the
Minister’s ability to reassess the Appellant in the circumstances. However, the
issuance of the Reassessments is subject to subsection 3(2) of the CUSTCA and
to Article 27 of the Vienna Convention, which afford paramountcy to the
provisions of the Convention. As well, Article 26 of the Vienna Convention requires
Canada to perform the Convention in good faith.
[156] In Gladden Estate v. The Queen, [1985] 1 C.T.C. 163, the
Federal Court-Trial Division observed:
The Treaty was
adopted, approved and made part of the domestic laws of Canada by the Canada-United
States of America Convention Act, 1943, 7 George VI c. 21. It is obvious
that since a treaty is a contract, Canada cannot unilaterally amend its tax
legislation contrary to the treaty except by amending that particular statute
which adopted the treaty. Furthermore this general principle of law is
emphasized and spelled out statutorily in section 3 of that Act which
specifically provides that, should there be any inconsistency between any part
of the treaty and the operation of any other law of Canada the former shall
prevail.[118]
[157] It is just as obvious that the Minister cannot enter into an
agreement with the IRS under paragraph (2) of Article XXVI of the Convention
and then simply choose to ignore that agreement. While Article XXVI may not
explicitly state that MAP agreements are binding on the parties, that does not
mean such agreements are not binding. Tax treaties are not to be interpreted in
such a legalistic fashion:
Contrary to an
ordinary taxing statute a tax treaty or convention must be given a liberal
interpretation with a view of implementing the true intentions of the parties.
A literal or legalistic interpretation must be avoided when the basic object of
the treaty might be defeated or frustrated in so far as the particular item
under consideration is concerned.[119]
[158] The manifest object of Article XXVI of the Convention in the context
of transfer pricing is to resolve by mutual agreement issues of juridical and
economic taxation.[120]
An issue is not resolved if it is open to one state to simply disregard the MAP
agreement that resolves the issue. It is also antithetical to the very notion
of an agreement between two treaty partners to suggest that either party may
simply choose to ignore the agreement. Not only is such a suggestion contrary
to common sense but the adoption of such a principle would effectively neuter
the mutual agreement procedure not only in the Convention but in all of
Canada’s tax treaties. After all, why would a treaty party agree to the
resolution of a tax treaty issue if Canada could simply ignore that resolution
and assess as it sees fit?[121]
[159] On a more technical front, subsection 3(2) of the CUSTCA gives
paramountcy to the provisions of the Convention when they are inconsistent with
the provisions of the ITA. In this case, the power of the Minister to further
reassess the Appellant under the ITA is inconsistent with the power of the CCA
and the USCA to resolve cases by mutual agreement under Article XXVI of the
Convention. Accordingly, the effect of the provisions of the Convention must be
given paramountcy over the effect of the provisions of the ITA.
(3) Section 115.1 of the ITA
[160] The Appellant also sought to rely on section 115.1 of the ITA. An
agreement described in subsection 115.1(1) is deemed to be in accordance with
the ITA. Subsection 115.1(1) states:
Notwithstanding
any other provision of this Act, where the Minister and another person have,
under a provision contained in a tax convention or agreement with another
country that has the force of law in Canada, entered into an agreement with
respect to the taxation of the other person, all determinations made in
accordance with the terms and conditions of the agreement shall be deemed to be
in accordance with this Act.
[161] The Letters describe the terms of the MAP agreement reached by the
CCA and the USCA pursuant to Article XXVI of the Convention. The Minister
expressly asked the Appellant to accept these terms as a condition of implementing
the MAP agreement. For the reasons already given, the Letters represent an
agreement to which the Minister and Appellant are parties by virtue of the
Appellant’s acceptance of the terms of the MAP agreement.
[162] Mr. Boychuk testified as to the typical form of section 115.1
agreements executed by the Minister. The implication of this testimony is that
the Letters do not conform to the typical form of such agreements. In my view,
this testimony is simply another way of suggesting that the Minister did not
have a subjective intention to enter into an agreement to which section 115.1 applied.
[163] The subjective intention of the Minister is not relevant to whether
an agreement was entered into by the Minister and the Appellant. Moreover,
subsection 115.1(1) does not stipulate that an agreement must be in a
particular form for the subsection to apply. The requirements of subsection
115.1(1) are as follows:
1. That the
Minister and another person have entered into an agreement;
2. That the
agreement have been entered into under a provision contained in a tax
convention or agreement with another country that has the force of law in
Canada; and
3. That the agreement
be with respect to the taxation of the other person.
[164] The MAP agreements were entered into by the Minister and the IRS
under paragraph (2) of Article XXVI of the Convention and the Appellant accepted
and thereby agreed to be bound by the terms of the MAP agreements. The MAP
agreements address the taxation of the Appellant and Compass under paragraphs
(1) and (3) of Article IX of the Convention. Consequently, subsection 115.1(1)
deems all determinations made in accordance with the terms and conditions of
the MAP agreements to be in accordance with the ITA.
[165] While subsection 115.1(1) deems the 2008 Reassessments to be in
accordance with the ITA, it does not address the Minister’s ability to further
reassess the Appellant to impose a transfer price different from that agreed to
by the Minister and the IRS and accepted by the Appellant. Accordingly, I find
that this provision is of no assistance to the Appellant regarding the question
of whether the Minister could reassess the Taxation Years.
VIII. Conclusion
[166] On the basis of the foregoing, I have concluded that the
Reassessments are inconsistent with the settlement agreements between the
Minister and the Appellant and with the MAP agreements between the Minister and
the IRS (collectively, the “Agreements”). The Agreements are binding on the
Minister for the reasons given. Accordingly, the appeals in respect of the issue
described in paragraph 3 of these Reasons for Judgment are allowed and the
Reassessments are referred back to the Minister for reconsideration and
reassessment on the basis that the income of the Appellants from the sale of
rock salt to NASC during the Taxation Years is to be determined so as to be
consistent with the Agreements. The parties have
30 days from the date of the Judgment in these appeals to make submissions
of no more than ten pages as to costs.
Signed
at Ottawa, Canada, this 10th day of March 2017.
“J.R. Owen”
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