REASONS
FOR JUDGMENT
Owen J.
INTRODUCTION
[1]
Cameco Corporation (the “Appellant”) appeals the reassessment of its 2003, 2005
and 2006 taxation years by notices dated December 17, 2010,
December 27, 2013 and May 22, 2014 respectively
(individually, the “2003 Reassessment”, the “2005 Reassessment” and the “2006
Reassessment” respectively, and collectively, the “Reassessments”). The Reassessments added the following
amounts to the Appellant’s income:
2003 Reassessment: $43,468,281
2005 Reassessment: $196,887,068
2006 Reassessment:
$243,075,364
[2]
In addition, the 2005 Reassessment and the 2006
Reassessment increased the resource allowance of the Appellant by $12,257,611
and $16,238,233 respectively. The outcome of the appeals regarding the resource
allowance is dependent on the outcome of the appeals regarding the additions to
the Appellant’s income for 2005 and 2006.
[3]
In issuing or confirming the Reassessments that
increased the income of the Appellant for its 2003, 2005 and 2006 taxation
years (the “Taxation Years”), the Minister of
National Revenue (the “Minister”) relied on
subsection 247(2) of the Income Tax Act (the “ITA”). In these appeals the Minister relies first on sham, second on
paragraphs 247(2)(b) and (d) and lastly on paragraphs 247(2)(a) and (c).
THE FACTS
A. The Fact Witnesses
[4]
The Appellant called the following fact
witnesses:
1.
George Assie. Mr. Assie joined the
Appellant in 1981 and retired on December 31, 2010. From 1981 to late
1999, Mr. Assie held a range of positions with the Appellant, including
the following: director, market planning; director, marketing North America and
vice-president, marketing. In August 1999, Mr. Assie was appointed as
president of Cameco Inc. (“Cameco
US”), a newly incorporated United States
subsidiary of the Appellant. At the end of 2002, Mr. Assie was appointed
as senior vice-president, marketing and business development of the Appellant,
a position he held until he retired.
2.
Gerhard Glattes. Mr. Glattes studied law in
Germany and the United States. Mr. Glattes joined a German corporation
called Uranerzbergbau GmbH (“UEB”) as head of its law department in 1969 and was admitted to the Bar
in Germany in 1974. From 1980 to 1995, Mr. Glattes was a managing director
of UEB. From 1984 to 1995, Mr. Glattes was the chief executive officer and
chairman of the board of three subsidiaries of UEB, including one Canadian
subsidiary—Uranerz Exploration and Mining or UEM—that was a joint venture
partner in the Key Lake and Rabbit Lake uranium mines in Saskatchewan. As well,
from 1988 to 1995, Mr. Glattes was chairman of the advisory committee of
the Euratom Supply Agency (“Euratom”), the European nuclear regulator. In 1996, Mr. Glattes
provided services to the Appellant as a consultant because of restrictions
imposed by a non-compete agreement with UEB. From 1997 to June 1998,
Mr. Glattes was the president of Kumtor Operating Company (“Kumtor”), a
wholly owned subsidiary of the Appellant that operated a gold mine in
Kyrgyzstan. Effective July 1998, Mr. Glattes entered into a
consulting agreement with the Appellant in which he agreed to act as a senior
representative of the Appellant in Europe. From July 1999 to
October 1, 2002, Mr. Glattes was the president and chairman of
Cameco Europe S.A. (“CESA”), a Luxembourg subsidiary of the Appellant with a branch in
Switzerland. After the Swiss branch of CESA was transferred to a Swiss
subsidiary of the Appellant—Cameco Europe AG (SA, Ltd.) (“CEL”)—in
October 2002, Mr. Glattes became the president and chairman of CEL
and remained in that position until July 31, 2004, at which point he
retired in anticipation of his 65th birthday in September 2004. After
retiring as president of CEL, Mr. Glattes continued to serve as chairman
of the board of CEL. Mr. Glattes was 77 at the time he testified at the
hearing of these appeals.
3.
William Murphy. Prior to 2000, Mr. Murphy
was the director of international marketing of the Appellant. In late 1999, Mr. Murphy
was appointed as the vice-president of marketing Canada and Asia at Cameco US.
In the summer of 2004, Mr. Murphy replaced Mr. Glattes as the
president of CEL, a position he held until the middle of 2007 when he retired.
4.
Kim Goheen. Mr. Goheen joined the Appellant
in May 1997 as treasurer. In 1999, he became vice-president and treasurer
of the Appellant and in 2004 he became the chief financial officer of the
Appellant.
5.
Lisa Aitken. Ms. Aitken joined the
Appellant in 1996 as a contract administrator but resigned in 1999. Ms. Aitken
returned to the Appellant in 2010 as manager of marketing Canada, later
becoming director of marketing Canada and intercompany
transactions
6.
Treva Klingbiel. Ms. Klingbiel is the president
of TradeTech, a third-party consulting firm active in the uranium industry.
7.
Ryan Chute. Mr. Chute joined the Appellant
in 2004 as an accountant in the finance department and moved to the marketing
department in December 2005 as a specialist in trading and transportation.
His current title is manager of inventory and transportation.
[5]
The Respondent called the following fact
witnesses:
1.
Loretta McGowan. Ms. McGowan joined Cameco
in August of 1994 as a contract administrator. She subsequently became senior
administrator for inventory and in 2005 she was appointed manager, marketing administration,
which involved managing a team of contract administrators. In
January 2010, Ms. McGowan left the employ of the Appellant.
2.
Marlene Kerr. Ms. Kerr started working at
the Appellant in 1980 and held a number of positions in the accounting and
marketing departments. In late 1999, Ms. Kerr was appointed as
manager of marketing for Asia of Cameco US. Effective January 1, 2003,
Ms. Kerr was appointed as manager, marketing
Europe of Cameco US, and effective August 1, 2004 Ms. Kerr was
appointed as vice-president of marketing Asia of Cameco US. At some point after
November 30, 2006, Ms. Kerr was appointed vice-president of marketing
Europe. Ms. Kerr retired in 2009.
3.
Tyler Frederick Mayers. Mr. Mayers joined
the Appellant in January of 2001 as a contract administrator, a position he
held for two and a half to three years. Subsequent to that he held a more
specialized position in inventory management, focusing on UF6
inventories. He left the employ of the Appellant on November 13, 2008.
4.
Rita Sperling. Ms. Sperling joined the Appellant
on September 29, 1986 as an accounting clerk. On
April 12, 1999, Ms. Sperling became a specialist
in marketing administration (also referred to as a contract administrator)
in the marketing department of the Appellant, and in 2006 Ms. Sperling
became a senior specialist in marketing administration.
5.
Tim Gabruch. Mr. Gabruch joined Cameco in
1994 as a contract administrator in the marketing department. From 1995 to 1999,
Mr. Gabruch was a sales representative for North America save for a brief
secondment to the Uranium Institute in 1998. In late 1999, Mr. Gabruch was
appointed manager of marketing North America of Cameco US. In 2004, Mr. Gabruch
was manager of marketing for Asia and Canada, and in 2005 Mr. Gabruch was
manager of marketing for Europe. At the beginning of 2007, Mr. Gabruch
returned to the employ of the Appellant as manager of corporate development and
in the same year became director of corporate development. In 2011, Mr. Gabruch
was appointed to his current position of vice-president of marketing for
Europe.
6.
Shane Shircliff. Mr. Shircliff joined the
Appellant in late 1998 as a contract administrator. Until 2003, Mr. Shircliff
held a variety of other positions in the marketing department of the Appellant,
including inventory administrator and fuel procurement and inventory
specialist. From 2003, Mr. Shircliff was first an analyst and then a
senior analyst in the corporate development and power generation department of
the Appellant. After 2007, Mr. Shircliff was the manager of corporate development
and then the director of corporate development and power generation of the
Appellant. Mr. Shircliff left the employ of the Appellant sometime after
becoming the director of corporate development and power generation.
7.
Raymond Dean Wilyman. Mr. Wilyman joined
the Appellant on March 19, 2001 in the contract administration group
where he remained until 2005. Starting in 2005 he worked for a year in
inventory management, managing U308 inventory. Following
that, he was manager of fuel supply, dealing with the Bruce Power fuel supply
contracts, and then he became a member of the strategy group. All of Mr. Wilyman’s
positions were in the marketing department of the Appellant. Mr. Wilyman
left the employ of the Appellant in January 2012. Prior to being employed
by the Appellant, Mr. Wilyman was employed by the Canada Revenue Agency
(the “CRA”) for eleven years.
8.
Sean David Exner. Mr. Exner joined the
Appellant in January 1996 as a senior accountant in the finance group.
From January 2003 to January 2007, Mr. Exner was the manager of
financial planning, and since January 2007, Mr. Exner has been the
director of corporate development of the Appellant.
9.
Gerald Wayne Grandey. Mr. Grandey joined
the Appellant on January 1, 1993 as senior vice-president of marketing
and business development, a position he held until 1998 or 1999 when he was
appointed executive vice-president. In 2000, Mr. Grandey was appointed president
of the Appellant and in January 2003 he was also appointed chief executive
officer of the Appellant. Mr. Grandey relinquished the title of president
in 2009 or 2010 to allow for succession and retired on June 30, 2011.
10.
Maxine Maksymetz. Ms. Maksymetz joined the Appellant in 1990 in the internal audit group. In 1992,
Ms. Maksymetz transferred to the tax and royalty group of the Appellant where
she eventually became a senior accountant before leaving the employ of the
Appellant in 2000.
11.
Fletcher T. Newton. Mr. Newton was
appointed the general counsel of Power Resources Inc. (“PRI”)—a
United States subsidiary of the Appellant—in 1997. In 1999, Mr. Newton was
appointed president of PRI and in 2004 he was appointed chief executive officer
of PRI, a position he held until he left the employ of PRI in 2007. Mr. Newton
also held senior positions with two other United States subsidiaries of the
Appellant: Crowe Butte Resources, Inc. and UUS Inc.
12.
Randy Belosowsky. Mr. Belosowsky started his career with KPMG in 1985 where he remained until 1995. In
1995, Mr. Belosowsky joined UEM in tax and special projects. In 1998,
Mr. Belosowsky joined the Appellant as a senior accountant, tax and
royalties, and in 2000 he was appointed manager, tax and royalties. In 2004,
Mr. Belosowsky was appointed director, tax and insurance for the Appellant,
and in 2005 he was appointed assistant treasurer of the Appellant. In 2009, Mr. Belosowsky
was appointed director of special projects, tax. In addition to his positions
with the Appellant, on May 6, 2004, Mr. Belosowsky was appointed
managing director of CEL.
[6]
Pursuant to subsection 133(1) of the Tax
Court of Canada Rules (General Procedure) (the “Rules”), the fact witnesses were excluded from the
courtroom until called to give evidence. Pursuant to subsection 146(3) of the
Rules, the Respondent cross-examined those witnesses called by the Respondent
who are in the current employ of the Appellant.
B. The Expert Witnesses
[7]
The Appellant called a total of five witnesses
who were qualified as expert witnesses:
1.
Thomas William Hayslett. Mr. Hayslett was
qualified as an expert in the uranium industry, in particular with respect to
the types of contracts seen in the uranium industry and the particular contract
terms and conditions seen in the uranium market during the 1999 to 2001 period.
2.
Doctor Thomas Horst. Dr. Horst was
qualified as an expert in transfer pricing.
3.
Carol Hansell. Ms. Hansell was qualified as
an expert on corporate governance, specifically with respect to commercial
relationships between parent and subsidiary corporations within multinational
enterprises.
4.
Doctor William John Chambers. Dr. Chambers
was qualified as an expert in issues of creditworthiness, particularly in the
parent-subsidiary context.
5.
Doctor Atulya Sarin. Dr. Sarin was
qualified as an expert in transfer pricing and financial economics.
Doctor Sarin co-authored his expert reports with Doctor Alan C. Shapiro,
who was also qualified as an expert in the same areas but did not testify.
[8]
The Respondent called a total of three witnesses
who were qualified as expert witnesses:
1.
Edward Kee. Mr. Kee was qualified as an
expert in the nuclear power industry for the purpose of rebutting aspects of
the reports of Doctor Horst and Doctor Sarin.
2.
Doctor Anthony J. Barbera. Doctor Barbera
was qualified as an expert in transfer pricing.
3.
Doctor Deloris Wright. Doctor Wright was
qualified as an expert in transfer pricing.
C. Credibility and Reliability of
Fact Witnesses
[9]
The credibility of a witness refers to the
honesty of the witness, or the readiness of the witness to tell the truth. A
finding that a witness is not credible is a finding that the evidence of the
witness cannot be trusted because the witness is deliberately not telling the
truth.
[10]
In Nichols v. The Queen, 2009 TCC 334,
the Court summarized the approach to determining credibility as follows:
This is a case where the decision depends
entirely on my findings of credibility taken in the context of all the evidence
adduced at the hearing. I must determine whether the Appellant has shown on a
balance of probabilities that the Minister’s assessments are incorrect. In
considering the evidence adduced, I may believe all, some or none of the
evidence of a witness or accept parts of a witness’ evidence and reject other
parts.
In assessing credibility I can consider
inconsistencies or weaknesses in the evidence of witnesses, including internal
inconsistencies (that is, whether the testimony changed while on the stand or
from that given at discovery), prior inconsistent statements, and external
inconsistencies (that is, whether the evidence of the witness is inconsistent
with independent evidence which has been accepted by me). Second, I can assess
the attitude and demeanour of the witness. Third, I can assess whether the
witness has a motive to fabricate evidence or to mislead the court. Finally, I
can consider the overall sense of the evidence. That is, when common sense is
applied to the testimony, does it suggest that the evidence is impossible or
highly improbable.
[11]
The reliability of a witness refers to the
ability of the witness to recount facts accurately. If a witness is credible,
reliability addresses the kinds of things that can cause even an honest witness
to be mistaken. A finding that the evidence of a witness is not reliable goes
to the weight to be accorded to that evidence. Reliability may be affected by
any number of factors, including the passage of time.[4] In R. v. Norman,
[1993] O.J. No. 2802 (QL), 68 O.A.C. 22, the Ontario Court of Appeal explained
the importance of reliability as follows at paragraph 47:
. . . The issue is not merely whether the
complainant sincerely believes her evidence to be true; it is also whether this
evidence is reliable. Accordingly, her demeanour and credibility are not the
only issues. The reliability of the evidence is what is paramount. . . .
[12]
With respect to each fact witness, I have
considered the factors identified in Nichols and I have concluded that
each fact witness is credible. Although there are at times inconsistencies
between the oral testimony of a witness and the documentary record as accepted
by me, I consider these inconsistencies to be a reflection on the reliability
of the evidence of the witness and not the credibility of the witness. I will
address specific examples later in these reasons.
D. Summary of the Evidence
(1) The History of the Appellant
[13]
The Appellant was incorporated under the Canada
Business Corporations Act in June 1987 for the purpose of acquiring the
assets of Saskatchewan Mining Development Corporation, a provincial Crown
corporation, and Eldorado Nuclear Limited, a federal Crown corporation. The
acquisition of these assets occurred in October 1988.
[14]
During the Taxation Years, the Appellant and its
subsidiaries (the “Cameco Group”) constituted
one of the world’s largest uranium producers and suppliers of conversion
services. The uranium-related activities of the Cameco Group included exploring
for, developing, mining and milling uranium ore to produce uranium concentrates
(U3O8) and selling produced
and acquired uranium, uranium conversion services and uranium enrichment
services to utilities. The Appellant had uranium mines in Saskatchewan and
uranium refining and processing (conversion) facilities in Ontario. United
States subsidiaries of the Appellant owned uranium mines in the United States.
[15]
The Cameco Group also explored for, developed
and operated gold properties, but those undertakings are not relevant to these
appeals.
(2) The Uranium Market
[16]
During the period 1999 through 2006, the uranium
market was comprised essentially of producers, traders and utilities.
[17]
Uranium is most commonly purchased and sold in
the form of either U3O8 or UF6.
The mining and milling of uranium ore produces uranium concentrate or
yellow cake. The uranium concentrate contains
anywhere from 75% to 99% U3O8 depending on the producer. U3O8 is comprised of essentially two uranium
isotopes: uranium-238 (approximately 99.3% of the total uranium) and
uranium-235 (approximately 0.7% of the total uranium). U3O8 is refined into UO3 and then processed into either UO2 or UF6.
[18]
UO2 is used in heavy water nuclear
reactors and UF6 is used in light water nuclear reactors. During the
period 1999 through 2006 there were approximately 100 nuclear power stations in the world, of which approximately 45 were located in the United
States, 25 were located in Europe and 14 were located in Asia. Approximately 40% to 45% of the western world’s commercial demand
for uranium comes from the United States with the remainder split between
Europe and Asia. Light water nuclear reactors in nuclear power stations create
approximately 95% of the world’s commercial demand for uranium.[12]
[19]
To use UF6 to generate electricity in
a light water nuclear reactor, the UF6 must first be enriched to
increase the content of fissionable uranium-235 to approximately 4.5% and then
the enriched UF6 must be manufactured into fuel assemblies which are
custom-made to meet the specifications of the purchasing utility.
[20]
The process that includes the mining and milling
of uranium ore and the production of fuel assemblies is called the nuclear fuel
cycle. It takes approximately 12 to 18 months to go from the mining of the
ore to the production of the fuel assemblies.
[21]
To convert U3O8 into UF6,
the owner of the U3O8 transports
the U3O8 to the processing facility of an entity that
provides conversion services (a “converter”). The
owner of the U3O8 must have an account with the converter
or must have the use of such an account. Ms. Klingbiel testified that
related parties “quite often” share accounts
with a converter.
[22]
The converter weighs and assays the U3O8
and credits the account with the number of pounds of U3O8
that were delivered to the converter by the owner of the U3O8. It is then possible for the owner of the U3O8
to sell the U3O8 by book transfer to a purchaser that
also has an account with the converter.
Ms. Klingbiel described the advantages of the book transfer system as
follows:
Well, there are a number of advantages. The
primary advantage is that you don’t have to actually physically transport the
material from one location to another in order to effect the sale at the converter.
It also allows, because it’s not physically transported, that you can conclude
a sale on any date the two parties agree to. The other advantage is that any
size lot of material can be agreed to. It’s not constrained by the cylinders or
the canisters that are used for transport. And the other one is that it allows
for confidentiality, because you don’t involve other third parties like
transportation companies or another third-party facility in the process.
[23]
The uranium industry is highly regulated and
because of non-proliferation treaties and political and other considerations
uranium is typically placed into two categories according to its country of
origin: restricted and unrestricted. Restricted uranium is not subject to any
restrictions–the “restricted” label applies
because the uranium can be sold in restricted markets. On the other hand,
unrestricted uranium is subject to restrictions—for example, import quotas or
bans on importation—in many countries. During 1999 through 2006, Russian source
uranium was unrestricted uranium and Canadian source uranium was restricted
uranium.
[24]
U3O8 and UF6
are each a fungible product. U3O8 or UF6 from one producer is
physically interchangeable with U3O8 or UF6 from
another producer. The uranium content of U3O8
varies according to where it is produced, but this variation is removed from
the determination of price when the U3O8 is assayed at a
converter. However, the price of U3O8
or UF6 may be affected by the origin of the uranium–that is, whether
it is restricted or unrestricted–with unrestricted uranium generally accorded a
lower price than restricted uranium.
[25]
Uranium is bought and sold under bilateral
contracts and is not traded on a commodity exchange. U3O8
is sold at a price per pound and UF6 is sold at a price per kilogram
(kgU). The price per kgU of UF6 is calculated by multiplying
the price per pound of uranium as U3O8 by a factor of
2.613 and then adding the price for creating one kilogram of UF6
from U3O8. The conversion factor is essentially the amount of U3O8
required to produce one kilogram of UF6, taking into account the
loss of uranium that occurs in the conversion process, and therefore the formula
yields an approximation of the price of UF6. The price of UF6
in a particular contract for UF6 may vary slightly from the result
produced by the formula.
[26]
The conversion services required to convert U3O8
into UF6 may be sold separately, in which case the purchaser
delivers U3O8 to the converter and the seller delivers UF6
to the purchaser at the same facility.
[27]
The price at which transactions in uranium occur
is not publicly disclosed. However, two companies-Ux Consulting Company LLC (“Ux”) and
TradeTech LLC (“TradeTech”)-published
price indicators during the period 1999 through 2006, although Ux did not start
publishing long-term price indicators until May 31, 2004. TradeTech was formerly Nuexco
and sometimes the TradeTech price indicator is
to as the Nuexco price indicator.
[28]
Ms. Klingbiel provided a description of the
price indicators published monthly by her company, TradeTech, during the 1999
through 2006 period:
. . . Basically there are two categories of
material that are delivered in terms of time periods. There’s the spot delivery
window, and there’s a long-term delivery window.
The spot window will include anything that
calls for delivery within the next 12 months from the transaction date. And
then there are long-term contract prices, or agreements, and those are
multi-year deliveries that occur at some time in the future.
. . .
Q. And can you just read out what
TradeTech’s definition is of the spot indicator.
A. It’s TradeTech’s daily, weekly,
and exchange value are the company’s judgment of the price at which spot and
near-term transactions for significant quantities of natural uranium
concentrates could be concluded as of the close of business each day, the end
of each Friday, or on the last day of the month, respectively.
. . .
Q. The long-term TradeTech price
indicator, could you read out the definition for that, that I understand is the
TradeTech definition.
A. Yes.
“The long-term price is the company’s
judgment of the base price at which transactions for long-term delivery of that
product or service could be concluded as of the last day of the month for
transactions in which the price at the time of delivery would be an escalation
of the base price from a previous point in time.”
Q. This long-term price indicator was
being published by TradeTech in the period 1999 to 2006?
A. It was.
(3) Overview of Contracts for the Purchase and Sale of Uranium
[29]
During 1999 through 2006, two broad categories
of contract were used to purchase and sell uranium in the uranium market: spot
contracts and long-term contracts.
[30]
A spot contract is a contract that provides for delivery of the purchased uranium within
12 months of entering into the contract. A long-term contract is a contract
that provides for delivery of the purchased uranium more than 12 months
after the entering into of the contract. Broadly speaking, these two contract
types are the basis for differentiating between the spot price for uranium and
the long-term price for uranium in the price indicators.
[31]
Mr. Hayslett opined in the Hayslett Report that
the following list of terms should be addressed in a long-term contract for the
purchase and sale of U3O8 or UF6:[37]
1.
Contract term
2.
Annual quantity
3.
Quantity flexibility
4.
Delivery schedule, notices, flexibility
5.
Delivery location(s), method
6.
Material origin
7.
Material specifications
8.
Pricing
9.
Payment terms
[32]
Uranium contracts utilize four types of pricing
mechanisms: fixed pricing, base escalated pricing, market-related
pricing and hybrid pricing. A fixed pricing mechanism specifies a fixed
price for the uranium (e.g., $15 for a pound of U3O8). A
base escalated pricing mechanism specifies a base price for the uranium that is
escalated over time according to a specified formula which typically accounts
for inflation. A market-related pricing mechanism specifies a price that is
determined by reference to one or more indicators of the market price of
uranium (e.g., TradeTech or Ux spot price indicators) at one or more points in
time. A hybrid pricing mechanism uses a combination of base escalated and market-related
pricing mechanisms.
[33]
A spot contract typically includes either fixed
pricing or market-related pricing.
Mr. Hayslett states at page 3 of the Hayslett Report that “[s]pot transactions tend to be done at a fixed price agreed
to between the seller and buyer at the time of contract signing.”
[34]
A long-term contract may include any of the
pricing mechanisms. Mr. Hayslett states at page 3 of the Hayslett Report:
. . . There are two basic pricing mechanisms
for [long-] term contracts: base-escalated and market-related. While there can
be a number of variations (escalation mechanism, base date, market index to
reference, floor price, ceiling price, etc.), pricing can generally be traced
back to one, or a combination, of these two mechanisms. . . .
[35]
A pricing mechanism may include a floor and/or a
ceiling. A floor sets a minimum price for the uranium and a ceiling sets a
maximum price for the uranium.
[36]
A contract will specify the quantity of uranium
being purchased and may provide the buyer with a flex option which allows the
buyer to increase or decrease within a specified range the amount of uranium to
be delivered by the vendor under the contract. To exercise a flex option, the
buyer issues a flex notice to the vendor within the time frame stipulated in
the contract.
[37]
Mr. Hayslett states in the Hayslett Report:
. . . Utility buyers have consistently
indicated that in evaluating offers price and reliability of supply are the two
dominant factors. While other terms, such as quantity flexibility and delivery
notice requirements, may have value, they are typically viewed as
“tie-breakers” between offers that are considered essentially equivalent as to
supply reliability and price.
(4) The Megatons to Megawatts Agreement
[38]
In the late 1980’s and early 1990’s, Mr. Grandey
was the president of the Uranium Producers of America. During this time frame,
an anti-dumping case was brought against the former Soviet Union, which
dissolved into separate states on December 25, 1991. In 1992, in
exchange for the suspension of the anti-dumping case, Russia executed a
suspension agreement (the “RSA”), which placed
restrictions on the sale of Russian source uranium in the United States.
[39]
On February 18, 1993, the United
States and Russian governments signed an agreement concerning the disposition
of highly enriched uranium extracted from nuclear weapons. This agreement was
also known as the Megatons to Megawatts Agreement
(the “MTMA”). The general
aim of the MTMA was to provide Russia with a means to sell uranium formerly
used in its nuclear arsenal. The commercial arrangement contemplated under the
MTMA was implemented through an agreement between the United States Enrichment
Corporation (USEC) and Techsnabexport (Tenex) (the “USECTA”). The RSA was amended to ease the restrictions on the sale of Russian
source uranium in the United States.
[40]
The uranium extracted from Russia’s nuclear
weapons had a high percentage of fissionable uranium-235 and consequently was
known as highly enriched uranium (HEU). To be
commercially marketable, the Russian HEU had to be blended down to low enriched
uranium (LEU) in the form of enriched UF6
that could be used to fuel light water nuclear reactors. To do this, HEU is
blended with natural (i.e., unenriched) UF6 to create the LEU.
[41]
The blending down of the HEU took place in
Russia and the resulting LEU (i.e., enriched UF6)
was delivered to USEC. In exchange, USEC was to
deliver an equivalent quantity of natural (unenriched) uranium in the form of
UF6, which I will refer to as the “HEU feed”, and credits for the enrichment services that would be required to
convert the natural UF6 into enriched UF6 (i.e., into the
LEU delivered by Tenex). The first delivery of LEU took place in June 1995.
[42]
The MTMA and USECTA did not contemplate how the
HEU feed was to be marketed or paid for, and USEC took the position that it was
not required to purchase or pay for the natural UF6 resulting from
deliveries of LEU by Tenex under the MTMA/USECTA.
[43]
In April 1996, the USEC Privatization Act
(the “USECPA”) was enacted. The USECPA regulated
the sale of HEU feed into the United States, allowed the Russian government to
regain title to the HEU feed and formally released USEC from any obligation to
purchase the HEU feed. In July 1998, the United States government
privatized USEC and provided uranium to it. This raised concerns that the
uranium market would be negatively affected by sales of uranium by USEC. To
alleviate those concerns, in September 1998 the Department of Energy (the “DOE”) agreed to withhold from the market for ten years
approximately 30 million pounds of uranium. In October 1998, the United States
government passed legislation which provided the DOE
with US$325 million to purchase the HEU feed arising in 1997 and 1998 from
deliveries of LEU by Tenex to USEC. The DOE also agreed to include the 28
million pounds of HEU feed purchased with the US$325 million in the 10-year
suspension of sales. In exchange, Tenex was to conclude commercial arrangements
for the sale of the HEU feed.[49]
(5) The Agreement Between Tenex and the Western Consortium
[44]
As early as February 24, 1993, the
Appellant was considering the opportunities and issues that might flow from the
arrangements under the MTMA. Fletcher Newton described the Appellant’s reason for this as
follows:
The feed deal, as it was called, was
generating a tremendous amount of UF6, and the Russians needed to monetize
that. So one way or another, that was going to come into the market. And Cameco
felt that it was important for them to at least, to the extent that they could,
participate in that agreement to at least try to control what happened to that
UF6, how it got sold, when it got sold, and where it went, because that much
UF6, if you just dumped it on the market, would have a tremendous impact.
[45]
Following the execution of the MTMA, the
Appellant pursued discussions with the Russian Ministry of Atomic Energy (“MINATOM”) and the United States government, prepared
potential financial scenarios, retained the consulting services of a company
owned by Tom Neff (who had originally proposed the megatons to megawatts
scenario), sought assistance from the Canadian and Saskatchewan governments to
secure an interest in the HEU feed and expressed concern to the United States
government about USEC being be allowed to sell the HEU feed on the spot market. In discussions regarding the HEU feed, Mr. Grandey was the
lead negotiator for the Appellant.[53]
[46]
Until sometime in 1996, the Appellant had
attempted to secure the HEU feed on its own. Other competing parties included
Cogema, a French state-owned uranium producer and competitor, and Nukem Inc. (“Nukem”), a privately owned United States trader in
uranium. The Appellant did not want Nukem to control the HEU feed because of
its concern that Nukem would dump the UF6 on the spot market thereby
depressing the price of uranium.
[47]
On January 27, 1997, the Appellant
submitted a proposal to MINATOM that had been jointly developed by the
Appellant and Cogema. The joint arrangement was considered necessary by both
parties because of the magnitude of the potential commitment to Tenex to buy
the HEU feed. A short time later, Nukem was added as a party with an initial
interest of 10 percent. The three entities were colloquially known as the “western consortium” or the “western
companies”.
[48]
On August 18, 1997, the Appellant
issued a press release reporting the following:
Cameco Corporation today reports that it has
signed an agreement in principle to purchase uranium resulting from the
dismantlement of Russian nuclear weapons.
The agreement covers the purchase by Cameco,
Cogema (a French 89% state-owned private company specializing in the nuclear
fuel cycle) and Nukem Inc. (a privately owned US uranium trader), of the
majority of the natural uranium hexafluoride (the uranium) becoming available
through 2006 as a result of the dilution in Russia of weapons grade highly
enriched uranium (HEU) to commercial grade low enriched uranium for delivery to
the United States Enrichment Corporation (USEC).
[49]
The Appellant was not a party to the agreement described
in the press release. Instead, Cameco Uranium, Inc. (“CUI”)–a Barbados
subsidiary of the Appellant-executed the agreement, which was in the form of a
memorandum of understanding.
[50]
The memorandum of understanding did not result
in an agreement with Tenex to acquire the HEU feed, and in 1998 there were
numerous discussions regarding the HEU feed among the Appellant, Cogema, Nukem,
MINATOM and Tenex.
[51]
Mr. Grandey explained the Appellant’s role in
the negotiations for the HEU feed:
Q. Would it be correct also that Cameco
Corporation took the lead in these negotiations on behalf of the western
consortium?
A. In the negotiations, Cameco was usually
the lead party sort of conducting the negotiation with the French-state owned
Cogema at the table and, later on, Nukem. Everybody obviously acting, but
Cameco was looked at as the leader.
[52]
In a confidential memorandum dated January 4,
1999, Mr. Grandey stated the following:
The United States government has provided a
strong incentive for the Russian Parties to conclude a long term commercial
arrangement on the HEU feed component by offering to purchase all of the 1997
and 1998 feed component deliveries for the sum of $325 million dollars. The
purchased feed component (approximately 28 million pounds U3O8)
would be added to the inventory of the U.S. Department of Energy (“DOE”). As a
further inducement to the Russian Parties, approximately 58 million pounds U3O8
of DOE inventory, including the feed component purchased from the Russian
Parties, would not be sold for a period of ten years. None of these DOE actions
will occur unless the Russian Parties enter into a long term commercial
arrangement on the displaced feed.
Negotiations between the Western Companies
and the Russian Parties recommenced in earnest in Washington D.C. in early
December followed by further discussions in Paris on December 21 and 22. While
the specific terms being discussed are confidential, the general approach is
dictated by the demands of Russian law that a certain minimum value (i.e.,
price) be realized for the feed component and, if not realized within 180 days
after delivery to the Russian Parties by the U.S. executive agent, the feed
component be returned to Russia. In essence, the parties to the negotiations
are discussing a series of options which would allow the Western Companies to
purchase the feed component at prices related to the market price at the time
of delivery, subject to a floor price which is equal to the “minimum” value
demanded by Russian law. To the extent the options are not exercised, the feed
component would be physically returned to Russia to be held in a specially
designated stockpile (the “Russian Stockpile”) subject to strict oversight by
the U.S. government.
[53]
On March 24, 1999, CESA, Cogema, Nukem and Tenex entered into the UF6 Feed Component
Implementing Contract (the “HEU
Feed Agreement”). Also on March 24, 1999, the DOE and MINATOM signed an agreement
facilitating the commercial arrangements under the HEU Feed Agreement.[64]
[54]
Mr. Grandey, as president of CESA, and Mr. Bernard Michel, as authorized signatory, executed the HEU
Feed Agreement on behalf of CESA. At that time, the board of directors of CESA
had not approved the execution of the HEU Feed Agreement. The board of
directors of CESA subsequently ratified the agreement at a meeting held on
April 6, 1999.
[55]
The delay in the board approving the HEU Feed
Agreement was the result of a delay in CESA obtaining the necessary licences, events occurring on March 24, 1999 that required the
Russian delegation to return to Russia a day earlier than the expected
execution date of March 25, 1999, and difficulty in predicting when
the HEU Feed Agreement would be executed by Tenex. At
the time the agreement was ratified, the regulatory issues had not been
resolved and a condition of the ratification was that CESA comply with all
applicable rules and regulations, including those imposed by Luxembourg.
[56]
Mr. Glattes was not present at the April 6,
1999 meeting of the board of directors of CESA, but he was represented by a
proxy. Prior to the April 6 meeting, Mr. Glattes had discussions
in person and by telephone with the members of the board to inform them of the
status of the negotiations with Tenex.
[57]
On April 13, 1999, Mr. Goheen
made a slide presentation to the Executive Committee of the Appellant. The notes accompanying a slide addressing the cost-benefit analysis
with respect to establishing a Swiss trading company state:
Marketing has estimated the gross profit
from HEU to be 4% to 2002 and 6% thereafter.
[58]
Mr. Assie provided the estimated gross profit
figures to Mr. Goheen.
[59]
On April 21, 1999, a law firm acting
for CESA sent a letter prepared in consultation with Mr. Glattes to the Swiss
nuclear energy regulator (the “BfE”). Following meetings with the BfE and Euratom, an arrangement was
reached whereby the purchases and sales of UF6 by CESA would be
governed by the BfE and not by Euratom even though CESA was a Luxembourg
corporation subject to the jurisdiction of Euratom. However,
CESA was required to obtain a specific authorization from the BfE for each
purchase or sale of UF6. In cross-examination, Mr. Glattes testified that, from a narrow
legal perspective, CESA/CEL was authorized to sell uranium only to affiliated
corporations but that the Swiss authorities probably did not care if CESA/CEL
sold to third parties.
[60]
On May 19, 1999, the Appellant
executed a guarantee (the “Tenex Guarantee”) in
favour of Tenex relating to CESA’s obligations under the HEU Feed Agreement. The Appellant guaranteed that CESA would make “due and punctual payment” of all amounts owing to
Tenex under the HEU Feed Agreement and that CESA would promptly and completely
perform all of its obligations under the HEU Feed Agreement. The Appellant was
not called upon to honour the Tenex Guarantee.
[61]
Mr. Assie testified that the guarantee was
requested by Tenex because CESA was a new company. The Appellant asked the
Russian Federation for a similar guarantee of Tenex’s obligations under the HEU
Feed Agreement, which Mr. Assie understood was given to the Appellant. Mr. Grandey testified that the guarantee was required by Tenex
because the structure was relatively new; historically Tenex had been dealing
with the Appellant, and Tenex wanted the assurance of the Appellant regarding
the performance of CESA under the HEU Feed Agreement. Fletcher
Newton provided the following explanation:
At some point in the discussions with Tenex
-- and I couldn’t tell you exactly when, but it was fairly early on -- Cameco
made it clear that, hopefully, when we signed this agreement, they would use a
subsidiary to actually purchase the feed. And the Russians, having had some bad
experiences with bankruptcies and subsidiaries, said, “Okay. That’s fine. Use
whatever Cameco subsidiary you want, but just make sure that we get a Cameco
guarantee to go with it, because ultimately we want to know that Cameco, the
corporation, is standing behind this.”
[62]
On or about August 20, 1999, Mr. Glattes
secured Euratom’s tentative agreement not to impose restrictions on the entry
of the HEU feed into Europe. This allowed CESA and CEL to sell HEU feed to European utilities
without restriction.
[63]
On February 18, 2000, CESA, Cogema and
Nukem signed a UF6 Feed Component Administration Agreement
(the “Administration Agreement”). The Administration Agreement was signed by Mr. Glattes on
behalf of CESA.
[64]
Under section 8.1 of the Administration
Agreement, an administrative committee was appointed to administer those
aspects of the HEU Feed Agreement that required common decision making. Each of
CESA, Cogema and Nukem appointed one individual to the committee. CESA
initially appointed Mr. Glattes.
[65]
Under section 9.1 of the Administration
Agreement, the administrative committee appointed an administrator. The Nukem
representative on the administrative committee proposed that Cameco US be
appointed the administrator, and that was approved by the committee. Mr. Glattes and Mr. Assie explained that this was because
Cameco US had the capabilities to fulfil this role, and Mr. Assie also
stated that Cameco US was “the face to the market”
and that Cogema and Nukem were familiar to the marketing people at Cameco US. Mr. Assie described the administrator’s role as being to
provide administrative services and as involving no decision-making authority.
[66]
Mr. Glattes attended the meetings of the
administrative committee in person, by video conference or by telephone. Draft minutes of each meeting were prepared and were circulated for
comment before being finalized.
[67]
In October 2002, Mr. Glattes advised the
BfE that the Swiss branch of CESA would be transferred to CEL effective
October 1, 2002. Mr. Glattes also negotiated with the BfE a new arrangement pursuant
to which the BfE granted a global authorization for CEL’s transactions in
uranium effective January 1, 2003.
[68]
The HEU Feed Agreement provided CESA, Cogema and
Nukem with exclusive first and second options to purchase the majority of the
HEU feed resulting from the delivery by Tenex to USEC of LEU in 1999 and
subsequent years until Russia’s commitment under the MTMA to deliver the
remaining balance of 440 metric tonnes of HEU, or the equivalent in LEU, was
satisfied.
[69]
A first option was exercised by delivering a
first option exercise notice (a “FOEN”) to
Tenex. Under the default price mechanism in
section 7.02(a) of the HEU Feed Agreement, the price for the UF6 was the greater of 92% of the “Restricted Spot Price” for the month of delivery and
US$29 per kgU. The restricted spot price for a month was the arithmetic average
of the restricted spot price per kilogram of uranium as UF6
published by Ux and TradeTech for the immediately preceding month.
[70]
Under sections 7.03(a) and (b) of the HEU Feed
Agreement, a company exercising an option could elect in the FOEN to use a base escalated price mechanism or a capped market
price mechanism.
[71]
Under the base escalated price mechanism in
section 7.03(a), the base price was the greater of 92% of the “Long Term Price” for the month the FOEN was delivered
to Tenex and US$29 per kgU. The long-term price was the TradeTech long-term
price indicator for U3O8 for the month prior to the month
the FOEN was delivered to Tenex multiplied by 2.61285 plus the TradeTech long-term
conversion price indicator for the same month. The base price so determined was
escalated by the Gross Domestic Product Implicit Price Deflator Index published
by the United States Department of Commerce.
[72]
Under the capped market price mechanism in
section 7.03(b), the price was the lesser of the price determined under the
default price mechanism and 150% of the price that would have been determined
under the default price mechanism if that price had been determined at the time
the FOEN was given to Tenex.
[73]
Mr. Assie was asked about the anticipated
profitability of the HEU Feed Agreement at the time it was entered into in
March 1999:
Q. What was the view within the Cameco group
as to the anticipated profitability of the HEU to be acquired, that could be acquired
under the HEU agreement--
A. Well--
Q.--as at the time of entering into the
agreement, in March of 1999?
A. Right. Well, at the time of that the
agreement was entered into, the expectation was that, at best, it would be
marginally profitable. The reality was that the prices here--the floor price
was right in line with where the market prices were at the time. And that’s the
very reason why it was struck as an option arrangement. There were no firm
purchase commitments made under the contract.
[74]
Mr. Goheen made a presentation to the executive
committee of the Appellant on April 13, 1999 in which he stated that
the “gross profit” from the HEU Feed Agreement
was expected to be 4% through 2002 and 6% thereafter.
Mr. Assie testified that he provided Mr. Goheen with that estimate.
[75]
Mr. Assie explained the low profit
expectations in the following exchange with counsel:
Q. Why did you have such low expectations
with respect to the profitability of the HEU agreement?
A. Well, as I have just stated, the
agreement contained a floor price which was, in effect, really pretty much at
the level of the market price at the time the agreement was being entered into.
And, you know, at that time, in the spring of 1999, those were not, I will say,
heady times in the uranium market. We were not particularly optimistic about
price over the next several years.
And you may recall from the marketing
presentations we looked at yesterday, whenever we were giving our price
projections--and they were often called hockey stick projections--we would
qualify the near-term projections by saying, you know, there’s a lot of
uncertainty in the near term. We would keep pointing to the longer term with
the view that the secondary supplies would ultimately, you know, be consumed or
drawn down and prices would be more reflective of production. But in the near
term, none of us could see that happening. So we had--in our view it was, as to
the profitability here, was not high.
The other thing to keep in mind is the way
the pricing mechanisms worked, you elected an option, and you were going to
receive either an 8 percent discount off the market at the time of delivery, or
you were going to pay a--if you elected a base price mechanism, you were going
to get an 8 percent discount if prices were high enough, an 8 percent discount
from the long-term price at the time you elected it.
If you look at it from a, you know, in some
respects, from a trader’s point of view, to the extent that you were then
placing that material, turning around and placing it with utilities, what could
you reasonably expect to earn on it? Well, the maximum would be 8 percent, but
you would have to deal with all your costs, you know, your costs of marketing,
any exchange fees, you know, market contracts, any discounts in them.
So, you know, coming up with an estimate as
to the profitability of being 4 to 6 percent, that would have been with the
view that, in effect, we were going to be able to elect options under the
agreement.
[76]
All of the uranium purchased by the western
consortium under the HEU Feed Agreement was delivered to the western consortium
at USEC and did not pass through Luxembourg or Switzerland. The UF6
would have been delivered to USEC even if the Appellant instead of CESA had
been a party to the HEU Feed Agreement.
[77]
The HEU Feed Agreement was amended a total of
eight times between 1999 and 2006.
Mr. Glattes stated that the fourth and eighth amendments were important
but that the fourth amendment was the most important. The other amendments were
minor and addressed matters such as banking arrangements and changes of
address.
[78]
The fourth amendment came about because Russia
was not happy with the quantities of UF6 being purchased by the western
consortium in 2000 and 2001. Mr. Grandey explained the issue at a meeting
of the board of directors of the Appellant on May 31, 2001:
Mr. Grandey told the board under the
HEU transaction, the floor price is $29 per kilogram which is the equivalent of
about $9.40 per pound. We believe this is a minimum price below which the
Russians would not sell. It is difficult to exercise options in a weak market
and pay $9.40 a pound. Through 2000 and 2001, the spot price was less than the
Russian floor price. In 2000, Cameco, Cogema and Nukem bought the quota amount
from the Russians to demonstrate to Russia and the US government that even in a
weakening market, we will play our part in the highly enriched uranium
contract. In 2000, we gave notice that we would not purchase in 2001. We met
with the Minister of Atomic Energy Adamov in November. He acknowledged and
understood our position. If the market was too weak, the Russian feed material
was to be returned to Russia. . . .
Russia at the same time was looking for other
sources to purchase this uranium. They were talking to USEC about buying the
feed component. This would be a breach of our agreement, but we are in a
difficult position. We do not want to buy it and to say no one else could buy
it is difficult to present to the Russians. Another possibility for the
Russians would be to increase the delivery of LEU, to sell more enrichment to
USEC. This would bring about more feed component in the market, although by the
agreement it would have to be shipped back to Russia. This would put more
pressure on the market. Therefore, for a variety of reasons, the western
companies decided to negotiate a transaction with the Russians with a discount
and for certain volumes to be paid in 2001.[106]
[79]
The fourth amendment to the HEU Feed Agreement
was negotiated in 2001. Mr. Grandey led the negotiation of the fourth amendment on behalf
of the western consortium. The negotiation included meetings with Tenex in
Moscow, Sochi and Paris. Mr. Glattes did not attend the meetings with
Tenex in Moscow and Sochi but did attend the meeting in Paris and signed the
amendment for CESA at that meeting on November 16, 2001. Mr. Glattes read the fourth amendment before signing the
document. Mr. Glattes kept the board of directors of CESA apprised of
the negotiations and the board authorized the execution of the fourth amendment
at a meeting on November 8, 2001.
[80]
Mr. Glattes testified that he attended a
meeting of the administrative committee held on August 29, 2001,
which preceded the meeting in Sochi. The purpose of the meeting was to consider
a working paper that set out the framework for the discussions to be held at
the meeting in Sochi. Mr. Glattes also attended a breakfast meeting held in London,
England in conjunction with a World Nuclear Association (WNA) conference.
[81]
Mr. Glattes testified that he was involved in
internal discussions about the fourth amendment, as well as discussions with
Cogema and Nukem, through his participation on the administrative committee.
The internal discussions took place during twice-weekly sales meetings
(described below) and were led substantially by John Britt but also
included George Assie, Gerald Grandey, Kim Goheen and Sean Quinn. Mr. Glattes received and reviewed protocols which resulted
from the various discussions.
Mr. Glattes testified that his main counterpart in the internal
discussions was John Britt, with whom he had had a long-standing very
close relationship.
[82]
The fourth amendment required the western
consortium to exercise first options for delivery of UF6 in 2002
through 2013 in exchange for a reduction in the base price of the UF6. In addition, the price to CESA and Nukem of 950,000 kilograms of UF6
to be delivered in 2001 under two FOENs exercised on June 29, 2001 was
reduced to $26.30 per kgU.
[83]
CESA exercised two FOENs in compliance with the
fourth amendment. One covered deliveries in 2002 to 2013 and the other covered
deliveries in 2004 to 2013.
[84]
Regarding the fourth amendment, Fletcher Newton
had the following exchange with counsel for the Appellant in cross-examination:
Q. Based on your experience and knowledge
having attended the negotiations there, was it a difficult decision for the
western parties to enter into Amendment No. 4?
A. It was extremely difficult. Remember
that, as I said earlier, the price of uranium hadn’t moved for 10 years. It had
not gone above $10 a pound. And now we’re in 2001, and I don’t recall exactly
where the price of uranium was at that point, but it still hadn’t began to
move. And none of us at that time expected to see what eventually happened.
There were a few hopeful signs that maybe the price might strengthen.
But the gist of the meeting in Sochi was
that the Russians wanted us, the three companies, to, number one, commit
absolutely to purchase a certain amount of material, which up until then we
really hadn’t; it had been more in the form of an option, and, two, agree to
pay them a minimum price, and the number that sticks in my head was $29 a
kilogram.
You know, this is a long time ago, so maybe
it was a different number. But that number, whatever it was, at that time, was
still $2 or $3 above the then market price. So they’re asking us to buy a lot
of material at a price that’s already above the spot market price. And I
remember we all stood around, and Gerry was in the group, and Gerry said,
“Listen, you guys, we’ve got to make a decision. Either we’re going to do this,
take the risk of what happens to the price, because it could have gone down
just [as] easily as it went up, or not. What are we going to do?”
And they agreed, after a lot of back-and
forth, that, yes, we’ll go ahead and do it, but, yes, it was a difficult
decision.
[85]
Mr. Glattes testified that he was directly
involved in the negotiation of the eighth amendment with Tenex. The amendment addressed issues relating to the uranium covered by
the second options under the HEU Feed Agreement and was
signed by Mr. Glattes in Paris on April 29, 2004 with effect as
of January 1, 2004. The board of directors of CEL approved the eighth
amendment in a conference call held prior to April 29, 2004 and
authorized Mr. Glattes to execute the amendment for CEL. This approval was noted at a board of directors’ meeting held on
May 6, 2004.
[86]
In cross-examination, Mr. Glattes agreed
with counsel for the Respondent that most if not all of the external meetings
he attended in respect of the Tenex transaction were either for the purpose of signing
an agreement or held in conjunction with a uranium conference.
[87]
Mr. Murphy was not involved in any of the
negotiations regarding the HEU Feed Agreement and the amendments to that
agreement as those negotiations preceded his appointment as president of CEL.
[88]
In 2006, Cameco US provided CEL with a proposal
summary dated March 17, 2006 addressing the exercise of additional
FOENs provided for in the eighth amendment to the HEU Feed Agreement. Mr. Murphy
reviewed and approved the proposal on behalf of CEL. He
testified that “it was a reasonable proposal and a good
deal for Cameco Europe”.
(6) The Urenco Agreement
[89]
On September 9, 1999, CESA entered
into an agreement (the “Urenco Agreement”) with
Urenco Limited and three of its subsidiaries (collectively, “Urenco”) to
purchase natural UF6. The
Appellant guaranteed “the payment to Urenco of all
amounts due to Urenco” under the Urenco Agreement.
[90]
Urenco was a uranium enricher that had struck a
deal with Tenex to have the tails resulting from its enrichment activities
re-enriched to the level of natural uranium. Urenco
would deliver its tails to Tenex and in exchange would receive from Tenex an
equivalent amount of uranium as natural UF6. The natural UF6
was considered to be of Russian origin regardless of the source of the uranium
that created the tails.
[91]
Mr. Assie testified that CESA accomplished two
things by entering into the Urenco Agreement. First, the arrangement avoided
Urenco dumping the UF6 in the market. Second, the arrangement
provided CESA with the opportunity to profit from the purchase and sale of the
UF6.
[92]
Mr. Assie testified that starting in the spring
or early summer of 1999 he and John Britt led the negotiations, but that
Mr. Glattes was involved in the discussions regarding the Urenco
Agreement, the regulatory issues raised by the agreement and the development of
the proposal to Urenco. Mr. Assie did not recall whether Mr. Glattes
attended meetings with Urenco.
[93]
Mr. Glattes testified that he attended
meetings when he could and that he had a close relationship with the head of
Urenco and with the head of Urenco’s legal department. Mr. Glattes testified
that the lead negotiator for the deal was John Britt but that, as with any
third-party agreement, every step was addressed at the twice-weekly sales
meetings.
[94]
Mr. Glattes testified that the management
committee of CESA was apprised of the proposed agreement with Urenco at a
meeting held on September 7, 1999 and that the management committee
authorized Mr. Glattes to sign the agreement. The
board of directors approved the agreement on September 28, 1999.
[95]
Mr. Glattes testified that he was responsible
for addressing the European regulatory issues raised by the purchase of the UF6
from a European vendor and the sale of the UF6 to European
utilities. Mr. Glattes dealt with the same three individuals at Euratom
that he had dealt with in the context of discussions regarding the HEU Feed
Agreement.[135]
[96]
The Urenco Agreement fixed the price of the UF6
as a base escalated price starting at US$25.05 plus 50% of the amount by which
the CIS spot price exceeded US$30.10. The CIS spot price was the average of the
spot price indices for UF6 published by Ux, TradeTech and Nukem.
Section 7.04 of the Urenco Agreement provided CESA with an option to request
that the price be renegotiated if the CIS spot price remained below US$25.05
per kilogram of UF6 for any period of six consecutive months. If the
parties failed to renegotiate a price then CESA could terminate the agreement.
[97]
The Urenco Agreement was amended a total of five
times. Amending Agreement No. 1 (“Amendment No. 1”)
is dated August 8, 2000 with effect as of January 1, 2000.
The amendment reduced the price for 2000 from US$25.05 to US$22.50 per kgU and
amended the base escalated price for 2001 and thereafter to $22.50 plus 50% of
the amount by which the CIS spot price exceeded US$27.55. The amendment also
changed the benchmark price in section 7.04 of the Urenco Agreement to reflect
the new base escalated price of US$22.50.
[98]
Amending Agreement No. 2 (“Amendment No. 2”) is dated
April 11, 2001 with effect as of January 1, 2001. The
amendment reduced the price for 2001 from US$22.50 to US$20.50 per kgU, amended
the price for the first 500,000 kilograms of UF6 delivered in
2002 and 2003 to $21.00 and amended the price for all other UF6 to a
base escalated price of US $22.50 plus 50% of the amount by which the CIS Spot
Price exceeded US$25.00. The amendment also deleted section 7.04 of the Urenco
Agreement and acknowledged the continuation of certain carve-out arrangements
entered into by CESA and Urenco. Exhibit A to the amendment lists a total of
five carve-out agreements executed between September 13, 2000 and
January 5, 2001.
[99]
The carve-out agreements were entered into by
Urenco and CESA to reduce the risk otherwise resulting from selling UF6
purchased from Urenco to utilities under long-term contracts at base escalated
prices. The risk arose because of the market-linked component of the price
payable under the Urenco Agreement. In exchange for removing that component of
the price, Urenco was paid a higher base price than provided for in the Urenco
Agreement. Each carve-out agreement was associated with a specific agreement
with a utility to sell UF6 to that utility.
[100] Amending Agreement No. 3 is dated May 10, 2002 with effect
as of January 1, 2002. The agreement
amended the definition of CIS spot price to limit the price indices used to the
Ux and Nukem indices.
[101] Amending Agreement No. 4 (“Amendment No. 4”) is dated February 12, 2003 and is between CEL and
Urenco. The recitals state that the Urenco Agreement was assigned to CEL by an
agreement among CESA, CEL and Urenco made October 1, 2002.
[102]
Amendment No. 4 extends the term of
the Urenco Agreement to 2009, amends Schedule A of the Urenco Agreement,
amends the price for deliveries on or after January 1, 2005, adds a
clause that allows CEL to request renegotiation of the
price if the CIS spot price remains below US$25.00 for 12 months or more,
adds a clause that allows Urenco to request renegotiation of the price if the CIS
spot price remains above US$38.00 for 12 months or more, confirms the carve-out arrangements and lists in Exhibit A those
carve-out arrangements entered into after Amendment No. 2. Exhibit A
lists three carve-out agreements dated June 12, 2002, October 14, 2002
and November 4, 2002.
[103]
Amending Agreement No. 5 (“Amendment No. 5”) is dated
December 22, 2006 with effect as of January 1, 2007. The
amendment replaces Schedules A and B of the Urenco Agreement.
[104]
In cross-examination, Mr. Assie was asked
about the negotiations with Urenco relating to Amendments No. 1
through No. 4 to the Urenco Agreement and relating to the carve-out
agreements identified in Amendments No. 2 and No. 4. Some of the e-mails from John Britt about the negotiations
with Urenco were copied or forwarded to Mr. Glattes. Mr. Assie testified that Mr. Glattes was kept apprised of
developments during the twice-weekly sales meetings.
[105]
Mr. Glattes testified that he was involved
in the internal decision making which happened during the sales meetings and
that he was kept informed by John Britt. Mr. Glattes testified that
he tried to attend meetings with Urenco but that it was not always possible,
and that he could not recall any particular meeting.
[106]
In cross-examination, Mr. Glattes agreed
with counsel for the Respondent that John Britt was the lead negotiator
for the amendments and the carve-out agreements.
Counsel for the Respondent alluded to evidence that Mr. Glattes did attend
at least one meeting with Urenco but Mr. Glattes could not recall having done
so.
[107]
Mr. Murphy did not participate in the
negotiations with Urenco regarding Amendment No. 5 to the Urenco
Agreement. Mr. Murphy did review a proposal summary dated
March 17, 2006 and his initials appear on the summary. Mr. Murphy
testified that he was kept apprised of developments in the negotiation of
Amendment No. 5 during the twice-weekly sales meetings and probably also
through activity reports.
(7) The Reorganization of the Cameco Group
[108]
Following the creation of the Appellant in the
late 1980’s, the business activities of the Appellant had been focused on
Canada. By the mid-1990’s, the Appellant was pursuing opportunities elsewhere. In
the fall of 1997, the Appellant undertook its first public offering of equity
and in 1998 the Appellant undertook its first public offering of debt.
[109]
In early 1999, the Appellant reorganized its
corporate structure. Mr. Assie described the reason for the reorganization
as follows:
Q. What was your understanding at the time
of why the concept of restructuring arose?
A. Well, in large part, it related to the
highly-enriched uranium agreement or the Tenex agreement, whereby we were going
to, hopefully at some point acquire this large quantity of natural uranium. And
the concept was, as I understood it, to maximize the profits of the company in
respect of that agreement by doing the transaction in as tax efficient way as
possible.
[110]
Mr. Goheen stated that he came up with the idea
to restructure the Cameco Group and he was responsible for leading the day-to-day
planning of the restructuring.
[111]
Mr. Goheen stated in cross-examination that
he was not aware that the idea of using a corporation in a low-tax jurisdiction
had previously been raised by Mr. Grandey and that CUI had entered into
the memorandum of understanding signed by Cogema and Nukem in 1997. However, after being presented with an agreement between CUI and
Trafalgar Management Services Ltd. entered into on November 6, 1997,
he confirmed that as at that time using a Barbados subsidiary to hold the HEU Feed
Agreement did make commercial sense. He
also agreed that his initial choice of jurisdiction was Barbados because he was
familiar with the people there and that, as of January 5, 1999, the
expectation was still that CUI would be a party to the HEU Feed Agreement and
that internal discussions regarding which jurisdiction to use continued into
1999. I note that Mr. Goheen was being asked to recall events that
took place 18 to 20 years ago and that minor lapses in memory are hardly
surprising in the circumstances.
[112]
With respect to the impetus behind the
reorganization, Mr. Goheen testified that in 1998 the price of uranium was
low and the Appellant was seeking to contain costs. One of those costs was tax. Mr. Goheen explained his initial rationale for the
reorganization as follows:
Q. What were your conclusions regarding how
Cameco could minimize its tax expense?
A. Well, we had a choice which -- you know,
I had had opportunities before, comparable. The company Cameco had a choice to
make. With these new opportunities, such as HEU and offshore purchases and
such, we could continue to run the company Saskatchewan focused. Everyone would
remain in Saskatoon. All of this material would be brought back in to Cameco
Corp., the Canadian parent. It would be sold through them and all that activity
would be as it had always been. Everything ran through Cameco. Then nothing
really would have changed. I would have the same tax bill. The same items would
be included in the tax calculation as it always had been, so nothing would have
changed.
But then I’d turn around and say, “Well,
from a cost reduction perspective, I haven’t done anything. What can the
company do? What can Cameco do to change that?” And the idea came up to say,
well, in particularly the HEU material, it’s Russian. It’s equivalent over the
life of it to about 80 million pounds for Cameco, which is a very substantial
uranium mine. It had no connection to Canada. Why bring it here, subject that
uranium to Canadian tax when it never was from Canada in the first place?
So that started me down the road of saying,
“All right. If you move the HEU material -- or if you don’t move it. If you put
the HEU material offshore so that it never, in the first place, becomes part of
the Canadian company, if you make your third-party purchases other than that
offshore for material that’s never part of Canada, all of that material, then,
is not part of the Canadian tax system. So that was the start of it.
[113]
Mr. Goheen also explained how his focus expanded
to Canadian source uranium:
Q. So take us through this. That was the
start-up, and then how did you progress?
A. Well, when I’m down at that stage, I say,
“Well, that’s fine. That’s a very large piece of this. But what else can we
do?” And the thought came to be that there was two other aspects to this from
the Canadian side. There is uncommitted production that Cameco expects to
produce, you know, uranium it expects to produce in the future that has not
been committed to an existing sales contract, and there’s the uranium inventory
that Cameco has in its name.
So the thought behind that was, well, all
right. Now that we’ve been down this road with the HEU and third-party
purchases, how can we build this into an even bigger entity? And those two
pieces from Cameco, I said, “Well let’s includes [sic] those in this pot
as well.” The driver there was that, under all circumstances, the uranium
coming out of Canada to this third party had to be sold across at fair market
value. That was an absolute unviolatable principle.
Q. Sold across to whom?
A. To a wholly-owned subsidiary offshore.
Q. Why did this plan of the wholly-owned
subsidiary getting the HEU and acquiring domestic uranium at fair market value
make sense to you?
A. Okay. Well, there was a number of
avenues. The tax one, directly first, is that, again, internally, we were
optimistic that prices couldn’t fall lower. In fact, they did, but that’s kind
of what companies do. They’ll have multiple opinions internally as to where
uranium prices are going to go or whatever commodity it is.
And at the time, at $8, well, it was $16 a
year ago. It can’t go much farther down. I said, well, all right. To the extent
that that may be true, then entering contracts to move this material, sell this
material to our wholly-owned sub offshore at the current fair market value
provides an opportunity. If subsequent to that, some of these forecasts turn
out to be true and prices rise, then that difference between the transfer price
and the realized price will be taxed offshore. And the offshore rate would be a
lower rate.
[114]
Mr. Goheen explained the other
considerations that went into the restructuring:
Q. So you have talked about the tax
advantages. Were there any other considerations that went into this?
A. Well, yes. Wherever the entity would be
and wherever the -- to complete the structure, you needed to choose location,
country, and so on. Wherever that had to be, it had to make sense, and it had
to be commercial. We weren’t going to create an entity in some part of the
world just because it had a low tax rate but it made no commercial sense. That
doesn’t fly. It wouldn't get anywhere with the board. I wouldn’t have proposed
it in the first place.
Q. Mr. Goheen, you talk about it making
“commercial sense.” So in terms of the structure, as you envisaged it at the
time with this plan –
A. Mm-hmm.
Q. -- what did the structure look like that
you envisaged, and why did it make sense?
A. Sure. Sure. Well, if you will, from a
single entity in Saskatchewan, we were breaking this into three pieces. The
Canadian arm, the Canadian entity, would continue to be a producer and seller
of uranium. The other aspect of it, being what I’ll call price risk,
infiltrating, we would create an offshore entity. And then the third arm would
be a brokerage equivalent who would be the marketing group that would be out
looking for, you know, people that would buy the uranium or sell their uranium
to us. So it’s three arms.
And how that made sense, then, is you kind
of focused each piece on where they had been, or focused Cameco Corp. on what
it had been, a miner, producer of uranium. It created a new entity, Cameco
Europe, as the trader in a jurisdiction that I thought made a lot of sense. And
then we put the sales force into the U.S., Minneapolis, because they were close
to the customer base. Two-thirds of our customers are in the U.S.
[115]
Mr. Goheen explained his view of the core
functions of CESA/CEL and how other requirements would be addressed:
Q. You described to us how you envisaged the
structure to be, and you described Cameco Europe as a trader. As part of your
restructuring, did you have a plan or ideas on how Cameco Europe would acquire
services that it needed?
A. Sure. I have to come back for a moment as
to what does a trader have to do. You know, to me a trader has three things. It
has to be a competent trader. It has to understand the market that it’s
operating within; it has to decide when to buy and sell and the terms; and it
has to enter [into] contracts that fulfil its obligations to buy and sell.
Beyond that, there is nothing that a trader needs to do itself that it cannot
outsource elsewhere.
Q. So what was your plan with respect to the
trader and the services it needed?
A. We focused on the three main functions
that a trader needs to do and other activities were then outsourced to Cameco
for the back office aspects of things, the contracts admin, and so on. And with
Cameco Inc. then on the marketing side for buying and selling, direct contact
with customers and clients, they were engaged to provide that service.
[116]
Finally, Mr. Goheen explained how the
restructuring changed the Cameco Group:
Q. Mr. Goheen, how did Cameco change
after the restructuring? If you were to look at the before and after pictures,
what was the difference in the Cameco organization?
A. Very dramatic. From everything focused
through Saskatoon, all activity based there, to three separate entities doing
three separate tasks, three separate businesses. Instead of Cameco, we now had
Cameco Corp., if you will, the Canadian side, being the producer, miner and
producer. We have Cameco Europe being the trader, the price speculator. And we
have Cameco Inc. being the broker, the one who finds the customers. That’s
quite a change.
[117]
In order to proceed with the reorganization,
Mr. Goheen had to involve the management committee of the Appellant, which
was comprised of the six senior officers of the Appellant and the
vice-presidents that reported to them. Ultimately, Mr. Goheen required the
approval of Bernard Michel, who, as CEO, had the final say as to whether
the matter would proceed to the board of directors of the Appellant.
[118]
On February 3, 1999, Mr. Goheen
made a presentation to the management committee. At
that point in time, the proposal for a reorganization had been around for some
time and was not new to the management committee. The
February 3, 1999 proposal envisioned the use of a Luxembourg
corporation (temporarily) and a Swiss corporation.
Accordingly, the jurisdictions for the new companies had been settled by
February 3, 1999.
[119]
On March 2, 1999, Mr. Goheen sent
a memo to the six senior officers of the Appellant summarizing the proposed
reorganization and the guidelines that were to be followed by CESA/CEL and
Cameco US. Mr. Goheen explained the purpose of the guidelines as follows:
Q. . . . What was your purpose in laying
this out in the detail that you did?
A. I wanted to make sure that the officers
understood there were clear guidelines, rules, that had to be followed. And,
again, this would not have been the first time. They were quite aware of it. I
was just putting it down to make sure that there was no ambiguity. These were
the rules that had to be followed.
[120]
The memorandum also indicated that the Appellant
would provide administrative services to both CESA/CEL and Cameco US. Mr. Goheen
explained the rationale for this approach as follows:
Q. Let’s go to page 4 of your note, the top
bullet point under “Miscellaneous”:
“Cameco’s market planning and contract
administration can provide services to both trading companies on a
fee-for-service basis.”
What was that about?
A. Well, again, just breaking these into
three separate businesses. The brokerage arm or the trading arm don’t need to
have market planning and contract admin staff within them. Whether you are
trading or you are looking for customers, you don’t need those services in
order to fulfil your direct function.
And prior to the reorganization, there was a
central group performing these tasks. They were very good at what they did, and
it made no economic sense to duplicate that activity or distribute that
activity overseas and down into Minneapolis, so we retained that in Saskatoon
and then charged out to the two entities for that service.
[121]
Mr. Goheen also explained the rationale for
using entities in Switzerland and Minneapolis:
Q. Mr. Goheen, why was Switzerland chosen as
the location for the new entity?
A. Well, as I say, what I wanted to put -- a
driver behind these structures, what I want – it’s not really what I wanted.
The driver behind these structures is to make sure that you have something that
makes sense that’s not going to put you in a worse situation than you were
before.
When it comes to Switzerland and uranium,
there are nuclear reactors in the country. It has a nuclear regulatory regime,
if you will. It is a western country. It’s easy to get in and out of. It has
laws that are established. It is a place that people do business in. It fits.
And, as I say, as compared to other jurisdictions in the world which may have
many of the same things, but do not have the nuclear history associated with
it.
So capture the nuclear friendliness, the
modern legal system, the ease to get in and out of. It made sense to go there,
and we weren’t worse off.
Q. Why was Minneapolis chosen as the
location for Cameco Inc.?
A. The U.S. made sense because 60 percent or
two-thirds of Cameco’s customers are based in the U.S., are U.S. utilities.
Minneapolis itself, Northwest Airlines, a
hub for -- easy to get around the U.S. and internationally from there.
As to more than that, that was a marketing
department decision. They kind of decided Minneapolis is where they wanted.
Those are the reasons I remember.
[122]
On March 15, 1999, Mr. Goheen
made a presentation to the executive committee of the Appellant, which was made
up of the six senior officers of the Appellant. The
presentation addressed Mr. Goheen’s March 2, 1999 memorandum.
[123]
On March 16, 1999, CESA was
incorporated. The initial board of directors of CESA was comprised of
Gerhard Glattes, Gerald Grandey, Gary Chad,
Teunis Akkerman, Eleonora Broman, Maggy Kohl-Birget and Rui Fernandes Da Costa.
[124]
On April 13, 1999, Mr. Goheen
made a slide presentation to the executive committee. The
presentation included business reasons for the new structure. In
cross-examination, Mr. Goheen was asked to explain the rationale for
including business reasons in the description of a tax-driven restructuring:
Q. Why were you presenting business reasons,
then, for the restructuring?
A. The tax aspects of this were known to the
board for some time, the idea that we were to look at restructuring to minimize
taxes going forward. But that, in and of itself, for a conservative company
like Cameco, was an important and critical factor, but wasn’t enough.
They wanted to see, well, okay. What’s the--as
I mentioned on one of the slides, the uncertainty of how long this might last
was always in there. So what else might there be here that at least would not
put us in a worse position than where we were if we kept everything in
Saskatoon?
So understanding that tax was -- you know,
future taxes was the driver behind much of this, what else might I show to the
board and say, “Well, at least here is some other aspects that at least would not make us
worse off than where we were”?
Q. Is another reason for articulating these
business reasons to provide non-tax reasons to the Canada Revenue Agency and
the IRS if they requested them?
A. No.
Q. That never entered your mind?
A. No. . . .
[125]
On April 30, 1999 Mr. Goheen made
a slide presentation to the board of directors of the Appellant. The board of directors approved the reorganization on
April 30, 1999. The minutes of the board state the following:
Mr. Goheen indicated that in order for
this proposal to be profitable the prices must rise in the future. It is clear
that if prices fall we will not make money in the trading companies and the
sales company, so there is business risk always present.
[126]
On July 29 or 30, 1999, Gerry Grandey
resigned as a director of CESA and Mr. Goheen was elected a director of
CESA in his place.
[127]
On August 11, 1999, Mr. Goheen
was appointed to the management committee of CESA. In
cross-examination, Mr. Goheen described his role on that committee as
follows:
Q. Did the management committee of the Swiss
branch, between September 1, 1999 and October 2002, carry on actual
management of the Swiss branch, or was that like you just described, a “sounds
like” but doesn’t really do anything?
A. The people in Switzerland managed the
company. I would have had no involvement in that.
Q. When you say the people in Switzerland --
A. It would have been Gerhard and the -- we
were looking for Justus Dornier and Rudolf Mosimann. So, again, I
don’t remember who was on those boards. I do know that, from a management
perspective, I stayed out of it.
Q. Even though you were on what’s titled the
“Management Committee of the Swiss Branch”?
A. It would be much like when I was a
director of Cameco Inc. I was there to understand what was going on, but I
understand the rules pretty clearly. I wasn’t a decision-maker for Cameco, but
I was trying to be very careful not to be involved in the decisions that Cameco
Inc. or Cameco Europe made.
[128]
On August 30, 1999, Cameco Services
Inc. (“CSI”) was incorporated in Barbados.
[129]
On September 15, 1999, CEL was
incorporated in Zug, Switzerland as Cameco Switzerland AG (SA, Ltd). The shareholders of CEL are listed as Cameco Investments AG (SA, Ltd)
as to 98 shares and Justus Dornier and Rudolph Mosimann as to one
share each. On June 29, 2001, the name of Cameco Switzerland AG (SA,
Ltd.) was changed to Cameco Europe AG (SA, Ltd),
that is, CEL.
[130]
In 2001, CESA entered into a services agreement
with CSI “made effective as of”
January 1, 2001. The contract was signed in late 2001. It
stated that, in exchange for the co-ordination and monitoring of all
administrative, operational and marketing activities of CESA carried on outside
Switzerland, CESA would pay CSI 50% of its gross trading profit as defined in
the agreement. CESA/CEL paid the services fees to CSI but CSI did not provide
any services to CESA. This arrangement reduced CESA’s income subject to tax in
Switzerland by approximately 50%.
[131]
The arrangements between CESA and CSI were put
in place pursuant to the terms of a Swiss tax ruling issued by the Canton of
Zug to CESA on July 15, 1999. A
second ruling was issued by the Swiss federal tax administration to CEL on
January 29, 2003. Mr. Glattes described the ruling as a well-known measure used
by Swiss authorities to entice international investors to move their activities
to Switzerland. Mr. Glattes stated that the Swiss tax authorities were aware
that CSI would not be providing services to CESA, and that CESA’s tax returns
in Switzerland were never questioned or reassessed by the Swiss tax
authorities.
[132]
On October 30, 2002, CESA and CEL
executed an Asset Purchase and Transfer of Liabilities Agreement pursuant to
which all the assets of CESA’s Swiss branch were transferred to CEL and CEL
assumed all the liabilities of CESA’s Swiss branch. The transfer was to have
effect as of October 1, 2002.
[133]
The Swiss branch of CESA and the Swiss office of
CEL were each located in Zug, Switzerland in office space rented from MeesPierson Trust.
The arrangement included access to boardrooms and a fireproof safe. MeesPierson Trust
also provided administration services to CESA/CEL until late 2006.
[134]
The principal service provider for CEL at MeesPierson Trust was Markus Bopp. Mr. Bopp
became an employee of CEL in August 2006. Until that time, the sole employees
of CESA/CEL had been first Mr. Glattes and then Mr. Murphy. After he became an employee Mr. Bopp began to participate in
the sales meetings and had access to “Contact!”,
the Cameco Group’s confidential marketing database.
[135]
Mr. Murphy testified that because CEL was
dealing with approximately 20 to 25 new contracts per year, two employees with
his and Mr. Bopp’s experience were sufficient to do the job and three would
have been too many.
(8) The
Financing of CESA/CEL
[136] CESA/CEL had two bank accounts: one with ABN for administrative
expenses and one with AIB International Financial Services Limited located in
Ireland (the “AIB Account”). The arrangements for the AIB Account were made by Mr. Goheen
because the Appellant had a pre-existing relationship with AIB.
[137]
AIB, CESA and the Appellant entered into a
services agreement dated April 11, 2000 (the “AIB Services Agreement”). Section 11(e) of the AIB
Services Agreement provides that CESA and the Appellant accept the risk of any
instruction or instrument being given to AIB or issued by an unauthorized
person and that CESA and the Appellant jointly and severally agree to hold AIB
harmless and indemnify AIB against all claims.[196]
[138]
Counsel for the Respondent asked Mr. Glattes
about an e-mail dated April 13, 2000 from David Doerksen, a
member of the treasury group of the Appellant. In the e-mail, Mr. Doerksen
writes:
Gerhard, further to our telecon earlier
today and with regard to our approval request for the AIBFS agreement, we fully
recognize the board’s right and mandate to review, and modify as necessary, the
agreement prior to approving it. Please accept our apologies for any concerns
our approval process for the AIBFS agreement may have caused.
[139]
Mr. Glattes responded that the e-mail was sent
because he had “complained a little bit that our involvement was not
sufficient, in my view”.
[140]
CESA/CEL was financed by an indirect subsidiary
of the Appellant called Cameco Ireland Company (“CIC”).
On November 24, 1999, CESA entered into a
demand loan agreement with CIC to borrow US$32,500,000 interest-free. On July 27, 2001, CESA entered into a demand loan
agreement with CIC to borrow US$4,500,000 interest-free. The funds borrowed by CESA under these agreements were used by CESA
to purchase uranium from Tenex, Urenco and the Appellant.
[141]
On July 10, 2002, CESA entered into a
revolving credit agreement with CIC for a credit facility of US$80,000,000 (the
“facility”). The amounts borrowed under the facility did not bear interest but
CESA was required to pay an annual commitment fee of 0.1% of the amount of the
facility.
[142]
Mr. Goheen testified that the facility was
put in place at the request of Mr. Dornier and Mr. Mosimann, who had
expressed concern that the informal financing structure originally put in place
did not work anymore and that a formal financing structure was required under
unspecified Swiss rules. Mr. Goheen worked with advisers to put in place a
solution that addressed the needs of CESA/CEL but did not create the capital
tax issues in Switzerland associated with an investment in equity.
[143]
On November 26, 2002, CIC, CESA and
CEL entered into a novation agreement pursuant to which CEL became the borrower
under the facility and the amount of the facility was increased to
US$120,000,000.[204]
By a letter dated February 5, 2004, CEL requested that the amount of
the facility be reduced to US$100,000,000 and an agreement effecting the change
was signed on March 1, 2004.[205]
[144]
In several cases, CESA/CEL requested loans
directly from the Appellant because there was insufficient time to obtain the
funding from CIC.
[145]
If CESA/CEL had surplus funds, then the
Appellant would invest the surplus funds on CESA/CEL’s behalf in CESA/CEL’s
name.
[146]
Counsel for the Respondent asked Mr. Glattes
about the role of the Appellant’s treasury group in determining CESA/CEL’s
financial requirements. Counsel presented an e-mail to Mr. Glattes dated
March 21, 2002 in which a member of the treasury group wrote:
Cameco Europe will be receiving
USD14,091,900.00 from Cameco Corp on April 1, 2002. The cash forecast for
Cameco Europe shows that these funds will not be required until later in the
year. Please provide a notice to Cameco Ireland (copy Randy B and Treasury) to
repay USD14,000,000.00 on April 2, 2002.
Thank you for your assistance with this
matter.
[147]
Mr. Glattes responded:
Q. —This is an example of an individual in
treasury making a recommendation, or telling Cameco Europe to make a repayment;
correct?
A. Yeah. There are contacts between CEL and
the treasury about best use of the funds, and that has been the case there, and
so that was nothing unusual, that there would be discussions about repayment
and so on.
[148]
Mr. Glattes went on to testify that
CESA/CEL had not transferred the task of monitoring CESA/CEL’s financial
requirements to the Appellant and that Markus Bopp also kept track of
these requirements. In two e-mails to Mr. Glattes dated March 12, 2003,
an individual in the Appellant’s treasury group writes:
The Cameco Europe Ltd. cash forecast is
showing a shortfall of approximately USD7,000,000 on March 31st due to payment
to Cameco Corporation. You may want to consider requesting funds from Cameco
Ireland in the amount of USD7,000,000 to be received by March 25, 2003
to ensure there are sufficient funds to also cover a payment of approximately
USD150,000 on March 26th as instructed by Markus.
. . .
Further to my e-mail, do you have any
information on the USD150,000 payment that Markus informed me about. I was
wondering if it has to be paid on March 26th or could it possible [sic] wait until March 28th. If it can wait, we could move the funding
request from March 25th to March 28th.
(9) The Twice-Weekly Sales Meetings and the Monthly Strategy Meetings
[149]
Following the reorganization in 1999, Cameco US
organized twice-weekly sales meetings (the “sales
meetings”) to discuss all matters relating to the marketing, purchase
and sale of uranium by the Cameco Group.
Mr. Glattes and Mr. Murphy attended the sales meetings by telephone
whenever their schedules permitted.
[150]
Initially, contract administrators attended the
sales meetings but because these meetings addressed many issues not relevant to
the contract administrators a separate meeting was set up to discuss contract
administration.
[151]
Cameco US also organized monthly strategy
meetings (the “strategy meetings”) to discuss
broader issues such as sales targets, market direction and opportunities for
future purchases and sales of uranium.
Mr. Glattes and Mr. Murphy attended the SM1 and SM2 strategy meetings
whenever possible, usually by telephone but sometimes in person. The SM1
meetings were for the most senior management in the Cameco Group.
[152]
In cross-examination, Fletcher Newton
testified that Mr. Glattes generally attended the strategy meetings and
was an active participant in those meetings.
Mr. Newton then had the following exchange with counsel:
Q. And, in your experience, what type
of contributions, if any, would Mr. Glattes make in those discussions?
A. Well, Gerhard was a key guy. I mean, he
had been in the uranium business a long time. He had been the president of
Uranerz, which had been a German producer. He was German, European. He knew all
the European utilities. So he was an ideal guy to have in Europe, talking to
the European utilities, talking to a company like Urenco – that’s U-r-e-n-c-o
-- and so he had a lot to contribute.
Q. In your experience, you found Mr. Glattes
to be knowledgeable about the nuclear industry?
A. Extremely.
Q. And you found him to be knowledgeable
about the uranium markets?
A. Yes.
Q. And that would include about uranium
prices?
A. Inasmuch as anybody can predict or be
knowledgeable about uranium prices, yes. Uranium prices are notoriously
difficult to understand or project.
Q. They’re unpredictable?
A. Extremely.
[153]
Cameco US did not keep minutes of the sales
meetings or the strategy meetings, but documents such as proposal summaries
were prepared after the meetings.[219]
Mr. Assie did have some brief notes that he made in advance of or at sales
meetings, but he did not always keep such notes.
Mr. Assie testified that on occasion he would “jot
down notes from [the strategy meetings] if it was something [he] wanted to
remember” but that he did not take comprehensive notes of those
meetings.[221]
[154]
Mr. Glattes took notes during the sales
meetings only if a new deal was discussed for which there was no proposal
summary. Mr. Glattes retained these notes until he received an offer
letter that contained the major terms. In
cross-examination, Mr. Glattes testified that he did not destroy other
notes.
[155]
Mr. Glattes did not take notes during the
strategy meetings because he was provided with materials regarding those
meetings.[224]
[156]
Mr. Murphy took notes during the sales
meetings from time to time but he did not keep the notes. When asked why he did not keep the notes, he stated:
A. Well, it wasn’t necessary to, because
anything that was agreed to was reduced to writing not long afterwards.
Q. In what form?
A. Well, the Cameco U.S. salesperson
responsible would prepare a proposal summary and would add it to the marketing
activity report for their region.
[157]
Mr. Murphy confirmed that after the sales
meetings he did not send e-mails summarizing what had been discussed during the
meetings.
[158]
Mr. Mayers described the sales meetings as
follows:
They were pretty casual. The Cameco Inc.
group would go around the table and discuss -- just give an update on
discussions they had had with utility customers or traders or word that -- any
information they had on what the marketplace was doing. Cameco Corp. would then
do the same thing, go around the table and raise any issues, any delivery or
customer issues that they were having. And Cameco Europe would come in and give
an update on anything that was happening in Europe.
[159]
Ms. Kerr had the following exchange with counsel
for the Respondent regarding the role of sales meetings:
Q. Did you meet with management before you
made those offers or proposals to your customers? Did you meet with Cameco
management?
A. Yes. Did I meet with --
Q. -- Cameco management before you made
proposals to customers?
A. Well, yes. We always discussed all of
these things in our regular meetings. And so there would always be, you know,
people from Cameco Inc., people from Cameco Europe, and typically somebody from
Cameco Corp., if they were available, to be part of the meetings.
And we would toss out ideas. And then, like
I said, once I could get the ideas and come up with what I thought was a
succinct proposal, we would go through all of that in a meeting again so
everybody was aware of what was going on. And, you know, especially, for
example, I would need to have talked to Cameco Europe to make sure that, if I
was going to make that proposal, that they were going to be able to supply me
with the material that I needed to fill that contract.
(10) The Activity Reports
[160]
The marketing group at Cameco US prepared
activity reports twice a month that documented all the significant business activities
of the Cameco Group. The activity reports included the terms and conditions of requests
for quotation (RFQs) and transactions under negotiation during the period
covered by the reports. This information was updated each time a new report was
released. The twice-monthly activity reports were made available to CESA/CEL
and to other corporations in the Cameco Group.
[161]
Mr. Glattes received copies of the activity
reports while president of CESA/CEL.
Mr. Glattes testified that the activity reports contained important
information for CESA/CEL and that he relied on the activity reports. Mr. Glattes testified that he retained the activity reports
only while the deals covered by the reports were being negotiated.
[162]
In cross-examination, Mr. Assie and
Mr. Glattes each testified that Mr. Glattes did not prepare activity
reports for CESA/CEL but that Mr. Murphy did prepare such reports after he
joined CEL. Mr. Murphy testified that he did not recall seeing, prior to
his joining CEL, any activity reports prepared by CESA/CEL.
[163]
Mr. Murphy testified that he prepared
activity reports for CEL. The first such report covered the period from September 1 through
November 15, 2004. Mr. Murphy testified that soon after he completed the first
report he started to prepare activity reports for CEL twice per month and he
adopted a different format.
[164]
The first twice-monthly report using the new format
covers the period December 1 to December 15, 2004 and includes
the headings “Inter-Company Offers”, “Contracting by CEL”, “Issues
Resolved”, “Issues Ongoing”, “Issues Pending”, “Miscellaneous” and “Routine Business”.
Mr. Murphy testified that he used this format until he retired in
mid-2007.
[165]
Mr. Murphy would send the reports to
Mr. Assie’s office in Saskatoon, at which point, he believed, the reports
were entered into a computer database called “Contact!”
maintained by the Cameco Group. In
cross-examination, Mr. Assie testified that he would receive collated
activity reports that incorporated the information from the CEL reports prepared
by Mr. Murphy.
[166]
Mr. Assie testified that one reason there
were no minutes of the sales meetings was that critical information from those
meetings was included in the activity reports.
Mr. Murphy testified that he did not keep notes of the sales meetings
because anything that was agreed to during the meetings was reduced to writing
in the form of proposal summaries and activity reports.
[167]
In cross-examination, Mr. Assie testified
that he would throw away his copy of an activity report once he was done with it. Counsel for the Respondent asked Mr. Assie about retention of
reports:
Q. Was there a central repository where
these kind of reports were kept?
A. I don’t know. It was nothing I ever
worried about too much because it was intended to be a real-time report of
activities that were underway. If they were done, from my -- from my point of
view, I wasn’t concerned about it.
Q. So you are not sure if there was one
person who was responsible for ensuring the hard copy documents of the activity
reports were kept?
A. Yes. I’m not aware that anybody was
assigned the responsibility of keeping all of these reports.
[168]
In cross-examination, Marlene Kerr had the
following exchange with counsel for the Appellant regarding activity reports
and sales meetings:
Q. Did you have any role in preparing
activity reports?
A. Yes. That was all of our roles was to
update these activity reports on a regular basis, because it was a big
information source for everybody. Put in all of our RFQs, all of our pending
business, everything that was going on in each of our market regions so that
everybody was aware exactly where we were at.
Q. You mentioned regular meetings in your
testimony earlier today. How often were these regular meetings held?
A. Well, typically it was twice a week. If
there was a lot of activity, you know, lots of RFQs or lots of things going on,
we may call an extra meeting in a week. It just depended what the activity was.
But generally they were planned for twice a week.
Q. And were activity reports ever discussed
on these twice a week regular meetings?
A. Yes. I never went to a meeting without my
activity report because it would have, you know, all of the things that I was
working on.
Q. And did Mr. Glattes participate in
these regular meetings?
A. Yes, he did.
Q. And during his time as president of
Cameco Europe, did Mr. Murphy participate in these sales meetings?
A. Yes, he did.
Q. I would like to take you to an activity
report that is already an exhibit. It is Exhibit A158056. This is an activity
report from May 2003. And this is the period when you are the manager
marketing, Europe at Cameco Inc.; correct?
A. Yes, I think so.
Q. Do you recall whether you would have been
involved in preparing this activity report or not?
A. Well, you know, again, I can’t
specifically say. I look at this as something I did, but this was a regular
activity that we all participated in, and it was something that was
consistently done, so I cannot imagine that I wouldn’t have.
Q. And if we go to page 2 of this activity
report, we can see the item at the top is “EdF UF6 Conversion.” Is that
correct?
A. Yes.
Q. And would this have been an item that
would be updated from time to time as negotiations progressed with EdF?
A. Yes.
Q. And, at the bottom, we can see under the
heading “Proposals-Under Discussion,” we have “EdF U3O8.” Is that another
proposal that would have been updated as negotiations progressed?
A. Yes. And the way this report worked too,
for example, when a proposal was -- it kind of -- it would move up on the
activity list too.
So, you know, when it was under RFQ, when
the RFQ was accepted, then it moved up, and then, you know, all of the comments
moved with it. So you always knew at a glance what was -- what new business you
had gotten accepted, what were just proposals outstanding, what were RFQs that
had just come in and any future RFQs that you were thinking might come in.
(11) The Contract for Services Between the Appellant and CESA/CEL
[169]
In a letter dated August 25, 1999 from CESA to
the Appellant, Mr. Glattes states that CESA “requires
services in respect of contract administration, legal, accounting etc”. In a letter dated September 22, 1999, from the Appellant
to CESA, Mr. Petroff lists services that the Appellant proposes to provide,
including:
Market Contract Administration-including
administration of both uranium purchase and sales contracts, administration and
management of inventory, monthly reporting of sales, revenues, and inventories,
administrative assistance in preparation of periodic plans, forecasts and
budgets.
[170]
The Appellant and CESA entered into a services
agreement effective September 1, 1999 (the “Services
Agreement”). Mr. Glattes and Mr. Mosimann signed the agreement
for CESA.
[171]
Mr. Assie testified that, under the Services
Agreement, CESA retained the Appellant to provide administrative and back-office
services, including administration of CESA/CEL’s uranium contracts, assistance
in market forecasting, legal services, human-resources-related services, and financial,
bookkeeping and accounting services, and that those services were provided
under the Services Agreement.[250]
Mr. Murphy and Mr. Glattes provided similar descriptions of the
services provided by the Appellant to CESA/CEL under the Services Agreement.
[172]
Mr. Assie characterized the services as “administrative-type, back-office-type accounting, bookkeeping
services” and “routine contract
administration-type functions and services”, which could have been
obtained from a source other than the Appellant. However, the Appellant had a
pool of trained people in Saskatoon and outsourcing to the Appellant worked
extremely well.
[173]
Mr. Belosowsky testified that the Services
Agreement was signed in March 2001 and that no amounts were paid under the
agreement until 2001.
[174]
In cross-examination, counsel suggested to
Mr. Glattes that the Services Agreement was not signed until
November 2001; however, Mr. Glattes only recalled that it was signed
after the September 1, 1999 effective date. Mr. Glattes stated
that the services were provided to CESA in 1999 and 2000 and that it took time
to finalize the language of the Services Agreement to ensure both parties’
interests were reflected in the agreement.
CESA’s annual accounts for the period ending December 31, 2000 show
administrative expenses of US$1,432,134 for the period
March 16, 1999 to December 31, 1999 and US$1,214,633
for the period January 1, 2000 to December 31, 2000.
[175]
Section 2.1 of the Services Agreement states:
Subject to and in accordance with the terms
hereof, Cameco Europe hereby engages CCO, and CCO hereby agrees, to perform
certain services for Cameco Europe as requested from time to time (the
“Services”).
The Services to be performed by CCO for
Cameco Europe shall initially be as follows:
• contract administration services as
indicated in Appendix A,
• assistance in market forecasting and
research,
• legal services on contract matters as
directed by Cameco Europe,
• assistance in human resource matters
including the provision of employee placement services (up to, but not
including, the hiring decision) as requested by Cameco Europe[,]
• preparing monthly payroll and related
information reports to satisfy compliance requirements,
• preparing and maintaining all customary
financial and accounting books in appropriate form and in sufficient detail to
support an annual independent audit of the financial condition of Cameco Europe
in accordance with instructions provided by Cameco Europe,
• making books and records available to
audit and answering questions with respect to same,
• based on accounting records,
calculating the fees and expenses of the supervisory directors in connection
with attending meetings, non-Canadian taxes, non-Canadian filing fees and other
costs and expenses incurred for the account of Cameco Europe,
• preparing quarterly and annual financial
statements for Cameco Europe,
• calculating the amount of dividends that
may be paid by Cameco Europe in accordance with guidelines provided by Cameco
Europe,
• preparing monthly reports containing
statements of net assets and liabilities, operations, changes in net assets and
subsidiary or detailed reports, as may be requested by Cameco Europe,
• placing on ledgers any financial
information based on information received from Cameco Europe, and
• any other related functions incidental to
the foregoing.
Such Services shall not include the
conclusion of any contractual terms on behalf of Cameco Europe.
[176]
Appendix A of the Services Agreement states:
Under the direction of Cameco Europe, Cameco
will provide the following services pursuant to this Agreement.
1. Ensure adherence to all of the terms and conditions
of the Cameco Europe marketing agreements.
2. Ensure the delivery of all product and
services pursuant to the Cameco Europe marketing agreements, including but not
limited to, communication with the customer, communication with relevant
conversion or enrichment facility, obtaining of all necessary regulatory and
government approvals and shipping of product.
3. Ensure the timely and accurate submission
of invoices and collections of funds for product and services sales, the timely
and accurate processing for payment of monies owing by Cameco Europe for
product and services purchases, timely and accurate invoicing or processing for
payment of other related revenues and expenses, such as transportation,
weighing and sampling and storage.
4. Maintaining and reporting of inventory
account balances owned and held by Cameco Europe.
5. Assistance in preparing budgets and
forecasts, and periodic sales, purchase, inventory and other reports as
requested.
6. Assistance with the drafting of legal
agreements pertaining to various marketing transactions entered into by Cameco
Europe.
[177]
Mr. Murphy testified that, in compliance
with the last line of section 2.1 of the Services Agreement, the Appellant did
not conclude contractual terms on behalf of CEL.[256] Mr. Assie testified
that neither the Appellant nor Cameco US made decisions regarding the purchase
and sale of uranium by CESA/CEL.[257]
[178]
Mr. Glattes testified that, although this
was not explicitly stated, the services described in Appendix A of the Services
Agreement included the making of routine decisions about which of CESA/CEL’s
inventory would be allocated to uranium sales contracts. However, more
important issues would be reported to Bernie Del Frari, who would
raise the issues in the sales meetings. Mr. Glattes testified that the
role of allocating CESA/CEL’s inventory to the sales contracts fell under the
general language of item 2 of Appendix A to the Services Agreement and that
there was no disagreement between CESA/CEL and the Appellant on this point.
[179]
Mr. Murphy testified that, once CESA/CEL
had agreed to supply uranium to Cameco US so that Cameco US could fulfil its
obligations under a contract with a third party, the contract
administrators were expected to deal with the delivery notice from the third
party to prepare a delivery notice for CESA/CEL to sign, to prepare a transfer
request in favour of Cameco US that was to be issued to the conversion facility
were CESA/CEL’s uranium was located and to obtain from the conversion facility acknowledgment
of the transfer request.
[180]
In an e-mail dated April 17, 2002,
Bernie Del Frari stated in response to a query from Mr. Glattes
about the fees for the services under the Services Agreement:
Cameco charges Cameco Europe S.A. for
services provided in administering all of the Cameco Europe S.A. purchase and
sales contracts and maintaining inventory records and various reporting.
Annually, Cameco estimates the cost of providing this service, which is
primarily the amount [of] time spent by Contract Administration Department staff
in providing these services for Cameco Europe. The Contract Administration
Department also provides the same services for Cameco with respect to its
marketing contracts and to other Cameco subsidiaries.
[181]
Mr. Glattes responded as follows on April 21:
Thanks for the info. I will talk to our Swiss outside tax
advisor as to whether this info is sufficient or whether we need any further
evidence, eg time sheets or the like which we obviously want to avoid. I do not
have the underlying Adm Agreement here in Germany, but I assume the procedure
which you use is in accordance with its terms. Just out of curiosity: Wouldn’t
it be simpler to base the admin fees [on] the proportionate annual contract
value of the companies in respect of which your department is involved in the
the [sic] contract admin?
I will get back to you following the discussion with the
Swiss tax advisor in case I need anything else.
[182]
In response to a question from the Respondent’s counsel as to why
he did not want to keep timesheets, Mr. Glattes stated that it was a
matter of simplification of the process and that there was no other reason than
being a bit more efficient.
[183]
Mr. Glattes was asked if he could recall
when CESA paid for the services rendered in 1999 and 2000 and Mr. Glattes
stated that his understanding was that payments were made but that he could not
recall when the payments were made.
[184]
Mr. Murphy testified that he created
spreadsheets to monitor various aspects of CEL’s operations, including
movements in and out of CEL’s uranium inventory and the payment of invoices. One of the spreadsheets is titled “DEL
NOTICES” and it lists CEL’s purchases, sales and exchanges of inventory
from September 15, 2004 to a date after Mr. Murphy retired. The
spreadsheet includes the name of the counter-party, the contract date, the
contract reference number, the type of notice, the delivery dates, the quantity
of uranium delivered, the origin of the uranium, the location at which the
delivery took place and the associated invoice number. The spreadsheet also
cross-references binders kept at CEL’s offices. Counsel
for the Appellant asked Mr. Murphy what went into the binders:
. . . We considered each contract as a
separate entity. So within the section of the binder for a contract, we would
have the intercompany offer, the contract, any significant correspondence. If
the contract needed some type of special approval, that would be in there,
transfers of title, delivery notices, invoices. Everything having to do with
that contract from the time it started until it terminated would be in the
contract file in the binders.
[185]
Mr. Murphy testified that CEL would use the
information in the spreadsheets and the binders to check the information
provided by the contract administrators, who were relied upon to keep track of
the same information.
[186]
Ms. Klingbiel testified regarding the
services provided by TradeTech to uranium industry participants during the
period 1999 through 2006. These services included price forecasting, pricing analysis,
competitor and industry intelligence, strategic advice, modelling of a client’s
overall position, market analysis involving the forecasting of worldwide supply
and demand, and contract portfolio analysis. Ms. Klingbiel elaborated on the terms
“market analysis” and “contract
portfolio analysis” as follows:
. . . Market analysis would involve, really,
all of the topics you have just outlined, but it would also include a price
forecast and providing input about where we see the market going, what is
directing and influencing the price, and it would also include perhaps
recommendations about actions that the client should take in terms of their
contract portfolio.
. . .
. . . [Contract portfolio analysis] would
involve taking their existing contracts and their portfolio and looking at it
in terms of, again, not just price, but the overall terms and conditions
contained in those existing contracts.
We would look at it in relation to what we
expected the market to do in terms of our forecast, and we would make
recommendations and provide advice to our clients about how they should
proceed, based on that input, in terms of exercising new contracts, exercising
flexibilities or options, and a variety of actions that they might take, buying
or selling, depending upon the client.
[187]
Ms. Klingbiel stated that during the period
1999 through 2006 TradeTech would charge a client between US$300,000 and
US$500,000 per year for these services.
Ms. Klingbiel stated that the fees were fixed and were not based on the
market movement of uranium.
(12) The Functions Performed by the Contract Administrators
[188]
Mr. Wilyman, Mr. Mayers,
Ms. McGowan, Mr. Shircliff and Ms. Sperling testified about the
functions performed by the contract administrators employed by the Appellant in
Saskatoon.
[189]
Mr. Wilyman testified that the contract
administrators had a portfolio of third-party contracts that they administered
and in doing so they worked closely with the sales group in Cameco US.
Mr. Wilyman described the annual delivery schedule or delivery notice from
a third-party utility as the driver behind the administration of a contract. Specifically,
once a binding delivery notice or a schedule was received, the contract
administrator would start planning for the delivery of the uranium under the
contract. If a third party did not send an annual delivery schedule or a binding
delivery notice, the contract administrator would advise the sales group in
Cameco US and they would determine who would follow up with the utility.
[190]
To make a transfer, the contract administrator
would send a transfer notice to the facility where the delivery was to occur
and on the day of the transfer the facility would acknowledge that the transfer
had been made.
[191]
Mr. Wilyman testified that, to his knowledge,
a delivery had never occurred without a binding delivery notice having been
received by the Appellant and that with third-party deliveries there was always
some sort of delivery confirmation by the facility making the transfer. In cross-examination, Mr. Wilyman acknowledged two instances
in which he had asked a utility for a past-due binding delivery notice. In re-examination, Mr. Wilyman clarified that the second
example may have been a late annual delivery schedule.
[192]
In the following exchange with counsel for the
Respondent, Mr. Wilyman described the respective roles of marketing and
contract administration:
Q. So, during this process, generally what
sort of interaction would you have with the CCI salespeople?
A. Well, the CCI salespeople would go out
and sell the uranium to the end customer. From that, they would start the
third-party agreements, and we would work with them and the legal group to
finalize those agreements. Once everyone was comfortable that they were ready
to be signed, they would typically be sent off to the sixth floor and get the
executive group to sign them. Sometimes we would actually walk them up there to
the sixth floor and get them to sign them, and then they would go to the sales
group in Minneapolis, and they would get the end utilities to sign them.
Once the contract was in place, the contract
administration group was charged with administering those agreements and would
have interactions with the third-party utilities. If there was anything that
came up that was at all contentious, for example, a notice being missed, then
typically you would advise the sales group and discuss the path forward to
resolving that.
Q. Other than if there was a notice missed,
for example, did the CCI sales group take a hands-off approach once a contract
had been signed with a third-party utility, or was there more interaction with
the contract administrators?
A. I would say that, you know, throughout
the process, the sales group worked very closely with the contract
administration group and, at times, the inventory group. It depended to some
extent, I suppose, on the sales manager themselves and the end utility customer
as to – you know, some utility customers were fabulous. They were never late
with their notices. They followed those contracts to a T. Others were a little
more laid back, I suppose, and you had to chase them down a little bit.
Q. Did it ever occur, for example, that a
third-party utility wanted to advance or defer a delivery?
A. Yeah. That did happen from time to time,
and sometimes you would get that information from the salespeople, because they
would have been contacted first. If it came in, in a notice that sort of caught
you off guard, then you immediately would contact the salespeople and have a
discussion with them, and more often than not, they would then go to the
third-party utility and have that discussion with them.
[193]
Counsel asked Mr. Wilyman about
intercompany notices:
Q. Now, you talked about the notices and the
transfer requests and delivery confirmations for the third-party utilities.
Were the notice provisions for intercompany transactions followed as
diligently?
A. No. Initially, when I first started
there, they were, you know, a little bit random and haphazard. As time went on,
there was more of a push to get that process, you know, sort of in place, and
it got better.
You know, I suppose in some ways it was
impacted by who was -- who was sort of driving those – the third party or the
-- pardon me -- the intercompany transactions. I know when Bill Murphy ended up
at Cameco Europe, he was much more diligent in trying to drive those notices,
make sure they were on time, and same thing with the intercompany agreements,
to make sure that they were completed in a timely fashion.
[194]
Mr. Wilyman acknowledged that some of the
notices were backdated and that he had backdated notices. He explained the reason for this as follows:
Q. And why did you do that?
A. Well, it would have been to have the
notices be dated within the terms of the contract and, you know, to have, I
guess, the appearance that it was filed normally, on time, as you would expect
with a third-party notice.
Q. Even though they weren’t?
A. Correct.
[195]
Mr. Shircliff testified that his role as a
contract administrator involved administering third-party contracts, which he
described generally as looking after deliveries to customers, preparing
notices, preparing invoices and generally abiding by the terms of the contract
and ensuring that the contracts were fulfilled. Eventually,
he also looked after some of the administration of the bulk sale contracts.
[196]
Counsel for the Respondent asked Mr. Shircliff
about an e-mail he sent to Mr. Glattes on January 25, 2001 which
stated:
I just spoke with Bernie and he informed me
that Nufcor was looking for CSA to purchase the conversion material at USEC on
March 19, 2001 rather than April 1, 2001. He asked that I
get in contact with you to let you know if this was OK. From my estimates there
should be no logistical or governmental problems with Nufcor’s request.
[197]
Mr. Shircliff testified that this was an
example of his deciding on the delivery date under an intercompany contract.
Mr. Shircliff testified that generally he would discuss with
Bernie Del Frari and Doug Zabolotney any third-party request for
a delivery date and decide whether the date was acceptable. If it was accepted,
he would make the recommendation to CESA/CEL.
Mr. Shircliff testified that the recommendation was not always accepted by
CESA/CEL but he could not recall a specific example of non-acceptance.
[198]
Mr. Shircliff testified that he would make
recommendations to CESA/CEL regarding the placement of Russian source uranium.
He did not recall the details of what happened next but, if the recommendation
was approved, the HEU feed would end up being delivered to the end-user. He agreed with counsel that the binding delivery notices from
third-party customers would determine the dates in the binding delivery notices
issued by CESA/CEL to Tenex.
[199]
Mr. Mayers described his role as a contract
administrator as follows:
Cameco Corp. had contracts with utility
companies around the world, and within those contracts were notice provisions,
both that had to be given and had to be received. And, as a contract
administrator, it was my job to make sure that any notices that had to be given
were given, any notices that were due to be received were received on time and
accurate to the contract, as well as provide notices to the next stage.
The facility in the next stage is a fuel
cycle, whether that was a conversion facility or an enrichment facility, to
transfer any uranium or any product that was being sold under the contract, as
well as issuing the invoice to the client.
[200]
Mr. Mayers testified that the contract
administration process began with a non-binding delivery notice or schedule
from the utility. If there was a corresponding intercompany contract, then a
corresponding intercompany notice was required to be issued. The second step
was the receipt of a binding delivery notice from the utility. Again, if there
was a corresponding intercompany contract, then a corresponding intercompany notice
was required to be issued. The third step was the receipt of a transfer request
from the utility, which in turn required the issuance of a transfer notice to
the facility where the transfer was to take place. The fourth step was the
receipt of a confirmation notice from the facility. The fifth step was the
issuance of an invoice to the utility.
[201]
Mr. Mayers testified that he would
faithfully follow these steps for third-party contracts and that typically the
same process was followed for intercompany contracts.
Mr. Mayers did not recall specific instances where intercompany notices
were missed but he did recall one instance in which a notice under a purchase
and sale agreement between CESA/CEL and the Appellant was backdated, although
he did not recall why.
[202]
Mr. Mayers testified that, as a contract
administrator, he would rarely contact a utility directly but that when he did
it would typically have been about an upcoming deadline for a notice or
possibly the reliability of a non-binding notice. Mr. Mayers
did not call the transfer facilities (i.e., the conversion or enrichment
facilities) as a contract administrator, but he did as an inventory
administrator. He described his role as an inventory administrator as follows:
That was looking at the Cameco group of
company commitments and making sure that the right inventory of the right
origin of the right obligation was at the right place at the right time.
[203]
Mr. Mayers testified that the inventory was
addressed on a consolidated basis. The
information in the non-binding notices was consolidated in three spreadsheets–one
for each of the Appellant, Cameco US and CEL.
Mr. Mayers described the spreadsheets as follows:
. . . Across the top of the spreadsheet was
the origins and obligations, and then along the side was a calendar, January,
February, March. And under each monthly heading would have been the one
“Incoming Shipment” or “Expected Incoming Shipment,” “Expected Incoming
Purchases,” “Expected Incoming Transfers,” and then our expected outgoings, so
the debits and credits. It worked like a bank account.
[204]
Mr. Mayers testified that it was normal
that there would be insufficient inventory at a particular facility to meet the
delivery obligations set out in the non-binding notices. The solution was to physically ship inventory from a Cameco Group
facility, to purchase inventory or to exchange inventory. Mr. Mayers did
not recall shipping inventory for CEL.
[205]
Mr. Mayers described an exchange as one
entity exchanging inventory at one facility for inventory of another entity at
another facility. He explained that this was possible because the inventory was
fungible. The entity doing the exchange could be a Cameco Group entity or a
third party. Mr. Mayers testified that he would recommend a course of
action to Mr. Glattes or Mr. Bopp and that they would always accept
his recommendation. Mr. Mayers did not recall a circumstance in which CEL
initiated an exchange, or a circumstance in which CEL had to purchase uranium
but no contract was in place to allow for that purchase, or a circumstance in
which CEL initiated the suggestion to purchase from a third party.
[206]
Mr. Mayers described how he decided to
allocate inventory to particular contracts:
Well, the first thing you would do would be
to go to the contract to find out what the parameters were. Some contracts were
very specific, whereas, if it was a conversion deal and you were delivered a
certain origin of U3O8 feed material, that origin had to be delivered back in
the form of UF6. So you always had to work within the confines of the contract.
With respect to placement of the HEU, you
were confined by the Department of Commerce antidumping laws and quotas that
were put on to deliver to -- to the U.S. utilities at that location.
[207]
Mr. Mayers testified that it was
contemplated from the outset that CESA/CEL would purchase more Russian source
UF6 (HEU) than the United States import quotas would allow into the
United States. To address this, he would try to place the UF6 with
utilities located outside the United States such as utilities in Japan. Initially,
Canadian utilities did not obtain enrichment services at USEC so selling to
those utilities was not an option. However, that changed at some unspecified
later date. The excess Russian source UF6 remained in CESA/CEL’s
inventory until it was placed.
[208]
Mr. Mayers testified that he made the
decision of how and where to place CESA/CEL’s Russian source UF6. The
HEU feed would be delivered to either Cameco US or the Appellant, depending
upon the structure of the contracts. The HEU feed would either be delivered to
the Appellant, if it was being used for intercompany purposes, or be sold to
Canadian utilities. Counsel for the Respondent asked Mr. Mayers on several
occasions whether he made decisions regarding the purchase or sale of inventory
and Mr. Mayers consistently responded that he made recommendations and was
not the decision-maker.
[209]
Ms. McGowan appeared unable to recall many
of the details of her time with the Cameco Group and to address this I granted
leave to counsel for the Respondent to ask leading questions under subsection
144(4) of the Rules. Ms. McGowan testified that the contract
administration group did make decisions regarding the allocation of
inventory to meet contractual obligations and that this was sometimes based on
trading profits. As to what specific factors were considered with regard to
trading profits, Ms. McGowan’s only firm recollection was that transportation
expenses were a factor. She did not recall whether placing profits in
Switzerland was a factor. Ms. McGowan testified that the contract administration group
prepared monthly schedules that would show the inventory available to each
entity at each location and that these schedules would be used to allocate
inventory.
[210]
Ms. McGowan testified to the effect that the
Cameco Group had an inventory policy as of 2003 and that one of her roles was
to manage, report on, and monitor the Cameco Group’s inventory in accordance with
the policy. Ms. McGowan agreed with counsel for the Respondent that she
had been asked by Mr. Murphy on two occasions to provide CEL with its
purchase commitments, that she provided Mr. Murphy with summaries of CEL’s purchases
of conversion services, that she provided CEL with monthly contract balance statements, that she provided CEL with forecasts of intercompany transactions and that she provided CEL with quarterly inventory reports. Ms. McGowan also reviewed the statements of inventory balance
received from the facilities holding the inventory for CEL and prepared revenue forecasts for CEL that included a budget and a
three-year business plan.
[211]
Ms. McGowan testified that book transfers of
inventory among Cameco Group companies would not be entered into the Paradox
system that produces the inventory allocation and acquisition schedule but that
a spreadsheet was used to keep track of the transfers. A
revision or reversal of a transfer would require a new book transfer request
before being entered on the spreadsheet. A
transfer would be recorded internally as a transfer between the accounts of the
transferor and transferee, but no third-party would be notified of the
transfer.
[212]
In cross-examination, counsel for the Appellant
took Ms. McGowan to an e-mail in which she had stated that each month she
would provide Mr. Glattes with a three-month rolling forecast of CEL’s
purchases, exchanges and sales. Ms. McGowan testified that the e-mail
accurately described her practice and that Exhibit A004278 was an example of such
a forecast provided to CEL. Ms. McGowan testified that the trading reports were available in
“Contact!” as of June 2002.
[213]
Ms. Sperling testified that the job description
in her 2004 Job Information Questionnaire (“JIQ”)
described the role of all contract administrators. The
job summary on page two of the JIQ states:
Responsible for managing a broad portfolio
of short, medium, and long term uranium sales and related marketing agreements,
generating revenues in excess of C$600 million annually (C$700 million in
2003), with a world-wide base of customers. Provide an interface with Cameco’s
customers, our Marketing Sales team, Legal Department, Fuel Services, and
external regulatory bodies in order to co-ordinate deliveries of uranium,
ensure that all contractual provisions are fulfilled and that Cameco’s revenues
are invoiced and collected.
[214]
Ms. Sperling summarily described her role by
stating that she “administered contracts”.
[215]
Ms. Sperling testified that it was not her role
to decide whether a specific delivery should be made. However, she agreed with
counsel for the Respondent that from an e-mail she had sent to Tim Gabruch
on September 8, 2000 it appeared that she did make such a decision
even though she should not have. In
the same e-mail chain, Tim Gabruch sends an e-mail to Scott Melbye in
which he states:
I think we should discuss this next week. I
believe everything here is within Urenco’s contractual rights, however, what
worries me is [that] Rita did not discuss this with anyone before taking care
of everything with Don. The rogue contract administrator strikes again. I spoke
to Rita briefly to try and impress that someone (anyone!) should be brought
into the loop even on little matters like this before she agrees to any request
by a customer.
[216]
Mr. Gabruch testified that Ms. Sperling was not
really agreeing to a sale because the contract was a “requirements-based”
contract and therefore Urenco was entitled to request the additional material
even if there was a bit of a timing issue. He also testified that he was not
aware of another instance in which a contract administrator agreed to an extra
delivery or made a sale to a third-party utility without advising or consulting
with a Cameco US salesperson.
(13) Other Contractors and Employees
[217]
In addition to being questioned regarding MeesPierson
Trust and Mr. Bopp, Mr. Glattes was asked about two other consultants
to CEL and one employee of a subsidiary of CEL.
[218]
Counsel for the Respondent asked Mr. Glattes
about two agreements between the Appellant and Resource Strategy Associates
Inc. (“RSAI”), both made effective
November 22, 1999. Thomas Neff is the principal of RSAI. The Appellant guaranteed
CESA’s performance under both agreements.
[219]
Counsel for the Respondent took Mr. Glattes
to two pieces of correspondence from Mr. Neff. The first piece of correspondence
is an e-mail from Mr. Neff to George Assie, with a copy to
Gerald Grandey, sent May 14, 2004. The e-mail states that “Attached is our annual UF6 Feed Component Consulting Report
for 2003.” Mr. Glattes did not recall if he received a copy of the
report but he stated that he was familiar with the subject.
[220]
The second piece of correspondence is a letter dated
March 4, 2004 from Mr. Neff to George Assie regarding the “RSA-Cameco HEU Feed Component Variable Compensation Agreement”. Mr. Glattes did not know why this letter was addressed
to Mr. Assie. Counsel asked Mr. Glattes about the following excerpt from the
letter:
Finally, we need to clarify lines of
reporting. Our Agreement calls for us to report to Cameco Europe, with copies
to the Executive Vice-President of Cameco in Saskatoon. This is, in part, a
contractual issue as the Agreement is technically between Cameco Europe and RSA
(though Cameco Corporation guarantees performance).
In the past, our understanding has been that
our reports would be sent by Cameco Corporation to Cameco Europe as deemed
necessary by Cameco Corporation. We should probably formalize this arrangement
if you wish to continue in this manner.
[221]
Mr. Glattes testified that he had
long-standing contact with Mr. Neff, that he was not aware of the issue
identified in the letter and that he was not aware of any agreement with
Mr. Neff regarding reporting other than the agreement in the contract
between CESA and RSAI.
[222]
Counsel for the Respondent asked Mr. Glattes
about a consulting agreement between CEL and Alexander Chvedov. Mr. Glattes
agreed with counsel that the Appellant had entered into this contract on behalf
of CEL. Mr. Glattes testified that the process was not initiated by CEL
but that “we were all along informed and aware what’s
going on”.
[223]
Counsel took Mr. Glattes to an e-mail from
Mr. Bopp indicating that the Appellant had reached an agreement with
Mr. Chvedov on behalf of CEL without the knowledge of Mr. Murphy,
Mr. Glattes or Mr. Bopp. Mr. Glattes agreed with Mr. Bopp’s
comment that the Appellant entering into agreements over CEL’s head was “not really good” but maintained that he was aware that
there was an arrangement with Mr. Chvedov, possibly because it was mentioned
during a phone call by Mr. Grandey or Mr. Newton. Mr. Glattes
noted that by October 2004 he was no longer in Zug and therefore his suggestion
in his response to Mr. Bopp that he was not aware of the contract may have
been a miscommunication.
[224]
The final arrangement was with Paul Green.
Mr. Glattes testified that Mr. Green was previously employed by
British Nuclear Fuels Limited (“BNFL”)
and was experienced in the “whole conversion area”.
It was decided that it made sense for Mr. Green to be employed by a Luxembourg
subsidiary of CEL.
[225]
Mr. Glattes was asked whether giving
substance to the Luxembourg entity was a reason for placing Mr. Green in the
Luxembourg subsidiary and Mr. Glattes responded that substance was a “side aspect” and that Swiss social security issues
drove the decision. Counsel took Mr. Glattes to an e-mail from
Randy Belosowsky dated April 27, 2006 in which Mr. Belosowsky
stated, in part, “[t]here may, however, be a substance
benefit” to having Mr. Green employed by the Luxembourg corporation.
Mr. Glattes testified that the substance point raised by Mr. Belosowsky
related to the withholding tax issue with respect to the Luxembourg corporation
and CEL, and he agreed with counsel that substance meant “carrying on activities, et cetera”.
[226]
Mr. Glattes testified that the initial
proposal considered in the summer of 1999 was for CESA to enter into two
agreements with the Appellant: one spot purchase agreement for part of the
Appellant’s existing inventory and one long-term agreement for the purchase of
the Appellant’s future uncommitted uranium production. A
draft long-term agreement with a fax transmission date of August 3, 1999
was prepared and the management committee of CESA authorized Mr. Glattes
to finalize and arrange for the signing of the contract. However, the contract
was not signed. Neither Mr. Glattes nor Mr. Goheen was able to recall why
the draft long-term agreement was not signed.
a) The Sale to CESA of the Appellant’s Existing Inventory
[227]
CESA/CEL and the Appellant entered into a total
of ten spot sale contracts between October 25, 1999 and
November 22, 2002 (I will refer to these ten contracts collectively
as the “Spot Sale Contracts”). The first nine of these contracts were entered into in 1999, 2000
or 2001 and effected the sale of the existing inventory of the Appellant to
CESA (I will refer to these nine contracts as the “Inventory
Sale Contracts”). The deliveries under these nine contracts totalled
9.25 million pounds of U3O8. These deliveries were
completed by the end of 2002. The following table summarizes the key terms of
the Inventory Sale Contracts:
|
Exhibit #
|
Date
|
Quantity (lb)
|
Price (US $)
|
Year Delivered
|
|
A004807
|
25/10/1999
|
500,000
|
9.75
|
1999
|
|
A166897
|
30/11/1999
|
450,000
|
8.75
|
1999
|
|
A020785
|
01/01/2000
|
1,000,000
|
95% of Nuexco market value
|
2000
|
|
A020824
|
20/07/2000
|
500,000
|
8.65
|
2000
|
|
A020836
|
15/11/2000
|
1,500,000
|
Average of Ux and Nuexco market price indices
(MPIs)
|
2001
|
|
A020859
|
15/11/2000
|
800,000
|
Lowest of MPIs in the 6 months before
delivery
|
2000
|
|
A020961
|
22/2/2001
|
500,000
|
7.05
|
2001
|
|
A153626
|
27/3/2001
|
2,000,000
|
7.15
|
2002
|
|
A020969
|
04/04/2001
|
2,000,000
|
7.50
|
2001
|
[228] The tenth Spot Sale Contract was entered into in 2002 and provided
for the delivery on December 2, 2002 of 227,322 kgU of Russian-origin
UF6 at a price per kgU of US $30.00.
Mr. Assie did not know whether the Russian source UF6 sold by
the Appellant to CESA under this contract had been acquired by the Appellant from
CESA, and no other witness was asked about the contract.
[229]
Mr. Assie was asked by counsel for the Respondent
about the timing of the Inventory Sale Contracts and why the Appellant’s
uranium inventory was not sold to CESA immediately after the reorganization was
completed. Counsel pointed to an e-mail from Mr. Goheen to Mr. Assie
and Mr. Del Frari dated September 5, 2000, in which Mr. Goheen
stated, in part:
The underlying principle behind Cameco
Europe is that CE is to purchase all available inventory from Cameco asap. We’ve
let this slide, prudently as it has turned out, because of the concern for
prices continuing to decline.
Do you expect prices to fall further?
[230]
Mr. Assie testified that it was never his
understanding that the Appellant’s inventory had to be sold to CESA on day one,
and that a single sale of 10 million pounds of U3O8 would
have been completely unrelated to anything going on in the market and would have
commanded a huge discount. Mr. Assie testified that Cameco US was to
advise CESA, as a trader, as to when to be purchasing uranium and that the idea
was to move the inventory within a reasonable period of time on terms that
would generally reflect the market, although to expedite the transfer of the
inventory the volumes were sometimes above market levels.
[231]
Mr. Assie testified that, in the period
following the reorganization, uranium prices were falling rapidly and CESA was
not anxious to simply take 10 million pounds of UF6 at what was
generally perceived as being a high point in the market. He stated that
averaging the price over a reasonable period of time “seemed
like a logical thing to do.”
[232]
Counsel for the Respondent also asked Mr. Goheen
about his e-mail. Mr. Goheen testified that he was not involved in making
decisions regarding the timing of sales and that his e-mail was an attempt to
politely prod a peer in management to implement the agreements selling the
Appellant’s uranium inventory to CESA. Mr. Goheen acknowledged that he
must have been informed that the expectation at the time was that uranium
prices would be falling but since he had no knowledge of this himself he was
simply making an inquiry to determine what was going on.[344]
[233]
Counsel for the Respondent asked Mr. Goheen
if the danger everyone wanted to avoid was selling the Appellant’s inventory to
CESA at a price above what CESA would earn when selling the uranium to Cameco
US. Mr. Goheen stated that there was always a danger, when one relied on a
forecast, that the price of uranium would fall after CESA acquired the
inventory.
b) The Sale to CESA/CEL of the Appellant’s Uncommitted Uranium
Production
[234]
CESA/CEL and the Appellant entered into a total
of thirteen long-term agreements between October 25, 1999 and August 20, 2004
under which the Appellant agreed to sell uranium to CESA/CEL (I will refer to
these thirteen agreements collectively as the “Long-term
Contracts”).
[235]
Mr. Assie testified that the Long-term
Contracts were a means to sell all the Appellant’s uncommitted uranium
production to CESA.[347]
The number of Long-term Contracts was influenced by the fact that the
participants at the twice-weekly sales meetings did not want to enter into 15
or 20 agreements per year but did want to be able to rely on what they knew was
taking place in the market between arm’s length parties. This placed a cap on
the volumes that could be sold under a single contract.[348] Mr. Assie
testified that the idea was to make the volumes comparable to what larger
utilities could handle.
[236]
Nine of the Long-term Contracts provided for
deliveries of uranium by the Appellant in one or more of the Taxation Years. These
nine agreements were entered into between October 25, 1999 and
April 30, 2001 (I will refer to these nine Long-term Contracts
collectively as the “BPCs” and individually as a
“BPC”).
[237]
Mr. Assie, Mr. Glattes and Mr. Murphy
testified that the terms of the BPCs were discussed and settled during the sales
meetings.[351]
No notes or e-mails were exchanged regarding the terms
of the BPCs.[352]
[238]
Mr. Glattes signed all but one of the Long-term
Contracts for CESA/CEL. Mr. Murphy signed one of the Long-term Contracts—Exhibit R-001399—for
CEL shortly after his appointment as president of CEL in August 2004.
Mr. Murphy relied on Mr. Glattes to confirm the terms of the
agreement prior to signing the contract.
[239]
The following table summarizes the key terms of
the BPCs prior to any amendments:
[240]
One of the BPCs uses a fixed price, four use
base escalated pricing (BEP) mechanisms, two use market based (MP) pricing
mechanisms and two use a combination of base escalated and market based price
mechanisms.
[241]
Mr. Assie was asked by the Appellant’s
counsel how the mix of pricing mechanisms in the BPCs fit with the Cameco Group’s
target of 60 percent market-related and 40 percent base escalated pricing:
Q. How does that square with the 60 percent
market, 40 percent base escalated target that you mentioned, I think,
yesterday?
A. Right. So the target of the 60 percent
market related, 40 percent base escalated, that was the target that the Cameco
group had in respect of material that it would ultimately place with utilities.
The ratio here of two-thirds/one-third as opposed to 40/60, I believe, was much
more reflective of what was happening in the market. It was more a case that
more utilities were interested in base-escalated contracts than in market-related
contracts. And Cameco Europe, as a purchaser, was much more interested in
fixed-price contracts or base escalated contracts than market-related
contracts.
[242]
Counsel for the Appellant asked Mr. Assie
why CESA/CEL and the Appellant did not use the Appellant’s price forecasts to
establish the prices in the BPCs:
Q. . . . Why didn’t Cameco Corp. and
Cameco Europe use the pricing that corresponded to Cameco’s own forecasts?
A. Well, you’re not able to sell based on
forecasts. So it wasn’t a case of saying, “Oh, gee, our forecast was 15, so
we’ll sell at 15.” Then you’re not going to sell any uranium.
[243]
Counsel for the Respondent asked Mr. Assie
whether anyone looked at the Appellant’s cost of production and Mr. Assie
responded:
No. Typically what people looked at was the
market forecasts. We’re not in an industry that allows you to sell based on
your cost of production.
[244]
Subsequently, Mr. Assie testified that the
people negotiating the BPCs did look at market price indicators published by
TradeTech and Ux but did not look at the Appellant’s own forecasts. Mr. Assie provided the following reason for not using the
Appellant’s forecasts:
. . . Our forecasts were forecasts of future
market prices. They were not prices that anybody would -- I mean, if you were
going to contract at those prices, they would only contract on a market-related
mechanism, not on a base-price mechanism at those prices.
[245]
Mr. Assie testified that the terms and pricing
in the Urenco transaction had some influence in determining the terms and
conditions of the BPCs, taking into account the unique aspects of the Urenco
transaction, such as the fact that the uranium was the equivalent of natural
uranium delivered in Europe as UF6 and, unlike the Appellant’s
uranium production, was not legal for sale in the United States.
[246]
Counsel for the Respondent asked Mr. Assie
if the HEU Feed Agreement was considered and Mr. Assie responded:
No. You know, that agreement was -- well, I
mean, it’s -- given the way that agreement was ultimately -- or the timing of
which it was finalized, et cetera, you know, I guess it would have been
informative to some degree in -- where was it -- the fall of 2001 when it was
finalized, but it was a unique transaction as well.
So I don’t want to say that it didn’t
influence our thinking, and it clearly influenced market prices. But to say
that we took that agreement and said, “Okay. Yeah, that’s the price, you know,
at which we should do a bulk purchase agreement,” I don’t think that’s the
case.
I guess the point I am trying to make is we
took into account everything that was occurring in the market, and it was not a
situation where you could say, “Okay. Well, here, we can point to this, you
know -- like, like here’s a deal that -- all the exact terms.” We’re not in
that sort of a market. So it was a case of coming up with what we believed
represented a reasonable transaction between arm’s-length parties.
[247]
Mr. Assie testified that no analysis of the
Appellant’s profit was undertaken because “the market
is the market. Frankly, buyers don’t care what your profit margin is.”
[248]
Counsel for the Respondent asked Mr. Assie
why the duration of the BPCs extended past 2004 when the marketing strategy at
the time was to limit sales to third parties to before 2005. Mr. Assie
responded that the marketing objective was to limit the term of contracts to
before 2005 if possible but that strategy was not always successful. With
respect to the BPCs, the understanding was that the terms had to reflect
contracts between arm’s length parties. Similarly,
the prices used in the BPCs were intended to reflect the market at the time.
i.
The Flex Options under the BPCs
[249]
All of the BPCs included flex options which
ranged from plus or minus 20% to 30% of the quantity deliverable under the
contract.
[250]
Counsel for the Respondent presented Mr. Assie
with a schedule indicating that in 2005 the maximum deliverable quantity of
uranium under the BPCs was just under 23 million pounds. Mr. Assie testified that he did not recall looking at an
analysis of the Appellant’s production forecasts, at the time the BPCs were
negotiated, to determine if this quantity would be available. He testified that
the Appellant had never had production issues to that point in time (2001) and
the production plans would have been taken at face value. He agreed it was
reasonable to assume that expected production would have included some
production from the Cigar Lake mine.
[251]
Counsel for the Respondent asked Mr. Assie
why the flex options in the BPCs were 20 to 30 percent of the contract volume
when the marketing strategy at the time was to hold flex options to 15 percent
of contract volume. Mr. Assie responded that at the time volume was king
and that in high-volume contracts such as the BPCs the buyer could reasonably
expect flex options in the range of 20 percent to 30 percent. Mr. Assie
referenced the flex options in an August 2001 contract with Exelon, which
was 20 percent.
[252]
With respect to the exercise of the flex
options, Mr. Assie testified that at times the decision whether to
exercise a flex option would be discussed but that the general understanding
was that if the price under the BPC was reasonably expected to be below the
market price at the time of delivery then the upward flex option would be
exercised by CESA/CEL. If it was a close call, then the contract administrators
would check with Cameco US and CESA/CEL.[368]
[253]
Mr. Assie identified a fax dated
October 2, 2001 in which he had made recommendations to Mr. Glattes
regarding the exercise of flex options under three of the BPCs and an e-mail
from Mr. Glattes dated October 4, 2001 in which Mr. Glattes
indicated acceptance of the recommendations.[369]
In cross-examination, Mr. Assie testified that he did not recall whether
he gave written recommendations regarding flex options on other occasions but
that the topic was something that would have been discussed from time to time
in sales meetings or in strategy meetings.
[254]
In cross-examination, Mr. Assie was asked
if flex options were offered to traders such as Nukem. Mr. Assie testified
that spot sales to traders would not include a flex option because the quantity
sold in a spot sale is fixed.
Mr. Assie testified that typically a flex option puts the risk of supplying
the flex amount on the producer and that for 2002 he recommended to CEL an
upward flex on the BPCs that would provide CEL with the greatest profit given
the forecast purchase price under the contract.
[255]
Mr. Assie testified that for 2003 CEL exercised
the downward flex option for three of the BPCs and the upward flex option for
one of the BPCs. For 2004, CEL issued non-binding delivery notices in mid-2003
that called for the delivery of the base quantity under all but one of the BPCs,
and in respect of that one CEL flexed downward. CEL
exercised the maximum upward flex for 2006 and for the following few years.
[256]
Mr. Glattes testified that the contract
administrators had standing instructions to exercise the flex option under a
BPC if it made commercial sense, which generally meant that the price under the
BPC was lower than the market price. If it was a close call, the contract
administrators were instructed to consult their supervisor and ask for guidance,
and if it was a really close call the issue would be addressed during a sales
meeting. Mr. Glattes did not have any specific knowledge as to why
CEL issued no flex notices for 2004 under the BPCs.
[257]
Mr. Murphy testified that the contract
administrators understood that if the market price was above the price in the
BPC then they were to issue a flex notice to the Appellant exercising
CESA/CEL’s upward flex option. However, if the prices were close then the
matter had to be discussed and a decision had to be made.
[258]
Ms. McGowan testified that she believed the
contract administrators would have to base their recommendations as to whether
CESA/CEL should exercise flex options on its requirements for inventory and on price.
With respect to price, Ms. McGowan testified that “if the price was a good price, then we’d probably want to
flex up.” Ms. McGowan did not recall advising Mr. Glattes about issuing
flex notices, nor did she recall whether there were standing instructions with
respect to flex notices or who initiated the preparation of flex notices.
ii.
The Deferral of Deliveries under the BPCs
[259]
Counsel for the Appellant asked Mr. Assie
about the deferral of certain deliveries under the BPCs that took place in 2004
and 2005. Mr. Assie testified that the deferral was the result of a “water inflow” event at the Appellant’s McArthur River
mine which reduced the Appellant’s production of uranium. CEL and the Appellant
discussed the quantities involved, the best way of dealing with the issue and
realistic solutions in light of the circumstances and reached an agreement to
defer the delivery of uranium under the BPCs.
[260]
Mr. Assie testified that the focus was on
meeting the Appellant’s commitments to its customers. However, because the
Appellant would ultimately honour its commitments to CEL, the value of the
particular BPCs to CEL was preserved.
Mr. Assie then had the following exchange with counsel for the Appellant:
Q. Was this proposal discussed with Cameco
Europe before it was put on paper in this fashion?
A. Yes, it was.
Q. In what context was it discussed?
A. Well, obviously Cameco Europe would have
preferred to have all of its material delivered, but it wasn’t practical. This
was a significant volume of uranium.
I should highlight that, prior to 2003, I
would say Cameco’s operations always operated without a glitch, and so we had
come to rely on the forecast of productions from operations. We took it almost
as the Bible. And so you had a significant shortfall and how to deal with it.
And this was what was proposed. And it was generally consistent with what was
going on in the industry.
[261]
Eight of the nine BPCs were amended in 2004 and
again in 2007 to provide for the deferral of delivery of uranium by the
Appellant to CEL.
[262]
Mr. Assie testified that the Appellant did not
rely on the force majeure provisions in the BPCs to address its
inability to meet its delivery obligations because it had determined on the
basis of exchanges with customers that those provisions did not provide the
Appellant with the option to defer delivery. The Appellant did however start to
incorporate provisions in its third-party agreements to address production
interruptions or shortfalls.
[263]
Counsel for the Appellant asked Mr. Assie why
CEL did not take the position that the Appellant should purchase the shortfall
in the market so that it could meet its obligations to CEL and Mr. Assie
responded:
Cameco Europe was holding -- had significant
inventory on hand, you know, so it was able to mitigate the impact to some
degree. And, you know, frankly it just wasn’t realistic to tell Cameco Corp., “Well
you go out and buy 4 million pounds in the market.” That wasn’t in Cameco
Europe’s best interests. Ultimately we believed that it should deal with Cameco
Corp. the same way that Cameco U.S. was proposing to deal with its utility
customers, and that is, “We’ve got a production problem. We -- you know, we’re
asking for your indulgence to allow us to defer these quantities.”
[264]
Mr. Assie described an example of a
deferral agreed to by Cameco US with a customer because of a delay in the
start-up of the Appellant’s Cigar Lake mine in Saskatchewan. Under section 8.1
of the contract with the customer, Cameco US had the right to defer, reduce or
cancel the deliveries of uranium required under the contract if there was a
shut down or interruption that reduced the production or supply of concentrates
from Cigar Lake. Instead of cancelling, Cameco US proposed to defer delivery of
the uranium on the same pricing terms and the customer agreed to accommodate
Cameco US’s request.
[265]
Counsel for the Respondent asked Mr. Assie
about an agreement made effective November 1, 2004 that amended Exhibit
A153624–one of the BPCs-and the proposal summary dated December 6, 2004
for that amending agreement. Mr. Assie testified that he did not recall when the
discussions about amending the BPCs began and that he did not recall any
written notes, faxes, e-mails, et cetera that predated the proposal summary. The third bullet point of the proposal summary states:
During 2004, Cameco Corporation delivered
13,675,000 pounds U308 under contracts with Cameco Europe
when Cameco Europe would have preferred to take delivery of the maximum volume
of 18,225,000, a shortfall of 4,550,000.
[266]
Initially, Mr. Assie was not able to
explain why, notwithstanding the statement in bullet point three of the
proposal summary, no upward flex notices or binding delivery notices requesting
quantities greater than the base amounts under the BPCs were issued by CEL for
deliveries in 2004. Mr. Assie agreed that such notices should have been
issued. Mr. Assie stated that he would have taken the statements in the
proposal summary at face value. The
following day, Mr. Assie volunteered the following explanation:
. . . I believe that the reason there were
no formal delivery notices was because that that was the very subject of the
discussions that were ongoing between Cameco Corp. and Cameco Europe, but the
realization that there was no way that Cameco Corp. was going to be able to
deliver the nominal or certainly not the flex quantities under those contracts.
And if we look at that December 6, 2004 proposal summary again, it
notices in there that it was Cameco’s -- Cameco Europe’s desire to take upward
flexibility. So I believe the reason the notices weren’t given was because
those discussions weren’t [sic] ongoing.
Now, I admit that, in the beginning of
January of 2003, I no longer attended the twice weekly sales calls, but as the
officer responsible for marketing, I was certainly apprised of the issue and
that there were ongoing discussions.
So to come back to the point, I just want to
clarify. When I couldn’t recall why there was no 2004 delivery notices, I
believe it was because the matter was being dealt with by ongoing discussions
between Cameco Corp. and Cameco Europe.
[267]
Mr. Assie confirmed that he had no
knowledge of any notes, e-mails, or correspondence reflecting this discussion
in the middle of 2003 about whether or not Cameco Europe should exercise an upward
flex in respect of 2004.
[268]
Mr. Del Frari states in the first
paragraph of a letter to Mr. Murphy dated February 9, 2005:
Cameco Corporation confirms receipt of
Cameco Europe’s notices indicating its intent to take the maximum contract
quantities for Delivery Year 2005 under the Long Term Uranium Sale and Purchase
Agreements with Cameco Corporation. In addition, Cameco Corporation acknowledges
that it was Cameco Europe’s intent to take maximum contract volumes in Delivery
Year 2004 under the same Agreements however Cameco Europe elected to take
nominal or minimum quantities to assist Cameco Corporation who was still
struggling with the impact of the McArthur River flood in 2003. Due to the
delayed start-up of Cigar Lake mine and the delay in the increase to McArthur
River and Key Lake production licenses, Cameco Corporation is unable to supply
the cumulative maximum quantities under the existing Long Term Uranium Sale and
Purchase Agreements in 2005.
[269]
On being shown contract summaries Mr. Assie
agreed that, because of option years, the exercise of upward flex options,
amendments and deferrals, the terms of eight of the BPCs were ultimately
extended as set out in the following table:
|
Exhibit Number
|
Original Expiration Year Including Option
Years
|
New Expiration Year
|
|
A004808
|
2009
|
2012
|
|
A022414
|
2010
|
2015
|
|
A153564
|
2008
|
2011
|
|
A153597
|
2009
|
2013
|
|
A153615
|
2007
|
2009
|
|
A153624
|
2010
|
2015
|
|
A153633
|
2009
|
2013
|
|
A153642
|
2010
|
2015
|
[270] Mr. Assie was asked why three Long-term Contracts were entered
into in 2004 (Exhibits A163425, A162970 and R-001399) if there were ongoing
discussions about production shortfalls in 2003 and 2004. Mr. Assie
testified that the proposal summaries would have been presented to him and he
believed he signed the agreements. He testified that the contracts would have
been based on the production forecasts for the years of delivery. Mr. Assie
did not ask for production forecasts and did not remember seeing any analysis
of production forecasts. Rather, he “took it on face
value” that those considerations were taken into account.
[271]
Ms. McGowan testified that she made the
recommendation to defer deliveries to CEL to Mr. Doerksen. The deferrals
were caused by a lack of inventory that resulted from the flood at the McArthur
River mine. Ms. McGowan did not recall any other reason. Counsel for the Respondent took Ms. McGowan to an e-mail she
had sent to Mr. Murphy on July 18, 2006 at 17:39 CDT in which
she stated:
To my knowledge there is no intention to
extend any of the CEL sales agreements that end in 2006. If they were to be
extended it would be at the request of the third party customer and I have not
heard of any requests in that regards.
In regards, to the amendments to the bulk
agreements, we have concerns about not specifying a specific year for the
delivery of the 2006 deferral quantity. I just want to clarify that it is an
issue to mention any future year even if it is an existing contract delivery
year. I raise this as it is not our intention to add any additional delivery
years to the contract, but to add the 2006 deferred quantity to the last
existing delivery year under each contract. We will need to revisit how to best
handle the 2006 deferrals if we can not reference a future delivery year, as we
would not offer such flexibility to a third party customer.
[272]
Counsel then had the following exchange with Ms.
McGowan:
Q. Could we go to the first page. In your
e-mail to Mr. Murphy, in the last sentence, you indicate that you weren’t sure
that you could defer to a future delivery year as you wouldn’t offer such
flexibility to third-party customers. Do you see that?
A. Yes.
Q. Why would you be telling that to Mr.
Murphy?
A. Because what was proposed was different
than what we would offer third-party customers.
Q. How did you know what would be offered to
third-party customers?
A. Because we’d seen the sales agreements.
[273]
In cross-examination, Mr. Glattes was asked
about the deferrals of deliveries under the BPCs in the context of whether CEL
had an inventory policy. Mr. Glattes testified that the policy of having
six months’ forward supply in inventory was a Cameco Group policy and that
CEL’s inventory policy was determined with reference to the strategic plan and
other elements which fixed sales targets for the Cameco Group. CEL had to
retain sufficient inventory to meet the portion of total sales it was expected
to make. However, the determination of inventory levels was a complex topic
and sales targets were not the only determinant of inventory.
[274]
Mr. Glattes testified that the flex options are
included in the ten-year strategic plan but that the actual decision whether to
exercise a flex option is made at the time the option must be exercised. In
that context, whether CEL needed the material for deliveries to CCI did not determine
whether CEL exercised an upward flex option.
[275]
Mr. Glattes testified that the decision in
2003 to reduce inventory levels from 6 months to 4 months was a strategic
decision of the Appellant’s management resulting from a number of
considerations, including the “water inflow” at
the McArthur Lake mine. Counsel for the Respondent asked Mr. Glattes why CEL was
taking maximum flex under the BPCs while agreeing to defer deliveries in 2004,
2005 and 2006. Mr. Glattes responded that CEL had a contractual right to
upward flex and had to look at its own interests in that regard. The deferrals
were a separate issue and were the result of negotiation with the Appellant. Mr. Glattes was asked to confirm that there were no notes
about the deferral discussions and he stated:
I can assure you there were long, long, long
discussions about deferrals and the terms and conditions. I mean, in a
corporation like Cameco, with this complex decision-making process, you cannot
expect that everything is minuted and can be found 15 years later in some
records.
[276]
Mr. Murphy testified that, because of a
disruption in production at the McArthur Lake mine in 2003, lower than
anticipated production volumes from McArthur Lake in 2004 and a delay in
the commencement of production at Cigar Lake, the Appellant would not be
able to supply the total volume of uranium that had been requested by CEL under
the BPCs.
[277]
Mr. Murphy also testified that commencing
in 2003, while he was with Cameco US, there were lots of discussions at the
sales meetings and strategy meetings about how to handle the situation.
Mr. Glattes represented CEL during the meetings until Mr. Murphy
became the president of CEL in August 2004. In cross-examination,
Mr. Murphy testified that CEL did not write to the Appellant regarding the
shortfalls in 2004 because of the ongoing discussions in relation to them.
[278]
Mr. Murphy was asked by counsel for the
Appellant if CEL had any input in the process:
Q. Did Cameco Europe have input into the
ultimate decision as to how to deal with it?
A. Absolutely. It was everybody involved. We
didn’t want to lose revenue. So we’re looking around at: Does Cameco
Corporation need to buy from the spot market? Does Cameco U.S. -- what are they
going to need to meet their commitments? That means: What is Cameco Europe
going to need to meet its commitments? And when all was said and done, we all
figured out that, you know, at this period, we can handle this by Cameco Europe
simply drawing down its strategic inventory from something like six months to
four months. And, in that way, Cameco U.S. was able to meet all of their
commitments to the utilities. Cameco Europe was able to meet all of its
commitments to Cameco U.S. And by these deferrals, it meant that -- it was
actually advantageous to Cameco Europe, because we would be getting these
quantities out in the future when we hoped the market prices would be higher,
and the prices for those volumes would be what were agreed to some years
earlier under that contract when the deferrals were going to happen.
[279]
Mr. Murphy testified that he accepted the
proposal summary for CEL after discussing approval issues with Mr. Glattes.
On the offer from the Appellant, signed by Mr. Murphy, it is stated in
Mr. Murphy’s handwriting that the offer is accepted subject to the
condition that CEL receive all necessary authorizations and approvals from BfE.
Mr. Murphy described the amendments as being the extension of the term of
the existing agreements by one year (the “additional
year”) and the delivery of the deferred quantities in the additional
year.
[280]
Mr. Murphy described the amount deferred as
“the difference between the maximum annual contract
quantity and the delivered quantity for ‘04 delivery year plus the difference between
the maximum annual quantity and the base quantity for 2005.” The actual quantities are set out in a table on the second page of
the offer as follows:
[281]
Mr. Murphy testified that the price of the
uranium delivered by the Appellant in the additional year was the price set out
in the original contract.
[282]
Counsel for the Appellant asked Mr. Murphy
about an e-mail from him to Mr. Glattes in which he asked Mr. Glattes
about the offer and the requirement for authorizations. Mr. Glattes’
response was as follows:
I agree the proposed arrangements do not
look unreasonable, even though I feel it is a borderline case. The yardstick
is, of course, how unrelated parties would have acted. Under these
circumstances the purchaser could have taken the position that the seller sells
the maximum quantity resulting from the exercise of the quantitative
flexibility and then re-purchases the differential quantity at the present
market price. That would, of course, have quite a detrimental impact on CCO. In
a nutshell, I would suggest that you sign the letter agreement, since we can
think of sufficient reasons why we act in this manner. I assume Randy was involved
in the decision-making in S’toon (you will not be able to check right now
because he is on vacation until February 21). If not, he should probably be
informed in passing after his return.
In the context of the Bern authorization we
have to apply for an amendment to the existing authorisation [sic] which
was granted at the time when the global authorization did not yet exist. While
the total quantity should be unchanged (provided that we have assumed maximum
exercise of the quantitative flexibility which we have usually done), the
delivery schedule will be extended by one year.
[283]
Mr. Murphy provides the following explanation
why CEL did not insist that the Appellant deliver the uranium required under
the BPCs:
. . . Well, that may have been considered,
but if you -- if you think about it in detail, it wouldn’t really make any
sense because, for Cameco Corp. to go to the market to buy these kinds of
volumes, even if they were available in the market, it would cost Cameco
Corporation a tremendous amount of money, and it would impact the market price,
the spot market price.
So, at first glance, you would say, “Well,
that’s great. Cameco Europe is going to benefit from an increased spot market
price.”
Well, they’re not really, because all of our
market related contracts had ceilings, which were very low in those contracts.
So we might have got a little bit of a bump from an increase in the spot market
price, but we weren’t going to get anything like what it would cost Cameco
Corporation. And when you considered that we could handle this by just reducing
our inventory and we were going to get these deferred quantities further out at
low prices, it just -- it made infinite sense to do it this way.
[284]
Mr. Murphy agreed with counsel for the Respondent
that if the Appellant had had to purchase the uranium in the spot market,
assuming the quantity needed was available, it would have lost money selling
the uranium to CEL at the prices in the BPCs.
Mr. Murphy also agreed that CEL would not have been worse off from a
monetary perspective because of the deferral.
[285] Counsel for the Respondent took
Mr. Murphy through various documents relating to the amendment of one of
the BPCs (PO 7015). The proposal summary for the amendment (Exhibit A000792) is dated
December 6, 2004. Mr. Murphy agreed that the contract amending
the BPC was signed after its effective date of November 1, 2004
and after a draft of the contract was received from Lorrie McGowan in
May 2005. The contract itself does not indicate when it was signed.
[286] Counsel for the Respondent asked Mr. Murphy about a proposal
summary dated December 12, 2006 which provided for a second amendment
to eight of the BPCs whereby the delivery of more uranium would be deferred to the additional year (i.e., to the additional year resulting from the
first amendment of the BPCs). The amount of uranium whose
delivery was to be deferred is the difference between the minimum and maximum
quantity of uranium to be delivered in 2006 under the eight BPCs, and that
difference totals 8,450,000 pounds of U3O8. The terms
in the proposal summary are repeated in an offer from the Appellant to CEL
dated December 19, 2006, which is accepted by Mr. Murphy on
behalf of CEL and formalized in a letter agreement dated January 8, 2007. The price of the uranium whose delivery was deferred under the
second amendment is the price in the original BPCs.
[287]
Counsel for the Respondent asked Mr. Murphy
about a proposal summary dated April 9, 2007 which provided for a
third amendment to eight of the BPCs whereby a second additional delivery year
(the “second additional year”) would be added to
these BPCs and the delivery of uranium deferred from 2007 to the second
additional year. The amount of uranium the delivery of which was to be deferred
is the difference between the minimum and maximum quantity of uranium to be
delivered in 2007 under the eight BPCs, and that difference totals 14,950,000 pounds
of U3O8. The terms in the proposal summary are repeated
in an offer from the Appellant to CEL dated May 25, 2007, which is
accepted by Mr. Murphy on behalf of CEL. The
price of the uranium the delivery of which was deferred under the third
amendment is the price in the original BPCs.
iii.
Other Issues in Respect of BPCs
[288] Counsel for the Respondent asked Mr. Glattes about the origin of uranium delivered to CEL by the Appellant in
January 2004 under PO 6920. The
contract provided for uranium of Canadian origin, but the uranium delivered was
in part of Namibian origin. Mr. Glattes testified that Markus Bopp
would have reviewed and approved the associated invoice under his supervision,
but he did not recall whether Mr. Bopp had brought the issue to his
attention.
[289]
Counsel for the Respondent asked Mr. Glattes
about a binding delivery notice for a February 2005 delivery under PO
6920. The contract required that the notice be provided by
November 1, 2004, but it was actually dated November 19, 2004.
Mr. Glattes agreed that the notice was sent late.
[290]
Counsel for the Respondent asked Mr. Glattes
about a discrepancy under PO 6958 between the annual delivery schedule for
2003 and the contract summary for that year. Mr. Glattes agreed with
counsel that the contract administrators would have made the initial decision
as to when, where, and how much to deliver under PO 6958 for 2003. Mr. Glattes
also agreed that there would have been very little, if any, e-mail traffic
between the Appellant and CEL explaining differences between the annual
delivery schedule and the binding notices and the actual deliveries in 2003.
Mr. Glattes testified that, because of the requirement for BfE approval, CEL
had to be made aware of changes in delivery dates and therefore would usually
be involved, indeed had to be involved, in any suggested changes. However,
because of the “water inflow” event at the
McArthur River mine in April 2003, 2003 was an atypical year and for
that reason the change in this case did not surprise him.
[291]
Counsel for the Respondent asked Mr. Glattes
about the Appellant’s having refused to admit that no transfer request existed
for a delivery in January 2002 under PO 6958, instead stating that
the document could not be located. Mr. Glattes testified that any such
document that existed would be in the manila folder maintained for that
particular contract in Zug, Switzerland.
(15) The Sales of Uranium by US Subsidiaries of the Appellant to CESA/CEL
[292]
In 2002, 2003 and 2005, four United States subsidiaries
of the Appellant entered into long-term uranium sales contracts with CESA/CEL.
Six of the contracts were entered as exhibits. The
uranium production sold by the US Subsidiaries came from two mines in the
United States.
[293]
Counsel for the Respondent put it to Mr. Assie
that it appeared from an e-mail from Byron Little to Lorrie McGowan
sent April 25, 2005 at 10:16 a.m., which is contained in a long
e-mail chain started by Lorrie McGowan, that
he directed the US Subsidiaries to enter into the contracts signed in 2002 and
2003. Counsel also put it to Mr. Assie that he told Mr. Newton that
as long as he was a president of a Cameco Group company he would do as
Mr. Assie told him to do. Mr. Assie categorically denied these
assertions.
[294]
Mr. Newton testified in chief that the US
Subsidiaries did not negotiate anything with the Appellant and that as
subsidiaries of the Appellant they did what the Appellant told them to do.
[295]
With respect to the contract dated as of
December 19, 2005 (between CEL and PRI) and the contract effective as
of January 6, 2006 (between CEL and Crowe Butte) (together, the “2005/2006 contracts”),
Mr. Newton testified that he received an initial proposal summary from CEL
in February 2005 and that he had concerns that the price was too low and
that PRI and Crowe Butte would not be able to deliver the requested volumes. Counsel for the Respondent then had the following exchange with Mr. Newton:
Q. Did you speak to Mr. George Assie about
these concerns?
A. At some point, yeah.
Q. And what do you recollect about that
discussion or those discussions?
A. Well, at one -- some point, I don’t
remember when it was exactly, but George said, “Look, if I tell you to sign the
contract, you’re going to sign the contract. Now, you know, you’ve made your
point. We hear you. Sign the contract.”
And so that was it. And I remember that
because it was probably an acrimonious exchange, and I remember going back to
Collings and Magnuson, because they were worried about this as well. In fact,
they might have been the ones to bring it up in the first place.
And I said, “Look, this is the deal, guys. I
just got off the phone with George, and, you know, it’s – it’s their way or the
highway.” So . . .
[296]
In cross-examination, counsel for the Appellant
asked Mr. Newton about the circumstances surrounding the execution of the two
contracts made as of August 6, 2002.
Mr. Newton agreed with counsel that he had had discussions with Mr. Assie
in Saskatoon regarding the terms of these contracts, that Byron Little and Shane
Shircliff had worked out the details regarding the volumes to be included in
the contracts and that on the cover sheet of the fax forwarding the proposal
summaries to him Mr. Assie had stated “If you are
in agreement, please sign where indicated and fax copies back to me.”
[297]
Mr. Newton also identified an interoffice
memo from him to Mr. Assie dated March 21, 2002 in which, in the
first paragraph, he stated:
This is in reply to your memo of
March 19, 2002 and the proposed summary of terms for purchase of
material from PRI, Geomex and UUS. We are agreeable to the terms you have
suggested, with the proviso that perhaps Kim Goheen should review them to make
sure they pass the “arms-length” test required for sales between companies with
common ownership. Obviously, at these prices, PRI, Geomex, and UUS will lose a
lot of money on the sales, however I don’t think this is relevant given the
fact that all of the financial and sales information for the Cameco companies
is ultimately consolidated.
[298]
Counsel for the Appellant asked Mr. Newton
about the circumstances surrounding the 2005/2006 contracts. Mr. Newton
again testified that he had raised issues with Mr. Assie regarding the
terms of a proposal summary dated February 28, 2005 and that the concerns focused on the proposed price formula,
which effectively capped the price at US$24 per pound of U3O8,
and the volumes, which PRI and Crow Butte may not have been able to provide.
Mr. Newton identified an e-mail he had sent to Bill Murphy and
John Guselle on March 8, 2005 regarding the
February 28, 2005 proposal summary, in which he stated:
I have read through the summaries of the proposed
contracts and also Bill’s comments.
From PRI’s perspective, as a subsidiary of
Cameco, I don’t mind selling all of our available production under whatever
terms Cameco chooses. The mechanism you have outlined John seems like a good
one since it would ensure that we are able to sell all of our available production,
even if we’re not entirely sure how much it’s going to be at the end of each
year. The one thing I do not want is to somehow create the illusion that PRI
and CBR are committing to supply CEL with a certain amount of material come
hell or high water. In other words, we’ll sell all of our production, whatever
that ends up being, and we should be able to give CEL a pretty good indication
(e.g., the strategic plan) what that production is going to be. But if for some
reason we can’t deliver all that we’ve promised to deliver, well, we’ll just
deliver all we can and leave it at that. I don’t want CEL (as another
subsidiary of Cameco) raising hell that we haven’t met our delivery
commitments.
As far as the price goes, again, we’re
following Cameco’s lead on this. If we were truly an independent company
there’s no way we’d sign a contract like this (i.e., one that effectively
limits the price paid to $24/lb in a market that is already above this) -- but
we’re not an independent company, so the question is irrelevant. My only
concern is the question of transfer pricing and whether we can justify this
contract price to the tax authorities in Wyoming and Nebraska. (This contract
price will be used to determine certain kinds of taxes, and will also obviously
have a huge impact on our income tax.) The mechanism you have outlined here, John,
seems like a reasonable one, although I’m certainly no expert on the limits of
transfer pricing. (I do wonder, however, when somebody in the Wyoming or
Nebraska departments of revenue is going to take a closer look at our “contract
prices” -- especially the current one which is just a little over $13/lb.) As
far as royalties are concerned, we’re going to use an independent market price
indicator (instead of the contract “price”) to calculate the royalties we pay,
so the contract price really doesn’t matter here.
Those are my thoughts for now.
[299]
Counsel for the Appellant then took Mr. Newton
to an e-mail sent by John Guselle (at the time, vice-president, marketing
(Europe) and trading at Cameco US) to him and Bill Murphy on
June 2, 2005. Attached to the e-mail were a draft letter and a draft
proposal summary each dated June 2, 2005. Mr. Newton agreed with
counsel for the Appellant that the changes in the proposal summary terms
contained in the draft documents responded to the concerns he had raised in his
March 8, 2005 e-mail.
Mr. Newton acknowledged that he sent an e-mail to Mr. Murphy and
Mr. Guselle on June 3, 2005 that stated:
I just read the darft [sic] of John
G’s letter and think it’s excellent. It explains everything we’re trying to
accomplish and will provide a clear record of our reasoning here.
[300]
Mr. Newton accepted the June 2, 2005
proposal summary by signing the document on behalf of PRI and Crowe Butte. Mr. Newton subsequently signed the 2005/2006 contracts incorporating
the terms set out in the June 2, 2005 proposal summary.
(16) The Sales of Uranium by CESA/CEL to Cameco US
[301]
Following the reorganization, Cameco US would
sell uranium to customers outside Canada and would purchase uranium from
CESA/CEL to fulfil its obligations to those customers. Between
November 1, 1999 and December 15, 2006, CESA/CEL and Cameco
US entered into a total of 90 agreements for the sale of uranium by
CESA/CEL to Cameco US (the “Cameco US Contracts”). Each of the Cameco US Contracts mirrored an agreement entered into
by Cameco US with a customer except that the price paid by Cameco US to
CESA/CEL was 2% lower than the price paid to Cameco US by the customer. Mr. Assie described the mechanics of these arrangements as
follows:
Q. And, similarly, the expectation was that
Cameco Europe would sell inventory to Cameco U.S.?
A. The expectation was that Cameco Europe
would utilize the services of Cameco U.S. to place the material into the
market. It didn’t sell inventory to Cameco U.S. Cameco U.S. -- any delivery
that Cameco U.S. took from Cameco Europe was immediately delivered on to the
utility.
Q. Cameco U.S.’ only supplier, aside from
some conversion services from Cameco Canada, was Cameco Europe; correct?
A. Yes.
Q. And it was never envisioned by the senior
managers that Cameco Europe would decline to provide the necessary uranium to
Cameco U.S.?
A. Oh, no, no, no, no. As I have told you,
quite a few times now, before a proposal was ever put in front of a utility,
Cameco Europe -- we had to secure Cameco Europe’s agreement that it would
supply on those terms.
So Cameco U.S. were a pretty knowledgeable
group. We think we were pretty good at selling uranium. We knew Gerhard Glattes
extremely well. He was a very gifted and talented individual. It was very much
a collaborative discussion, if you will, as to what terms, et cetera, were
required.
If you are asking me: Did Mr. Glattes ever
say, “No, absolutely not. I’m not selling on those terms,” it never got to that
from the point of view that, if -- we would be making recommendations based
upon the market at the time. This is the way it looks, you know, on and on and
on.
Ultimately, Mr. Glattes had to make -- act
on our recommendation. And, as I say, it was very collaborative. I don’t want
to suggest that, you know, he was -- we were just telling him, “Here are the
deals. Take it or leave it.” That wasn’t the case. These were discussed at
quite some length. So that’s the way we operated.
[302] Mr. Assie, Mr. Glattes and Mr. Murphy each testified that the agreements between Cameco US and its
customers were discussed during the sales meetings and
that Mr. Glattes and Mr. Murphy were active participants during these
discussions.
[303]
Mr. Assie, Mr. Glattes and Mr. Murphy
each testified that the understanding was that, to the extent that Cameco US
agreed to sell uranium to a customer on terms discussed during the sales
meetings, CESA/CEL would agree to sell uranium to Cameco US on the same terms
less 2% of the sale price to the customer.
[304]
Mr. Wilyman testified that he did not
believe that during the sales meetings he attended CESA/CEL was expressly asked
to confirm its agreement to sell uranium to Cameco US, and Mr. Mayers
testified to much the same effect.
[305]
Mr. Mayers described the sales meetings as
including market information and updates on discussions with utilities, and
Mr. Wilyman agreed with counsel for the Appellant that there was a sharing
of market information and that there were discussions regarding the proposals
that were going to be made to customers.
[306]
Counsel for the Respondent asked Mr. Glattes
about the Appellant’s refusing to admit that an origin notice for 2000 under
PO 6983, certificates under section 6.2(d) of PO 6995 and a transfer
request or a delivery confirmation notice for a June 30, 2003 delivery
under PO 6995 did not exist, but stating instead that these documents
could not be located. Mr. Glattes testified that any such documents that
existed would be in the manila folder maintained for the particular contract in
Zug, Switzerland.
[307] In cross-examination, counsel for the Respondent asked Mr. Murphy
about several of the intercompany contracts between CESA/CEL and Cameco US.
[308]
The first intercompany
contract addressed by counsel for the Respondent is an intercompany
contract signed effective as of March 15, 2004 that supported a
contract between Cameco US and ENUSA.
Mr. Murphy testified that the intercompany contract was not signed until
at least September 2005. In re-examination, Mr. Murphy testified that the intercompany
offer letter setting out the terms in the intercompany contract was received by
CEL by fax on July 11, 2003 and was signed by Mr. Glattes. The
signature date is July 13, 2003.
[309]
The second intercompany contract addressed by counsel
for the Respondent is an intercompany contract signed with effect as of
September 28, 2006 that supported a contract between Cameco US and
Exelon Generation Company, LLC.
Mr. Murphy testified that the quantities in the contract did not match the
quantities in the offer letter introduced by counsel for the Respondent.
[310]
In re-examination, counsel for the Appellant
took Mr. Murphy to another offer letter and to another intercompany
contract. After reviewing the documents, Mr. Murphy testified that the
terms of the intercompany contract in issue matched the terms in the offer
letter introduced by counsel for the Appellant and that the terms in the offer
letter introduced by counsel for the Respondent matched the terms in the contract
introduced by counsel for the Appellant. As well,
the notation used by CEL to identify the intercompany contract introduced by
counsel for the Appellant matched the notation in the offer letter introduced
by counsel for the Respondent.
[311] The third intercompany contract addressed by counsel for the
Respondent is an intercompany contract signed with effect as of
February 2, 2005 that supported a contract between Cameco US and Public
Service Electric & Gas.
Mr. Murphy testified that the quantities in the contract did not match the
quantities in the offer letter introduced by counsel for the Respondent.
[312]
In re-examination, Mr. Murphy was taken to
a memorandum to him and Markus Bopp from Scott Hyman to which were attached
three execution copies of the intercompany contract. The memorandum stated that
“[a]s reported in previous discussions” the
quantity of uranium in the contract had been reduced by 200,000 pounds for
2006. Mr. Murphy testified that he would be surprised if he was not a
party to the discussions but that he had no specific recollection of the
discussions and was not able to describe the substance of the discussions.
[313]
The fourth intercompany contract addressed by
counsel for the Respondent is an intercompany contract signed effective as of
June 30, 2005 that supported a contract between Cameco US and
Southern Nuclear Operating Company (“SNOC”) and
Alabama Power Company. Mr. Murphy testified that the quantities in the contract did
not match the quantities in the offer letter introduced by counsel for the
Respondent although he noted that the contract was in support of SNOC and
Alabama Power while the offer letter referenced only SNOC.
[314]
The fifth intercompany contract addressed by
counsel for the Respondent is an intercompany contract signed effective
September 27, 2004 that supported a contract between Cameco US and
WMC. Mr. Murphy testified that the intercompany contract was signed
after its face date of September 27, 2004 and before
December 14, 2004. He agreed with counsel for the Respondent that two invoices showed
deliveries under PO 7286 (of 250,000 pounds in each case) made on each of October 1 and 15, 2004.
[315]
In re-examination, counsel for the Appellant
reviewed the terms of PO 7286 and the two deliveries in October 2004
and then took Mr. Murphy to an intercompany offer letter dated
August 16, 2004, in which Cameco US offered to purchase from
CEL 500,000 pounds of U3O8 to be delivered in two
equal tranches on October 1 and 15, 2004. The offer letter
was faxed to Mr. Glattes on August 18, 2004 and was signed by
Mr. Glattes and faxed back to Cameco US on August 19, 2004.
Mr. Murphy testified that the uranium described in the offer letter
matched the quantity and origin of the uranium delivered by CEL to Cameco US on
October 1 and 15, 2004.
(17) Other Contracts Between CESA/CEL and Cameco US
[316]
In addition to the Cameco US Contracts, CESA/CEL
entered into a total of 11 conversion services contracts with Cameco US between
March 27, 2001 and December 7, 2006.
(18) The Sales of Uranium by CESA/CEL to the Appellant
[317]
Between December 7, 1999 and
December 6, 2006, CESA/CEL and the Appellant entered into a total of
22 agreements for the sale of uranium by CESA/CEL to the Appellant (the
“CC Contracts”). Only two of the CC Contracts were entered into after 2004.
[318]
The terms of the CC Contracts were discussed
during the sales meetings. Once the terms of a contract were settled, a proposal summary or
intercompany offer was prepared by the Appellant and forwarded to CESA/CEL and,
after CESA/CEL confirmed its agreement to the terms, a formal contract was
prepared and executed. No notes or e-mails were exchanged regarding the terms of the CC
Contracts.
[319]
In 2005, the Appellant determined that
purchasing uranium from CEL created foreign accrual property income (“FAPI”) in CEL. The Appellant and CEL took steps to
rectify the situation by amending existing agreements and ensuring that new
agreements were for conversion services only. Under the amended and new
agreements, CEL sold conversion services to the Appellant instead of uranium. In mid-2005, Tyler Mayers prepared a PowerPoint presentation
titled “HEU Product Flow”. Mr. Mayers
recalled that the exercise addressed inventory management and he had no
recollection of the FAPI issue.
[320]
Counsel for the Respondent asked Mr. Glattes
about the Appellant’s refusing to admit that an advice of delivery location
under section 2.03 of PO 6933 did not exist, but stating instead that one
could not be located. Mr. Glattes testified that it would have been the
contract administrators that would have made the suggestion as to delivery
location, and that any such documentation would be in the manila folder
maintained for that contract in Zug, Switzerland.
(19) Other Contracts between CESA/CEL and the Appellant
[321]
Between August 29, 2001 and November 26, 2006
CESA/CEL entered into 16 uranium exchange agreements with the Appellant;
between April 14, 2003 and June 9, 2006, CEL entered into
four uranium loan agreements with the Appellant; and on December 1, 2004,
CEL entered into a conversion services agreement with the Appellant.
[322]
In addition to these agreements, counsel for the
Respondent took Mr. Murphy to a series of documents relating to a
conversion services agreement between the Appellant and BNFL. Counsel put to Mr. Murphy the propositions
that the Appellant rather than CEL purchased the conversion services because
BNFL required guarantees if CEL was the purchaser, that the purchase price paid
by the Appellant was £2.85 (sterling) times an escalation factor, that CEL purchased the
conversion services from the Appellant for £2.91 times an escalation factor,
and that Cameco US purchased the conversion services from CEL for £6.00 times an escalation factor. Mr. Murphy
generally agreed with these propositions.
[323]
In re-examination, counsel for the Appellant
revisited the above three purchase agreements.
Mr. Murphy agreed that, under the contract between the Appellant and BNFL,
the Appellant shipped UO3 to BNFL and BNFL converted the UO3
into UF6. After reviewing the recitals to the contract, Mr. Murphy
explained the reason for this as follows:
. . . In early 2001, BNFL made a public
announcement that it would end production of UF6 at its facilities located in
Springfield, England. And they were going to do that in March of 2006. BNFL is
able to continue to operate their fuel facilities after March 31, 2006
if the feed supplied to the facilities is UO3. And Cameco is prepared to
provide to BNFL all of the UO3 quantities BNFL requires to produce UF6. And
then Cameco, which is Cameco Corporation, will purchase all of the conversion
services provided in connection with the conversion of the UO3 to UF6 and will
take delivery of all the UF6 produced from that UO3.
And as a result of this, BNFL is prepared to
defer decommissioning of their fuel facilities in order to sell to Cameco all
of the conversion services required in connection with the conversion of the
UO3 to UF6 and will deliver the UF6 produced to Cameco.
[324]
Mr. Murphy testified that the price for
converting UO3 to UF6 under the contract between the
Appellant and BNFL was £2.85 escalated per kgU of UF6, that the
delivery years were 2006 through 2016 and that the volumes were 2,500 metric
tonnes in 2006, 5,000 metric tonnes in 2007 through 2015 and 1,250 metric
tonnes in 2016, for a total of 48,750 metric tonnes.
[325]
Mr. Murphy next reviewed the contract
between the Appellant and CEL and testified that under that contract the
Appellant agreed to convert CEL’s concentrates (i.e., U3O8)
into UO3 at its refining facility at Blind River and then have
the resulting UO3 converted to UF6 at BNFL’s conversion
facility at Springfield, England. The
price for these services was broken down into a price for the refining of CAN$2.22
escalated and a price for the conversion of £2.91 escalated. Mr. Murphy believed both prices were per kgU of
UF6, although the unit on which for the refining price was based was
not stated in the contract. The total volume for the period 2007 through 2016 was 46,250 metric
tonnes.
[326]
Finally, Mr. Murphy reviewed the contract
between CEL and Cameco US and testified that the contract was for both the
refining of U3O8 into UO3 and the converting
of the UO3 into UF6. The
delivery years under the contract were 2007 through 2012 and the total quantity
to be delivered was 1,200 metric tonnes of UF6 as compared to
48,750 metric tonnes under the contract between the Appellant and BNFL. The pricing of £6.00 escalated was for both the refining and
conversion services.
(20) Other Uranium Purchase Contracts between CESA/CEL and Third Parties
[327]
In addition to the HEU Feed Agreement and the
Urenco Agreement, CESA/CEL entered into 43 more contracts with third parties
between November 16, 1999 and July 16, 2006, which provided
for the purchase by CESA/CEL of uranium.
[328]
Counsel for the Respondent specifically addressed
two of these contracts: Exhibits A030869 and A030955.
[329]
The first contract, between CESA and USEC, was entered
into as of December 7, 1999.
Timothy Gabruch testified that he prepared the documents for this transaction. Both he and Maxine Maksymetz were asked about a handwritten comment
on a draft letter to CESA setting out the terms of the purchase. The handwritten
comment was “make it seem like the decision-making in
the hands of CSA”.
[330]
Mr. Gabruch testified that he did not
recognize the handwriting and that he did not recall any discussion along the lines
of the topic of the note. He also did not recall whether he had seen the note
at the time.
[331]
Ms. Maksymetz testified that she believed
the note was hers. She then had the following exchange with counsel for the
Respondent:
Q. So are you, in this fax that you are
sending to Mr. Assie and Tim Gabruch, telling them to make it seem
like the decision-making is in the hands of CSA?
A. I think it would be that the decision-making
was in the hands of CSA, and the contract wasn’t obvious about that, so it was
clarifying that.
Q. So you think the reference to “seem” is
to make the --
A. -- is to clarify where the decision
making was.
[332]
Counsel for the Respondent asked Mr. Gabruch
about a subsequent amendment to the contract, made at the request of USEC, which
added a further 1790 kilograms of uranium that did not meet the specifications
in the original contract. Counsel put forward the proposition that a memo from
Mr. Gabruch to Mr. Glattes suggested that the decision to amend the
contract had been made before the amendment was put to CESA. Mr. Gabruch
responded that the transaction was very small, that every arrangement with
CESA/CEL would have been the subject of “its own
discussion” and that the fact that the material did not meet the
specifications was really only an issue for the production facility.
[333]
The second contract was made between CESA and
Kazatomprom on August 15, 2000.
Kazatomprom was an entity controlled by the Kazakhstan government and a
joint-venture partner of the Appellant in a uranium-mining project in
Kazakhstan called Inkai.
[334]
Mr. Grandey testified that in 2000 the
Appellant had agreed to purchase 150 tonnes of uranium from Kazatomprom. A
brief description of the arrangement is set out in an e-mail from
Mr. Grandey to Fletcher Newton sent on May 20, 2000:
Kazakhstan went as well as could be
expected. All minor issues resolved. Cameco agreed to purchase 150 tonnes U
over the next 3 years at a discount of 12% off of the restricted market price
(non-CIS price). We really did not want it, but it is a favour to a partner. We
will find a home somewhere.
[335]
Mr. Grandey explained the arrangement as
follows:
. . . Kazatomprom had a minor amount of
uranium that they wanted to sell. And, of course, it was restricted, so they
were having a difficult time, so we agreed 150 tonnes, we could somehow handle.
[336]
Mr. Assie set out the proposed terms of the
purchase in a letter to CESA dated July 21, 2000. The letter concluded as follows:
If this opportunity to purchase is
acceptable to Cameco Europe S.A., please indicate by signing in the space below
and fax same back to me at your earliest convenience.
Once I have received your acceptance, we
will forward you a draft contract with KazAtomProm for your review.
[337]
Mr. Glattes testified that, after Mr. Grandey’s
discussion with Kazatomprom, he became aware that Mr. Grandey had agreed
to purchase uranium from Kazatomprom. Mr. Glattes testified that the
relationship with Kazatomprom was important and that it was in CESA/CEL’s interest
that “things would move in a positive way in Kazakhstan”.
In his view, the 12 percent discount was attractive to CESA/CEL and he had no
objection to the agreement under “these special
circumstances”. By fax dated August 3, 2000, Mr. Glattes reported to
Mr. Assie and Mr. Murphy that the management committee of CESA had
approved the agreement with Kazatomprom.
[338]
Mr. Glattes agreed with counsel for the
Respondent that the agreement with Kazatomprom was an example of the Appellant
rather than Cameco US identifying a purchase opportunity for CESA/CEL.
[339]
In 2001, Mr. Grandey was approached in
London, England by Mr. Dzhakishev regarding Kazatomprom’s obligation
to deliver 390,000 pounds of U3O8 to CESA in 2002 under
the August 15, 2000 contract.
Mr. Dzhakishev followed up this conversation with the following letter to
Mr. Murphy at Cameco US, dated October 12, 2001:
We highly appreciate the CAMECO support provided
to us by contracting our uranium for 2000-2002 delivery years. We understand
that CAMECO has entered into this contract to help KAZATOMPROM at hard time of
market recession, even though Kazakh uranium supplies are only a minor part for
CAMECO.
To sell our uranium produced in excess to
contractual obligations we have been trying hard not to add pressure on to the
current price. And we have reached an agreement on uranium supply to a country,
which until now was not considered as uranium purchaser.
As I understand from my conversation with
Mr. Grandey during the WNA Symposium earlier this month, it is no hurt to
CAMECO to refuse further deliveries from Kazakhstan.
In connection to the above we propose
signing of an additional agreement to cancel 390,000 lbs U3O8
delivery due in year 2002 pursuant to the Contract between NAC KAZATOMPROM and
CAMECO-EUROPE dated 15 August 2000.
We thank you again for all your support and
understanding. Hopefully, our mutual business will be developed further.
[340]
On October 13, 2001,
Lorrie McGowan wrote in an e-mail to Mr. Glattes:
In the last paragraph of Kazatomprom’s
letter to Cameco Europe dated October 12 they ask us to inform them about
a decision made on the delivery year ‘2000’ for planning purposes. I assume
they are referring to the 2002 delivery. It is my understanding that
Kazatomprom would prefer to not make the 2002 delivery to Cameco Europe. I
gather from their question that we have not sent them anything formal regarding
the 2002 delivery. Please advise if you would like me to have legal prepare a
letter agreement releasing Kazatomprom from their 2002 delivery obligation?
[341]
Mr. Glattes responds to Lorrie McGowan
on the same date:
It is also my understanding that they are referring
to the 2002 delivery in respect of which Jerry Grandey expressed
willingness vis a vis Dschakichev in London to abstain from requesting
delivery. I raised the matter of documenting this gentlemen’s agreement in one
of the recent sales meetings and George was going to contact Jerry for
confirmation. George did not yet come back. So maybe you could raise it in one
of next sales meetings[.] I will be travelling next week and can therefore not
join in on both days.
[342]
With respect to Mr. Glattes’ reference to a
sales meeting, Mr. Assie recorded the following note regarding a sales
meeting on October 4, 2001:
Kazakh U3O8 purchased – f/u w/GWG [Follow up
with Mr. Grandey] as to whether we should initiate paperwork to eliminate 2002
delivery.
[343]
In a letter amending agreement dated
November 16, 2001, CESA agreed to amend the August 15, 2000
contract to delete Kazatomprom’s obligation to deliver 390,000 pounds of U3O8
to CESA in 2002. The letter amending agreement was signed by Mr. Kasabekov
of Kazatomprom on December 4, 2001.
[344]
Counsel for the Respondent asked Mr. Glattes
about a uranium exchange contract between CESA and Nufcor International Limited
(“Nufcor”).
Counsel took Mr. Glattes to several documents relating to this contract. The first document was an e-mail from John Britt to
Gary Stoker of Nufcor sent April 23, 2002 which states:
We are ‘good to go’.
Would you like us to prepare the execution
copies and have them sent to Gerhard Glattes at Cameco Europe for signing? He
would then send them on to you.
Please advise.
[345]
The second document is a letter dated
April 24, 2002 from an employee of the Appellant to Mr. Glattes
enclosing three execution copies of an exchange agreement between CESA and
Nufcor.
[346]
The third document is an e-mail from
Mr. Glattes to John Britt sent on April 24, 2002, which
states:
It appears that a proposal summary for the
Nufcor Exchange has not yet been prepared. Could you kindly arrange for the
proposal summary to be faxed to the Swiss office.
[347]
The fourth document is a letter from George Assie
of Cameco US to Mr. Glattes setting out the terms of the exchange and then
stating:
By completing this exchange, Cameco Europe
will save the cost of transporting the U3O8 from Canada to Europe, a savings of
approximately US $24,000. Please confirm that Cameco Europe will proceed with
the exchange by signing and returning a copy of this fax to us. We shall then
arrange for a draft contract to be sent to you.
[348]
The fifth document is a request dated April 29, 2002
from CESA to the BfE asking the BfE to authorize the exchange with Nufcor.
[349]
The final document is the cover sheet of a fax
from Mr. Glattes to Mr. Assie dated April 30, 2002, to
which was attached a signed copy of the April 25, 2002 letter. The fax
cover sheet states, in part: “Thank you for arranging
the U3O8 Exchange with Nufcor on CSA’s behalf.”
[350]
Mr. Glattes testified that he could not
recall the specifics of the exchange agreement with Nufcor but that if it was
important it would have been discussed in advance. He went on to state:
So I was aware of the context, but whether
it then worked out or not, obviously, I heard later on. But, again, I think, in
these cases, there were usually sort of in-advance agreements. If we can secure
an exchange, well, we will do it, even if it’s a CCI person, then telling, in this
case, Stoker from Nufcor, “Well, and CEL will be the exchange partner,” and
then that’s all great. But it was -- it was really sort of -- there was
agreement in advance being achieved.
(22) CEL’s Conversion Services Account with the Appellant
[351]
In cross-examination, Ryan Chute testified
that the Appellant maintained an account which recorded CEL’s entitlement to
conversion services (i.e., the services required to convert U3O8
into UF6). The account was maintained in accordance with a letter agreement
dated December 1, 2004. The letter agreement required CEL, if it
wished to deposit conversion credits to its account, to instruct the Appellant
to add such credits to the account, and it also required CEL to provide the
Appellant with 30 days’ notice of withdrawal of conversion credits from the
account.
[352]
Mr. Chute agreed with counsel for the
Respondent that on one occasion CEL made a withdrawal from the account without
the notice required by the letter agreement. This occurred because delivery to
TXU—a customer of Cameco US—had been moved by the contract administrators from
December 29, 2006 to December 15, 2006 and Mr. Chute
was not advised of the change in time to amend the notice. Consequently, the
notice he had originally prepared for December 29 was no longer correct. The
delivery of UF6 was made by CEL to Cameco US and by Cameco US to the
customer on December 15, and CEL’s account was debited for the required
credits without the correct notice. An e‑mail
from Mr. Murphy to Randy Belosowsky sent on
November 15, 2006 indicates that Mr. Murphy was aware of the
change in the delivery date because he complains to Mr. Belosowsky about
the contract administrators making the change without consulting CEL.
(23) The Evidence regarding the Intercompany Documentation
[353]
Mr. Assie, Mr. Glattes and Mr. Murphy
each testified in chief that there had been issues with the timeliness of
documentation between CESA/CEL and Cameco US and between CESA/CEL and the Appellant
and that backdating of some intercompany documents had occurred.
[354]
The late and backdated documents identified by
Mr. Assie, Mr. Glattes and Mr. Murphy fall within two general
two categories of documents. I will address each category separately.
a) Notices and Schedules
[355]
The first category of documents is comprised of non-binding delivery notices, binding delivery notices,
delivery schedules and flex notices required under the terms of the contracts
between CESA/CEL and Cameco US and between CESA/CEL and the Appellant (I will
refer to this category of documents as the “intercompany
notices”).
[356]
Generally speaking, if a contract for the
purchase of uranium provides for non-binding delivery notices, binding delivery
notices, delivery schedules or flex notices, the obligation to issue the
notices falls on the purchaser. As a
result, the only intercompany contracts under which CESA/CEL had an obligation
to issue intercompany notices were the Long-term Contracts. Cameco US had the obligation to issue intercompany
notices to CESA/CEL under the Cameco US Contracts that required notices and
the Appellant had the obligation to issue intercompany notices to CESA/CEL
under the CC Contracts that required notices. The
only exception to this is in Exhibit A020929, which required CESA to provide
the Appellant with 5 days’ notice of the delivery date within the
delivery month specified in the contract.
[357]
Mr. Assie testified that he was aware that
there were late and backdated intercompany delivery notices. Mr. Assie testified that critical information for scheduling
deliveries was received from the customers and that the intercompany delivery,
notices were not very important because the contract administrator was
notifying himself/herself or a colleague of information that had already been
received from the customer.
[358]
Mr. Assie testified that customers were
sometimes late with delivery notices, that Cameco US would follow up with them
and would make the delivery and that Cameco US had never refused delivery
because of a late delivery notice.
[359]
Mr. Assie testified that he was aware that
flex notices had been issued late. He believed the decisions to exercise the
flex options were made in a timely manner, but the documentation was not always
prepared in a timely manner. Mr. Assie also testified that he was aware
that flex notices had been backdated. Mr. Assie testified that he did not
know why the backdating of flex notices occurred but that the Cameco Group did
not seek or obtain any commercial advantage as a result of flex notices being
late or backdated.
[360]
Mr. Assie testified that Cameco management
did not give any instructions to backdate either flex notices or delivery
notices and that people were instructed not to backdate documents.
[361]
Mr. Glattes testified that backdating had
been an issue since 1999 and that he had raised the issue with Mr. Zabolotney
and others at the Appellant. Mr. Glattes testified that senior personnel did not encourage
or condone the problematic behaviour but that it nevertheless persisted.
[362]
Mr. Glattes testified that the backdating
of intercompany notices originated with the contract administrators that
provided services to CESA/CEL under the Services Agreement. Mr. Glattes
testified that the delivery notices under the BPCs had no practical significance
because the contract administrators employed by the Appellant who prepared the
notices for CESA/CEL under the terms of the Services Agreement were essentially
notifying themselves.
[363]
With respect to flex notices, Mr. Glattes
testified that the delivery of a flex notice was a formality required by the
terms of the BPC once the decision to exercise the flex option had been made
and that the notice lacked relevance for the same reason as the delivery
notices, i.e., the contract administrators were notifying themselves.
[364]
Counsel for the Respondent asked Mr. Glattes
whether in light of the issues with late documents he had considered other
options for the provision of services to CESA/CEL. Mr. Glattes responded
that there were other options but that he had not pursued those options because
of the resulting duplication of services and because of his optimism that the
issue of timeliness would eventually work itself out satisfactorily.
[365]
Counsel for the
Respondent asked Mr. Glattes about several specific examples involving the
backdating of intercompany notices. Mr. Glattes agreed that each such
notice was backdated, and that backdating occurred on annual delivery
schedules, binding delivery notices and flex notices. In
response to a question as to why there were so many missed deadlines, Mr. Glattes
replied:
Again, the responsibility for these notices,
we had a service provider in Saskatoon. It was their job. I mean, everything
that was done here by Mr. Bopp and so on was, in principle, something
which wouldn’t have been necessary if Cameco Corporation would have diligently
sort of fulfilled its job. So, I mean, that’s the basis.
[366]
Mr. Glattes testified that the delivery
notices had no function or importance because the contract administrators were
notifying themselves and that, in terms of contract implementation, the
backdating had no relevance and provided no benefit to CESA/CEL because the
contract was fulfilled in the same way.
[367]
Mr. Glattes agreed with counsel for the
Respondent that backdating the intercompany notices made it look as if the
notices were within the requirements of the intercompany contracts and that the
backdating was misleading to third parties, but stated that the backdating yielded
no economic benefit and no tax benefit and had no bearing on compliance with
the intercompany contracts.
[368]
With respect to flex notices, Mr. Glattes
testified that CESA/CEL did not receive any economic benefit from late flex
notices and that CESA/CEL did not deliberately issue backdated flex notices to
see how the market would play out.
[369]
Mr. Murphy testified that the delivery
notices required under the Cameco US Contracts had no impact on the conduct of
CEL’s business and played no role in the operation of that business because the
contract administrators already had the information about the deliveries, having
received it from the customers of Cameco US. He explained that since each
Cameco US Contract backed up a contract with a customer of Cameco US, CEL was
required to deliver its uranium to Cameco US at the time and place that Cameco
US had to deliver the same uranium to its customer. The delivery information
was in the binding delivery notice received by Cameco US from its customer and
the contract administrators providing services to CEL under the Services
Agreement had that information.
Mr. Murphy testified that he expressed concern about the timeliness of the
intercompany notices because his personality was such that he wanted to have “a proper set of documents”.
b) Intercompany Offers, Proposal Summaries and Contracts
[370]
The second category of documents is comprised of
the intercompany contracts between CESA/CEL and Cameco US and between CESA/CEL
and the Appellant and the intercompany offers or proposal summaries that set
out the proposed terms of these contracts (I will refer to this category of
documents as the “intercompany contracts”).
Mr. Murphy testified that intercompany offers typically came to CEL from
Cameco US and that proposal summaries typically came to CEL from the Appellant.
[371]
Counsel for the Respondent
asked Mr. Glattes about two of the Long-term Contracts entered into in
2004.
[372] The first Long-term Contract is Exhibit A163425. Mr. Glattes
testified that this contract was signed by him after its effective date of
January 1, 2004 and that the preceding offer from the Appellant to
CEL dated November 24, 2003 was not received by CEL until after
January 22, 2004. Mr. Glattes testified that his “vague recollection” was that the proposed agreement
was discussed at the sales meetings in November 2003 and that the delay in
executing the contract was a result of the Christmas break. He also stated that
the agreement would only standout in his mind if the usual procedure for such
agreements had not been followed. Mr. Assie
testified that he did sign the proposal summary dated November 3, 2003
for the Long-term Contract, but he could not recall when he did so. Mr. Assie agreed that it appeared the offer and acceptance for
the contract was signed on January 27, 2004 and faxed to the
Appellant on January 28, 2004.
[373]
The second Long-term Contract is Exhibit
R-001399. Mr. Glattes testified that he did recall the details of this
contract and that it was signed by Mr. Murphy shortly after its effective
date of August 20, 2004. Mr. Glattes testified that Mr. Murphy
took a few days’ vacation in August 2004 on his way to Switzerland but
that he was calling the Zug office quite frequently and being kept up to date
by Markus Bopp regarding the contract.
[374]
It would appear from Mr. Murphy’s testimony that
he arrived in Zug on August 27 or 28. Since he had not been a party to the
discussions regarding this contract, before signing the intercompany offer on
August 27, 2004 and the contract sometime in September, he consulted
with and relied on Mr. Glattes regarding the terms agreed to with the
Appellant. Mr. Assie testified that the proposal summary was dated
August 16, 2004 and that the intercompany offer for the contract was
dated August 20, 2004, which is the effective date of the contract.
[375]
Mr. Glattes was asked about the base price
in the contract of $18.75, which was $0.25 and $4.25 lower than the TradeTech
long-term price indicator for July and August, respectively, of 2004. Mr. Glattes
testified that the June 30 indicator of $18.75 was the basis for the price
in the contract (even though the proposal summary was dated August 16, 2004).
[376]
Mr. Assie testified that the latest
available price indicator at any time during a month would be the month-end
prices for the previous month. Mr. Assie
testified that the $0.25 discount over the TradeTech long-term price indicator
for July was attributable to the large volume of the contract.
[377]
Counsel for the Respondent asked Mr. Glattes
about six other intercompany contracts and related documents:
1.
UF6 Conversion Services Agreement
between Cameco US and CEL made with effect as of April 27, 2004. The contract does not expressly state when it was signed but
Mr. Glattes agreed that it was not signed on April 27, 2004 and
that it is likely Mr. Murphy was the president of CEL when the document was
signed. Mr. Glattes also agreed with counsel’s English translation of an
e-mail from Mr. Bopp dated December 27, 2004 in which Mr. Bopp
states in German that the contract has arrived, that it must be dated before
May 1, 2004, and that Mr. Glattes’ signature is required.
2.
Uranium Concentrates Loan Agreement between CEL
and the Appellant made with effect as of
April 14, 2003. The contract states on the signature page that “the parties have
executed this Agreement effective as [of] the date first above written”.
Mr. Glattes agreed with counsel that the associated offer from CEL to the
Appellant had a face date of April 14, 2003 but that the fax track indicated
July 14, 2003 and that the delivery confirmation indicated the
transfer took place on April 14, 2003. Mr. Glattes also agreed
that he was not made aware of the transfer on or prior to April 14, 2003
and that he was sent signature copies of the contract by cover letter dated
July 21, 2003. Mr. Glattes testified that the transfer of uranium to the
Appellant occurred in the context of a crisis caused by a “water inflow” event
at the Appellant’s McArthur River mine, that the Appellant inadvertently
overdrew against CEL’s uranium account with the Appellant and that this error
was rectified by treating the withdrawal as a loan effective as of the date of
the withdrawal on April 14, 2003.
Mr. Assie testified that the Appellant’s account was overdrawn
on April 14, 2003 and that the loan was put in place after that date
to address the shortfall. Mr. Assie agreed that the paperwork showed that CEL
was informed of the loan on July 14, 2003.
3.
A Uranium Hexafluoride Conversion Spot Purchase Contract
between CESA and Cameco US dated as of April 10, 2001. The contract states on the signature page that “the parties have
caused this Contract to be executed by their duly authorized officers as of the
10th day of April 2001”.
In an e-mail to Mr. Glattes dated April 16, 2001, Rita Sperling
states:
Attached is a
copy of the invoice for the sale of conversion (using Conversion Credits) by
Cameco Europe to Cameco Inc. This delivery supported a sale of 170,000 kgU/UF6
by Cameco Inc. to APS at USEC on April 12, 2001 (PO 7029).
I have prepared
the invoice (and backup) and all calculations have been checked. The backup is
also attached for your reference if needed.
Please print the
invoice on Cameco Europe letterhead and fax a copy to my attention. The
original can be sent by the usual method. If you have any questions or need
additional clarification, please don’t hesitate to call me at 306-956-6273.
In an e-mail
to Mr. Glattes dated April 17, 2001, Scott Melbye states:
You were
understandably left wondering where the offer and acceptance is that
corresponds with the contract and invoice that you currently have before you.
Let me explain:
This CCI / APS
deal was always intended to be sourced from CCO (we have a proposal accepted by
Jerry Grandey dated March 14, 2001). In the week leading up to
last Thursdays [sic] delivery to APS, Shane decided to instead source
this deal using CSA conversion credits (the contract before you for execution
will provide for that).
What I will send
to you today is a corresponding offer (for you [sic] acceptance) to
close the loop.
Mr. Glattes
testified that the issue of how to optimize the use of CESA/CEL’s conversion
credits came up frequently but that it was “nothing of commercial -- really big
commercial importance.” Mr. Glattes agreed with counsel for the Respondent
that the offer from Cameco US to CESA had a face date of April 4, 2001
but that the fax track indicated it was faxed to him on
April 18, 2001. Mr. Glattes also agreed that the date of the
contract was chosen because it was before the date of delivery, which was
either April 11 or April 12, 2001.
4.
A UF6 Conversion Services Agreement
between CEL and Cameco US effective as of March 3, 2003. The contract states on the signature page that “the Parties hereto
have executed this Agreement under the hands of their proper officers duly
authorized in that behalf.” There is no reference to a signature date.
Mr. Glattes agreed that (i) a letter dated
March 4, 2003 stated that a delivery (of 125,694 kgU of UF6)
would take place effective March 25, 2003; (ii) a faxed copy of
the same letter and the contract had a fax track indicating that these documents
were faxed to him on April 9, 2003; (iii) a letter dated
April 4, 2003 stating that a delivery of 125,807 kgU of UF6 would
take place effective April 24, 2003 had a fax track of either
April 26, 2003 or April 28, 2003, indicating that the
letter was sent after the delivery date; and (iv) a transfer confirmation dated
June 20, 2003 confirming a transfer made on June 16, 2003
was probably sent by Mr. Bopp by courier on June 27, 2003.
5.
Five notices confirming the transfer of uranium
under a Conversion services Supply Contract between CESA and Cameco US signed
by CESA on March 27, 2001 and by Cameco US on March 14, 2001. The notices were dated September 1, 2001,
January 29, 2002, February 26, 2002,
March 29, 2002 and May 29, 2002. Mr. Glattes agreed
that the five notices were issued after he received from Jackie Schlageter
an interoffice memo dated August 23, 2002 in response to an e-mail he
had sent to Lorrie McGowan on August 1, 2002 requesting
clarification regarding the quantities delivered under the contract and asking
that in the future the Appellant send delivery notices when the deliveries
happened. The interoffice memo states:
After becoming
familiar with the KHNP/Cameco Inc. conversion agreement (PO 6960) )[sic],
as the new administrator, and the corresponding intercompany deliveries under
the CSA/CCI agreement (PO 7018/0071) I have noticed CSA did not receive written
confirmation of the transfer of concentrates to your account at Cameco (6928)
as part of the intercompany delivery correspondence. To date there have been a
total of 5 deliveries involving CSA and the delivery of UF6 (with
one pending in October 2002).
In order to make
the files complete I have subsequently created the necessary concentrate
transfer confirmations and dated them as appropriate for the corresponding
delivery. Because Tim Kopeck would have normally signed these letters and
he is no longer working at head office, Doug Z. suggested we have them
signed by Bob Cherry who had previously administered the same agreement.
(I of course could not sign them as I was away on maternity leave during this
time.) We are hoping this exercise will satisfy any audit that would occur at a
future date.
Please feel free
to contact me with any questions or concerns given the unusual nature of these
letters.
Mr. Glattes
testified that he did not know which audit is being referenced in the
interoffice memo, that there were no conversations with the contract
administrators that specifically addressed completing documentation to satisfy
audit concerns or in which the audit was the main aspect of the conversation,
and that it was CEL’s desire and concern that the books and the paperwork be in
good order.
Mr. Glattes
was asked about an e-mail from Crystal Reich sent to him on September 12, 2002
in which Ms. Reich states:
Dear Gerhard,
Please sign the
attached document and send back to Corp.
ps: You should
have a binding notice from Jackie for this delivery already. It was dated
August 26, 2002 which is inside the delivery notice terms, therefore
she is going to resend it to you via courier only. Please destroy your copy of
her first notice and replace it with the new one dated August 16, 2002.
Thanks Gerhard!
Mr. Glattes
testified that he had no specific knowledge as to why the replacement notice
was sent by courier and that he did not recall whether he asked at the time.
Mr. Glattes then had the following exchange with counsel:
Q. To your
knowledge, did the Cameco Corporation administrator send you documents via courier
only in order to avoid having fax tracks at the top of the document by which a
date could be determined?
A. No.
Q. She notes:
“Please destroy
your copy.”
And then you
send Markus a note, and you’re basically telling him about this and asking him
to look out for the notice.
A. Well, I said:
“Please review
the quantity and delivery date in connection with the BfE approval.”
And he should
keep an eye on the exchange of the notices.
6.
An Agreement for the Conversion of Uranium
Concentrates and the Supply of UF6 between CEL and Cameco US made
effective as of July 1, 2003. The
contract states on the signature page that “the Parties hereto have executed
this Agreement as at the day and year first above written under the hands of
their proper officers duly authorized in that behalf.” The contract states on
the cover page that it is in support of EDF PO 7160. Mr. Glattes agreed that
the contract was forwarded to him for his signature on
October 16, 2003 and that Mr. Bopp returned two executed copies
of the contract to the Appellant on October 21, 2003. Mr. Glattes was then asked about a second contract, between
the Appellant and Cameco US, which had the same effective date, was for the
supply of the same quantity of UF6, and stated on its cover page
that it was supporting EDF PO 7160. An
interoffice memo from Dean Wilyman to George Assie and Jerry Grandey
appears to show that the second contract may have been executed on or about
October 8, 2003, although no one testified about the content of the
memo. Mr. Glattes testified that he did not recall whether at the time he
signed the first contract he had been made aware of the second contract.
Section 5.01
of the two contracts provided for the delivery of quantities of UF6
in 2003, 2004, 2005, 2006 and 2007 “[u]nless otherwise agreed upon by the
Parties”. Mr. Glattes was asked about a letter dated August 15, 2003,
which stated that, pursuant to section 5.01 of their contract, CEL and Cameco
US agreed that the quantities of UF6 to be delivered in 2003 and
2004 were zero, and about an interoffice memo from Dean Wilyman to
Mr. Glattes dated November 25, 2003 in which Mr. Wilyman
states:
Please find
enclosed two copies of a Letter Agreement between Cameco Europe Ltd. and Cameco
Inc. The Letter Agreement formalizes that pursuant to section 5.01 the Annual
Quantity to be supplied by Cameco Europe Ltd. in 2003 and 2004 is equal to zero
(0). Please have these documents signed, keeping one original for your records
and returning one original to me for furtherance. I will make a copy to retain
here and forward the original to Cameco Inc.
Mr. Glattes
testified that he had no recollection of why there were no deliveries by CEL to
Cameco US in 2003 and 2004. He also did not recall whether there were
discussions during the sales meetings about leaving open alternative sources to
supply Cameco US. Mr. Glattes agreed with counsel that he would not have
seen the letter agreement showing August 30, 2003 as the date on
which he signed it until at least November 25, 2003.
[378]
Mr. Murphy testified about his
preoccupation with the timeliness of intercompany contracts and with backdating
and about his desire to have accurate and timely documentation. Mr. Murphy raised the issue as early as November 2004 and
he included the following in a draft activity report for November 15
through December 3, 2004:
CEL, with the cooperation of CCI [Cameco US]
and CCO [the Appellant], is trying to establish a “system” for ensuring that CEL
receives inter-company offers “ICOs” in a timely manner.
[379]
Mr. Murphy described the issue as follows:
In my opinion, I was not receiving the paper
from Cameco U.S. that would show, in writing, our verbal agreement on terms and
conditions. I wasn’t receiving that paper as quickly as I thought I should
receive it and as I wanted to receive it.
And I was working with my colleagues in
these two locations to try to improve the timing of that.
[380]
In an e-mail to John Britt and others dated
December 17, 2004, Mr. Murphy writes
Following up on our discussion during the
December 16 sales meeting, here is a first attempt to describe what can
and will be done to improve the existence and timeliness of documentation
between CEL and CCI/CCO. Please pass this email on to whomever you think
appropriate and please give me your comments, concerns and suggestions.
Inter-Company Offers (“ICOs”):
Within (5?) days after receiving an
“Acceptance” from the third party, information will be sent to CEL. If the
Acceptance is sufficiently clear, then such information will be in the form of
an ICO, sent for CEL’s acceptance. If the Acceptance is ambiguous, then a note
containing the best available interim information (e.g. name of 3rd party, form
of uranium, delivery years, volumes, flex, pricing mechanism) will be sent.
This will allow CEL to create a slot for the pending ICO as well as a way to
keep the pending ICO on the radar screen. The responsibility for sending the
ICO (and the interim information, if applicable) rests with the respective
(Vice President? Sales Manager?)
Inter-Company Contracts (“ICCs”):
1) Preparation / Completion of the ICC:
Responsibility for ensuring that the ICC has been prepared, reasonable time has
been allowed for CEL to review and comment, and the ICC has been fully executed
prior to the first delivery thereunder, rests with the respective (VP? Sales
Manager?)
2) Deliveries not to be made unless the ICC
is in place: Market Administration will not issue transfer/delivery
instructions without first confirming that the ICC is in place. Responsibility
for this rests with the respective (Specialist? Supervisor?) In addition, CEL
will not sign transfer/delivery notices until it has confirmed that an ICC is
in place. Responsibility for this rests with M. Bopp and WLM.
[381]
The responses to Mr. Murphy’s e-mail
suggest 15 days to prepare the intercompany offers, but Mr. Murphy
replies that 15 days is too long. Mr. Murphy testified that, in any
event, his proposal regarding the timing of intercompany documentation was not
adopted in any form.
[382]
In 2006, Mr. Murphy created a spreadsheet
that tracked the timeliness of the documentation between CEL and Cameco US. The spreadsheet shows the following information:
[383]
In cross-examination, Mr. Murphy testified
that one month to put an intercompany contract in place was reasonable but that
his concern was with the intercompany contracts that were outstanding for more
than six months.
[384]
Mr. Murphy testified that he raised the
timeliness issue with Mr. Assie.
Mr. Murphy prepared notes for one of his discussions with Mr. Assie. He
described those notes in cross-examination as follows:
This was two years after I had started to
get documentation, tried to get documentation more promptly. And I was
preparing for a phone call. And, as I testified, this was like a Rick Mercer
rant. It was using extreme examples. It was -- it was going over the top. I
didn’t intend to use all of these examples to say all of this to George. I
wanted to get the point across, and I was having this in my mind as a result of
my frustration.
[385]
Mr. Murphy testified that although the timeliness
of the intercompany documents was an issue for him, the intercompany documents
only papered the agreements already reached by CEL and Cameco US during the
sales meetings and the paper was in place before any deliveries occurred under
the agreements. Accordingly, the timeliness issue had no impact on CEL’s
business.
[386]
Mr. Murphy testified that in two cases he became
aware of a suggestion by an individual he believed at the time to have been, in
each instance, a contract administrator that documents between CEL and the
Appellant be destroyed. The first case involved a specific intercompany
contract for the sale of uranium by CEL to the Appellant. Mr. Murphy’s
description of the second case was vague but he believed it involved a FAPI
issue that resulted from CEL selling uranium to the Appellant.
[387]
In the first case, the request was made by a
contract administrator in an e-mail. The
e-mail states that the reason for the request is a regulatory issue. Although
Mr. Murphy was not copied on the e-mail, he communicated his concern over
the suggestion and his refusal to participate in destroying documents to
Lorrie McGowan, and a different solution was implemented. In cross-examination, counsel for the Respondent suggested that the
regulatory issue cited by the contract administrator in the e-mail was in fact
the FAPI issue. Mr. Murphy responded that he did not recall the issue
being FAPI and that he did not recall what the issue was.
[388]
Mr. Murphy testified that in the second
case he had “every indication” that the
suggestion was made by a contract administrator; however, he had no further
information. Mr. Assie testified that he did not recall Mr. Murphy
ever raising the issue of destroying documents in a conversation with him.
[389]
Mr. Murphy testified that he was not aware
of any other instance during his tenure at the Cameco Group where a suggestion
or request to destroy documents was made and that no documents were destroyed
during his tenure at CEL. Mr. Murphy also stated that if anyone with any authority in
the Cameco Group had initiated such a suggestion he would have resigned.
[390]
Mr. Murphy testified that he made notes to
himself that identified “things [he] was thinking about”
or that he “may have been angry about”. Mr. Murphy found a copy of the notes on an external hard drive
that he had used to back up his computer while president of CEL. Mr. Murphy was questioned extensively about the notes in
examination-in-chief and in cross-examination.
[391]
Mr. Murphy explains on a number of
occasions that the notes were not for public consumption and that he was
working through a number of questions raised by his understanding that CEL was
to operate independently from the other members of the Cameco Group–a concept
that he had difficulty reconciling with the fact that CEL and the Cameco Group
shared all sorts of information that arm’s length parties would not share.
Mr. Murphy observes of these notes:
. . . I wasn’t careful with how I worded
these things that I was writing down for myself because I think it is normal,
if you’re making notes to yourself, you don’t worry about grammar or anything
else. And I tend to exaggerate.
[392]
The overall tenor of the notes is that Mr. Murphy
was concerned about the ability of the corporate structure to withstand a tax
audit considering the lack of timeliness of intercompany documentation, the two
suggestions described above that documents be destroyed and what he perceived
to be a lack of awareness among the sales and marketing administration people of
what is and is not appropriate. Mr. Murphy’s notes are interspersed with
conjecture and questions indicating that in some instances he was not clear on whether
the issue he was identifying was a real issue or the product of either overreaction
or a misunderstanding of the concepts involved.
[393]
Counsel for the Respondent asked Mr. Murphy
about an amended and restated UF6 conversion agreement that amended
one of the contracts for the sale of UF6 by CEL to the Appellant. The terms of the amending agreement were set out in a proposal
summary that was dated July 19, 2005. The
amended agreement states on the signature page that “the
Parties have executed this Agreement as at the day and year first above written”,
which is July 20, 2005. After reviewing an e-mail, Mr. Murphy agreed that the amended agreement remained unsigned
as of December 7, 2005.
[394]
Counsel for the Respondent asked Mr. Murphy
about the way the date of the contract was presented in Exhibit A217602. In
particular, the signature page states that “the parties
have executed this Agreement as at the day and year first above written”
and the front page states that “THIS AGREEMENT is
effective as of the 20th day of July 2005.”
[395]
Mr. Murphy responded as follows:
My only comment
on this is that we relied on our legal advice, our legal advisers, who created
these documents. We had them sign off that they were satisfied with it. I’m not
a lawyer, so I didn’t -- I didn’t argue with them. I didn’t notice it. I didn’t
argue with them.
I look at the
effective date on the face of the document.
[396]
Mr. Murphy testified that he did not recall why
the agreement was amended and did not recall whether it addressed the FAPI
concern identified in his notes.
[397]
Counsel for the Respondent asked Mr. Murphy
about an amendment to a contract for the sale of U3O8 by
CEL to the Appellant. The amending agreement states that “the Parties
have executed this Amending Agreement under the hands of their proper officers
duly authorized in that behalf” and is made effective as of
November 1, 2005. Referring to an e-mail chain commencing December 6, 2005,
counsel for the Respondent put it to Mr. Murphy that the amending agreement
was backdated, and Mr. Murphy responded:
It depends on how you describe “backdated.”
My understanding is that the parties can agree to execute a contract that has
taken effect prior to the execution, made with effect as of a certain date. And
that was my understanding of what took place in this case.
[398]
In re-examination, Mr. Murphy testified that
the letter proposing the terms of the amendment, signed by David Doerksen,
was dated September 22, 2005 and that (having accepted those terms by
signing the letter for CEL) he faxed the letter back to the Appellant on
September 26, 2005.
[399]
Counsel for the Respondent asked Mr. Shircliff
about a uranium sale and purchase agreement between the Appellant and CESA made
the September 12, 2001. The
signature page stated that the contract was signed as of
September 12, 2001. Counsel took Mr. Shircliff to an e-mail sent
by him on September 19, 2001 that stated:
We have received the original execution
copies of this agreement back from Gerhard today however Jerry will not be
available to sign these agreements until Sept 28 (the day of our first
delivery). I suggest that we proceed on the assumption that this agreement will
be signed and that we will take delivery of 650,000 lbs on September 28
and 600,000 on December 1.
[400]
Mr. Shircliff testified that it appeared
that the contract was signed by Mr. Grandey after September 19, 2001.
(24) Resource Allowance Issue
[401]
The Appellant did not include the income and
losses from the sale of purchased uranium in computing its resource profits for
the Taxation Years. The Minister did not include in resource profits the income
earned in 2003 from the sale of purchased uranium but assessed to deduct losses
of $98,012,595 and $185,806,608 on the sale of purchased uranium in computing
resource profits for 2005 and 2006 respectively. The Appellant has since
determined that the amount of its loss from the sale of purchased uranium in
2005 was $109,568,159 and that the amount of its loss from the sale of
purchased uranium in 2006 was $183,935,257.
E. The Expert Evidence
[402]
The evidence of Doctor Horst,
Doctor Barbera and Doctor Wright addresses the transfer price of
uranium sold by CEL to the Appellant and uranium sold by the Appellant to CEL
during the Taxation Years.
[403]
The evidence of Doctors Shapiro and Sarin addresses (i) the functions performed, assets employed and risks
assumed by the Appellant and CEL, (ii) the arm’s length price of certain
services provided by the Appellant to CEL during the Taxation Years, and (iii)
the Minister’s analysis of transactions between CEL and the Appellant and
between CEL and Tenex.
[404]
The evidence of Carol Hansell addresses the
questions: (i) what constituted a commercially normal relationship between a
parent and its subsidiary within a large, complex multinational enterprise (“MNE”) between 1999 and 2006 (the “Relevant Period”), and (ii) in light of assumed facts
and information contained in certain documents, would the relationship between
the Appellant and CESA/CEL be considered commercially normal?
[405]
The evidence of Thomas Hayslett, Jr.
addresses (i) whether the commercial terms in the BPCs were similar to the
types of terms that would normally be present in uranium sales contracts
concluded by industry participants, and (ii) whether the values attributed to
the variable commercial terms (i.e., contract term; annual quantity; quantity
flexibility; delivery schedule, notices and flexibility; delivery location and
method; material origin; material specifications; pricing; and payment terms)
were generally consistent with the range of values seen in uranium sales
contracts offered and/or concluded by industry participants around the time the
BPCs were concluded.
[406]
The evidence of Doctor Chambers addresses
the creditworthiness of CEL for the period between October 1, 2002
and December 31, 2006 (the “Rating Period”).
[407]
The evidence of Edward Kee was solely in
rebuttal of certain aspects of the evidence of Doctor Horst and Doctors
Shapiro and Sarin.
(1) Doctor Horst
[408]
Doctor Horst identified twelve long-term
contracts (the “Horst Long-term Contracts”) and
six spot sale contracts (the “Spot Contracts”)
between the Appellant and CESA/CEL that provided for deliveries of uranium in
the Taxation Years (collectively, the “Contracts”).
[409]
Nine of the Horst Long-term Contracts are the
BPCs and three of the Horst Long-Term Contracts are for the sale of uranium by CESA
to the Appellant. Doctor Horst summarizes the terms of the Horst Long-term
Contracts in Table 3 of his expert report:
[410]
On the basis of his review of the 1995 Organisation
for Economic Co-operation and Development (OECD) transfer pricing guidelines
(the “1995 Guidelines”) and Information Circular
87-2R (the “IC”), Doctor Horst concludes
that the most appropriate transfer pricing methodology for determining an arm’s
length price under the Contracts is the comparable uncontrolled price (“CUP”) method, which is one of three traditional
transaction methods identified in the 1995 Guidelines and the IC. In order to
test the reasonableness of the results under the CUP method, Doctor Horst also
uses the resale price method (“RPM”), which is
another traditional transaction method.
[411]
Doctor Horst observes that, although the
traditional transaction methods are ideally applied to separate transactions,
they can also be applied to bundled related transactions such as those
occurring under long-term contracts for the supply of commodities or services. Doctor Horst
explains why this approach is appropriate in the case of the Horst Long-term
Contracts:
. . . To understand why the aggregation of
all deliveries over the life of an agreement may be appropriate, consider how a
buyer of uranium products would view a long-term agreement that has a fixed
base price that increases over time based on the rate of general price inflation.
While the buyer under an Escalated Base Price agreement may initially pay a
contract price that is higher than the current spot price, the increase in the
contract price in subsequent years covered by the contract is limited to the
rate of general price inflation. That is, under an Escalated Base Price
agreement, the contract price in future years does not depend directly or
indirectly on the contemporaneous spot price. The buyer would commit to an
Escalated Base Price agreement if and only if the prices it expected to pay
over the life of the agreement compared favorably both to the spot prices it
expected to pay over that same period and to the prices it expected to pay
under a long-term agreement with some alternative pricing formula (e.g., a
Capped Market Price agreement).
All of the pricing formulas and other
provisions of a long-term agreement are negotiated as a package. Therefore, the
forecasted prices over the entire life of the agreement also must be considered
as a package in evaluating whether the pricing formula yields an arm’s length
result. Furthermore, the initial base price and the escalation formula to apply
in future years are negotiated before the full agreement is ready for
signature. An evaluation of that pricing formula must be based on market
conditions (e.g., U3O8 spot prices, the TradeTech
Long-Term Indicator for U3O8) and on forecasts of future
U3O8 spot prices at the time the agreement is negotiated.
That is, the economic analysis of transfer prices under a long-term agreement
is properly based on economic circumstances and expectations when the pricing
formulas and other contract terms were negotiated, not on the actual spot
prices or other indices of economic circumstances occurring in later years when
deliveries are made at contract prices pursuant to that long-term agreement.
[412]
With respect to other transfer pricing
methodologies, Doctor Horst opines:
The Canadian and OECD Guidelines present not
only the three Traditional Transactional Methods just described, but also two
Transactional Profit Methods: the Profit Split Method and the Transactional Net
Margin Method (“TNMN”). In this particular case, the availability of comparable
third-party agreements allows a reliable application of the CUP method and a
test of its reasonableness using the RPM. By contrast, I could not see how
either of the Transactional Profit Methods could be applied reliably in this
case.
[413]
Doctor Horst identifies what he views as
the five key elements of the Long-term Contracts: the “valuation
date” of the agreement, the minimum and maximum deliveries to be made in
each year covered by the agreement, the specific formulas for calculating
contract prices for deliveries made in each year covered by the agreement, the
“duration” of the agreement, and the “level of the market.”
Doctor Horst’s explanation of these elements can be summarized as follows:
1.
The valuation date is the date on which the
parties first agree to the volumes and prices of the uranium being
purchased/sold. The agreement is typically evidenced by a signed offer and
acceptance of the terms of the offer
2.
The minimum and maximum deliveries to be made in
each year covered by the agreement are the minimum volumes the buyer is
obligated to purchase and the maximum volumes the buyer is entitled to purchase
at the stipulated contract price in each year covered by the contract.
3.
The specific formula for calculating contract
prices for deliveries made in each year covered by the agreement is the pricing
methodology used in the contract. Doctor Horst identifies the following
five methods for calculating contract prices:
4.
Fixed Price (FP)
5.
“Escalated Base Price (EBP)”
6.
Market Price (MP)
7.
Capped Market Price (CMP)
8.
Hybrid Price (a combination of “EBP” and MP
or CMP).
9.
The duration of a contract refers to the number
of years between the valuation date and the end of the last year of scheduled
deliveries (including any extension years).
10.
The “level of the market”
refers to the difference between purchases by a nuclear power plant operator or
other end-user of the uranium product or service and those by a distributor
that is purchasing in large volume for ultimate resale in smaller volumes to
nuclear power plant operators (“NPPOs”) and
other end-users.
[414]
With respect to the fifth element, Doctor Horst
goes on to explain:
. . . The CUP method as applied to long-term
agreements involves comparisons of the transfer prices between CCO and CEL to
the prices paid under comparable long-term wholesale agreements between third
parties. By contrast, the price paid under comparable long-term retail
agreements between third parties is the starting point for applying the RPM.
[415]
In his glossary of terms, Doctor Horst
defines a “wholesale agreement” as an agreement
between a uranium supplier and a uranium distributor and a “retail agreement” as an agreement to sell uranium to a
nuclear power plant operator.
[416]
In order to apply the CUP method to the Horst
Long-term Contracts, Doctor Horst sought out and identified long-term
wholesale agreements that he believed met all of the following three criteria:
1.
The comparable third-party contract was
negotiated in the same three-year period as the Horst Long-term Contracts.
2.
Copies of the original contract and any
amendments negotiated before the end of 2001 were available.
3.
The pricing formulae under the third-party
contract relied on one of the five methods identified in item 3 of the summary
of Doctor Horst’s explanation above.
[417]
On the basis of these criteria, Doctor Horst
identified the following comparables:
1. The terms under a February 24, 1999 amendment (“N‑K Amendment 1”) of a June 16, 1992 long-term contract between Nukem and
Kazatomprom (the “N-K Contract”). The amendment
provided for deliveries in 2006 through 2010. Doctor Horst viewed the
amendment as a new agreement vis-à-vis the terms of the 2006 through 2010
deliveries.
2.
The terms under a September 7, 2000
amendment (“N‑K Amendment 2”) of the N-K Contract that facilitated five retail agreements
between Nukem and its customers. Doctor Horst remarks:
The wholesale
prices that Nukem paid Kazatomprom under this “carve-out” agreement are considered
as additional comparables for purposes of my CUP analysis in Section IV. In
addition, Nukem’s fixed margin of $0.77 per pound on its resales to the five
designated nuclear power plant operators is also a potential comparable for
determining the appropriate resale margin in my application of the Resale Price
Method in Part V below.
3.
The terms of a December 5, 2000
amendment (the “N-SN Amendment”) to an April 10, 1992 long-term contract between Nukem
and Sepva-Navoi (the “N-SN
Contract”) resulting from the exercise by Nukem
of an option to extend the N-SN Contract for an additional five years (2002
through 2006). Doctor Horst viewed the N-SN Amendment as a separate
long-term contract vis-à-vis the terms of the 2002 through 2006
deliveries.
4.
The terms of three of five carve-out agreements
(the “N-SN Carve-outs”), negotiated in 1999 to 2001, in which Nukem obtained modified
pricing for certain quantities of uranium to be delivered by Sepva-Navoi under
the N-SN Contract. The terms of the N-SN Carve-outs were amended in 2003.
Doctor Horst disregarded those amendments on the basis that they could not
have been anticipated at the time the N-SN Carve-outs were negotiated.
5.
The terms of the original HEU Feed Agreement.
Doctor Horst treated the exercise of each first option under the HEU Feed
Agreement as a separate long-term contract between one of the western consortium
companies and Tenex.
6.
The terms of the six first options exercised by
the western consortium companies following Amendment No. 4 to the HEU Feed
Agreement. Doctor Horst considered each of these six first options as a
separate long-term base escalated price agreement between Tenex and one of the western
consortium companies.
7.
The terms of the original Urenco Agreement.
8.
The terms of the Urenco Agreement following
Amendment No. 1. Doctor Horst evaluated these terms as if the amended
agreement was a new agreement entered into on August 8, 2000.
9.
The terms of the Urenco Agreement following
Amendment No. 2. Doctor Horst evaluated these terms as if the further amended
agreement was a new agreement entered into on April 11, 2001.
10.
The terms of four of the carve-out agreements
relating to the Urenco Agreement.
[418]
With respect to the terms under the Urenco
Agreement and Amendments Nos. 1 and 2 to the Urenco Agreement, Doctor Horst
states:
Under Urenco’s agreement with Tenex, Tenex
was not contractually obligated to supply re-enriched UF6 to Urenco,
but only to use its “best efforts” to supply the quantities indicated in the
current agreement. Since Urenco was not a uranium distributor and did not want
to risk a loss if Tenex failed to supply the re-enriched UF6, Urenco
agreed to supply the re-enriched UF6 to CEL if and only if Tenex
supplied UF6 to Urenco. It is possible that the uncertainty about
whether Tenex would supply UF6 to Urenco and, thus, whether Urenco
would supply that UF6 to CEL may have had a negative effect on the
prices that CEL agreed to pay Urenco. This fact could call into question the
reliability of any comparisons of those prices to the transfer prices that CEL
paid to CCO.
[419]
Doctor Horst uses three approaches to the CUP
methodology to compare the prices under the Long-term Contracts with the prices
under his chosen comparables. He summarizes these three approaches as follows:
1.
My First CUP application compares the actual
transfer prices that CEL paid to, or received from, CCO in 2003, 2005, and 2006
to the actual prices CEL paid in the same years under its long-term agreements
with third-party suppliers. This First CUP application (1) uses Base Price
Discount Factors to adjust for differences in the dates and, thus, the market
conditions under which the pricing formulas in the various long-term agreements
were determined, and (2) adjusts the equivalent U3O8
prices of UF6 purchases to reflect the inherent preference for U3O8
over UF6.
2.
My Second CUP application compares the
forecasted transfer prices that CEL paid to, or received from, CCO over the
entire life of the long-term agreement to the forecasted prices CEL, Cogema,
and Nukem paid to third-party suppliers over the entire lives of their
comparable long-term agreements. Like the First CUP application, my Second CUP
application also (1) relies on Base Price Discount Factors to adjust for
differences in valuation dates and market conditions and (2) makes an
adjustment to the equivalent U3O8 prices of UF6
purchases for the inherent preference for U3O8. As
explained below, my Second CUP application, unlike the first application, uses
Monte Carlo simulation to adjust the Base Price Discount Factors for the
potential benefits for the buyer resulting from its options to increase or
reduce the volumes purchased in various years. The principal disadvantage of
the Second CUP application vis á vis the First CUP application is the
complexity resulting from the need to project contract prices and volumes over
the entire life of the long-term agreement and from using Monte Carlo
simulation to quantify the potential benefits of the buyer’s volume purchase
options. That is to say, greater accuracy is obtained at the cost of greater
complexity.
3.
My Third CUP application differs from my Second
CUP application in its reliance on Weighted Price Discount Factors, rather than
Base Price Discount Factors, to provide benchmark prices for comparing effective
contract prices under a long-term intercompany agreement with those under a
comparable third-party agreement. Weighted Price Discount Factors provide a
more reliable basis for comparisons, especially for long-term agreements that
apply a Capped Market Price or a Hybrid Price formula. The principal
disadvantage of my Third CUP application vis á vis my Second CUP
application is the added complexity resulting from the need to calculate the
appropriate weight to assign to Forecasted Spot Prices versus Escalated TT Base
Prices in calculating the Weighted Price Discount Factor. Again, greater
accuracy leads to greater complexity.
[420]
Doctor Horst concludes that the result
under all three methods is the same: the transfer prices between CEL and the
Appellant are generally consistent with, and in exceptional cases, higher than,
the prices in comparable third-party agreements. The
results of Doctor Horst’s third CUP analysis are found in Table 14-A of
the Horst Report:
[421]
Doctor Horst also performed an RPM analysis
as a check of the results under his CUP analysis. The results of the RPM
analysis are found in Table 14-B (revised):
[422]
Doctor Horst undertook a separate analysis of
the CC Contracts (i.e., the contracts by which CESA/CEL sold uranium to the
Appellant). Doctor Horst summarizes this analysis as follows:
In all cases, I compared the transfer prices
for intercompany deliveries in a year to the prices that CCO or CEL paid to
third parties under spot purchase agreements for deliveries in that same year.
I expressed the various contract purchase
prices as percentages of the published spot purchase prices for the same month
to adjust for month-to-month fluctuations in spot purchase prices. I refer to
these percentages as the Spot Price Discount Factors for the various
deliveries.
I presented separate analyses of the
transfer prices for the two periods 2003 and 2005-2006 because uranium spot
market conditions changed considerably between those two periods.
I concluded that the transfer prices paid in
2003 by CCO under three of the four intercompany spot agreements were arm’s
length values based on the prices that CEL and CCO paid and that CCI received
in comparable spot transactions in 2003 with third parties.
While the
volumes under two of the four intercompany spot purchase agreements were larger
than the volumes in the typical third-party spot purchase agreement,
third-party spot market suppliers were not offering volume discounts; they were
charging volume premiums. Accordingly, I concluded that CCO’s 2003 transfer
prices, at 100% of the most recent published spot prices, did not generally
exceed arm’s length prices.
However,
for one of the 2003 intercompany spot sales agreements, PO 7197, I would
increase CCO’s reported income by $672 thousand to pass through to CCO the
benefit of the (low) price that CEL paid to Rio Algom on its spot purchase of
Russian-source UF6.
Supplies of U3O8 were very tight in 2005-2006, whereas supplies of
UF6 were more plentiful. Thus, spot prices for U3O8 in 2005 often exceeded the
U3O8 equivalent price for spot purchases of UF6. Accordingly, I conducted
separate transfer pricing analyses of the transfer prices under CEL’s 2005
short-term agreements for U3O8 and UF6, respectively.
I could find no comparable short-term
third-party agreements providing for a series of deliveries of U3O8 or UF6 over
a one-year period. Therefore, I compared the transfer prices under the two
short-term intercompany agreements to contemporaneous third-party spot purchase
prices for U3O8 or UF6.
I concluded that the transfer prices
paid in 2005 under the two short-term intercompany agreements were generally
arm’s length prices based on those CUP comparisons.
[423]
Based on his analysis, Doctor Horst
recommends that the Appellant’s income for its 2003 taxation year be increased
by $671,547. Doctor Horst summarizes all proposed adjustments.
[424]
Doctor Barbera, Doctor Wright and
Edward Kee each wrote rebuttal reports in response to the Horst Report
and Doctor Horst wrote surrebuttal reports in response to these rebuttal
reports.
[425]
Doctor Barbera’s criticisms
of the Horst Report are as follows:
1.
Doctor Horst incorrectly assumes that CEL’s purchases
from its third-party suppliers are comparable to CEL’s purchases from the
Appellant. While the contracts are similar in form, the economic circumstances
under which the contracts were negotiated are materially different. In
particular, the circumstances surrounding the signing of the HEU Feed Agreement
and the Urenco Agreement were such that these agreements are not comparable to
the intercompany agreements between CEL and the Appellant.
With respect
to the HEU Feed Agreement, Tenex had no marketing capability and needed the western
consortium to sell its uranium to NPPOs. The US government’s payment of $325
million in 1998 provided a further incentive to contract with the western consortium.
Unlike the Appellant, Tenex did not have to spend vast quantities of capital
investing in a uranium mine or engaging in extensive exploration expenditures. Finally,
the Appellant’s strong customer base gives the Appellant options that Tenex did
not have and, at the same time, explains the need for Tenex to make a deal with
the western consortium.
2.
Doctor Horst fails to examine the Appellant’s
results in light of his conclusions regarding the intercompany transfer prices.
Such an analysis reveals substantial and durable losses that mandate closer
scrutiny of the transfer price obtained under the CUP method. The losses are
contrary to the principle that prices are arm’s length if those prices are judged
to promote the interests of the Appellant viewed as an unrelated party. The key
interest of the Appellant is to earn a level of profit that its (hypothetical)
independent investors require.
3.
Doctor Horst ignores the Appellant’s economic
incentives and available options. The reason for considering other options is
that a company in the course of conducting business with unrelated parties
would ordinarily assess its other realistic options when considering a
particular transaction. Given the Appellant’s price expectations, the Appellant
had other options. Because other arm’s length distributors would have been
willing to accept lower margins than those CEL was reasonably expected to earn,
the Appellant would never have sold its mined U3O8 to a
third-party distributor at the low prices at which it sold U3O8
to CEL over the 2003, 2005 and 2006 period. Doctor Barbera provides an
example of a possible alternative transaction based on the Appellant’s spot
price forecasts.
[426]
In his surrebuttal report addressing
Doctor Barbera’s rebuttal report, Doctor Horst criticizes
Doctor Barbera for ignoring the fact that uranium is a fungible product
and therefore its purchase and sale are governed by supply and demand and not
by the costs of the supplier, for using hindsight in the form of the actual
sales prices of the uranium sold by the Appellant to CEL to conclude that the
Appellant incurred unacceptable losses and for failing to present any evidence
that in 1999 to 2001 the Appellant expected the losses it actually incurred in
2003, 2005 and 2006.
[427]
Doctor Horst states that, following the
1999 reorganization, Cameco US marketed CEL’s and the Appellant’s uranium and
therefore the sales from Tenex to CEL were directly comparable to the sales
from the Appellant to CEL. With respect to the $325 million payment by the US
government, while a condition of the payment was that Tenex enter into a
commercial agreement with acceptable western parties, the payment itself
related to low enriched uranium delivered in 1997 and 1998 and did not alter
the fact that Russia had a clear economic incentive to obtain the highest price
possible and that the western consortium had an equally clear economic
incentive to obtain the lowest price possible.
[428]
Tenex pursued two strategies. The first strategy
sought to obtain the highest possible price. The second strategy, implemented through
Amendment No. 4, sought to obtain the highest possible sales volume. The
Horst Report did not suggest that the Appellant would have pursued either
strategy–only that the prices under the HEU Feed Agreement before and after
Amendment No. 4 provide an upper and lower limit to the range of arm’s
length transfer prices for the intercompany sales of uranium by the Appellant
to CEL.
[429]
Doctor Barbera’s suggested alternative
transaction terms effectively recharacterize the actual transactions. Doctor Barbera’s
hypothetical based on the margin earned by 76 distributors outside the
uranium industry is not realistic as those distributors could not provide broad
access to the retail uranium market.
[430]
Doctor Wright’s criticisms of the
Horst Report are as follows:
1.
Doctor Horst fails to address whether the
circumstances underlying the intercompany transactions differ from those
underlying the comparable transactions. In particular, Doctor Horst does
not adequately address (or fails to address) each of the attributes of the transactions
that must be considered to determine comparability, namely, (i) the
characteristics of the property or services transferred, (ii) the functions
performed by the parties (taking into account assets and risks), (iii) the
contractual terms, and (iv) the economic circumstances and business strategies
of the parties.
With respect
to these attributes: (i) the Horst Report does not consider whether U3O8
and UF6 are sufficiently similar for a comparison under the CUP
method and does not analyze whether the quotas on Russian source uranium have
an impact on price; (ii) arm’s length prices are the result of a comparison of
the related-party transaction with transactions between unrelated parties where
the functions performed, risks assumed and intangible property owned by each
party are the same or substantially similar, yet the Horst Report does not
discuss the functions performed by the parties and the risks assumed; (iii)
contractual terms include volume, length of contract, the dates the contracts
are signed, the currency used in the transaction and the risks borne by each
party to the contract, yet, with the exception of the contract dates, the Horst
Report only superficially addresses these terms; and (iv) the economic circumstances
of Tenex and the western consortium were different from those of the Appellant
and CEL. In particular, Tenex had the profit motivations of a government-owned
entity, lacked a market outlet for its uranium, which reduced its bargaining
power, and needed cash to satisfy the requirements of the Russian government.
On the other hand, the western consortium was motivated to deal with Tenex
because the western consortium wanted control over the uranium market. The
analysis with respect to the Urenco Agreement is conceptually the same with the
addition of the fact that Urenco was selling re-enriched tails.
2.
Doctor Horst’s CUP analysis is complex, does not
address the differences in the terms of the Appellant’s sales to CEL as
compared to CEL’s sales to the Appellant, does not address the price-limited
nature of the Appellant’s sales to CEL and fails to apply all three CUP methods
to all of the contracts identified as comparables.
[431]
In his surrebuttal report addressing
Doctor Wright’s rebuttal report, Doctor Horst states that, contrary
to what is suggested by the questions and issues raised by Doctor Wright
regarding the Horst Report, the Horst Report fully addressed the
difference between U3O8 and UF6, fully
supported the $0.08 per pound adjustment for the inherent preference of NPPOs
for U3O8 over UF6, provided (at
pages 5 to 9) appropriate descriptions of the functions performed by the
Appellant, CEL and Cameco US given the nature of the methods (CUP and RPM)
utilized, properly excluded the two Nukem umbrella agreements in applying the
first two CUP methods and properly included those two Nukem agreements in
applying the third CUP method, carefully considered and, where appropriate,
made well-supported adjustments for (1) the length of the various long-term
contracts, (2) the contract volume amounts, and (3) the differences in the
ability of the buyer to increase or decrease contract volumes, and used
discount factors based on the pricing formulas under the 1999 Tenex Agreement
and Amendment No. 4 to determine an upper bound and a lower bound,
respectively, on the arm’s length values for the Appellant’s long-term
agreements with CEL. Doctor Horst elaborates on each of these points in
his surrebuttal report.
[432]
With respect to the complexity of the CUP
analysis, Doctor Horst states:
. . . While a CUP analysis of spot
transactions may typically be simple and straight forward, a CUP analysis of
long-term agreements is complex because of the inherent complexity of the
pricing formulas, the buyers’ options, and other provisions of long-term
agreements.
[433]
With respect to Tenex’s bargaining power,
Doctor Horst states that Doctor Wright ignores the fact that uranium
is a fungible product and that the price that a distributor can obtain is
constrained by the prices available in the retail market (i.e., sales to
NPPOs). Doctor Horst opines:
. . . It seems unlikely to me that Nukem or
any other independent distributor would have been willing to pay higher prices
to CCO than the prices available from other third-party suppliers (e.g., Tenex)
because CCO was able to market its own uranium, but Tenex was not.
[434]
Doctor Horst also states that the Wright
surrebuttal report ignores the role of Cameco US as the marketing arm of the
Cameco Group following the 1999 reorganization. Doctor Horst summarizes
his view as follows:
In
summary, under the April 1999 restructuring of Cameco’s marketing activities,
CEL would operate hand-in-glove with CCI. CEL’s role was to be that of a
trading company bearing most of the price risk in uranium markets, while CCI’s
complementary role was to arrange all new uranium marketing transactions to be
supplied under back-to-back purchase agreements mainly with CEL. After CCI
commenced operations in 1999, CCI (not CCO) was responsible for finding
long-term customers for the uranium that CEL purchased from all suppliers,
including CCO, Tenex, and Urenco. Because CCO’s sales force had been moved to
CCI, CCO (considered as a separate entity that produced uranium) no longer had
the sales force to find long-term customers for the uranium that CCO sold to
CEL under the long-term agreements at issue in this proceeding.
[435]
With respect to Tenex’s profit motivation,
Doctor Horst states that he sees no difference between the Russian
government’s need for cash and the goals that a commercial seller would have in
seeking long-term agreements for the sale of uranium.
[436]
Mr. Kee’s criticisms of the Horst Report
are summarized at the beginning of his rebuttal report as follows:
3. Dr. Horst assumes that future
uranium prices of $12/lb or $8/lb were equally likely.
4. Dr. Horst notes correctly that “it
is not realistic” to assume that future uranium spot prices could only take on
two discrete values and presents an alternative approach that assumes that
uranium prices have a log-normal probability distribution.
5. Chart 4 shows the log-normal probability
distribution assumed by Dr. Horst. The prices in Chart 4 range from a low
prices [sic] of about $5 and a high price of about $18.
6. The probability distribution for uranium
prices used by Dr. Horst is inconsistent with actual historic uranium prices,
is inconsistent with uranium industry forecasts, and is inconsistent with
uranium industry fundamentals.
[437]
The balance of Mr. Kee’s rebuttal report expands
upon these points.
[438]
In his surrebuttal report addressing Mr. Kee’s
rebuttal report, Doctor Horst states that Chart 4 of the Horst Report
sets out a purely hypothetical example and does not show the basis of the
expected future prices of uranium used in his Monte Carlo analysis, which
is explained on pages 88 to 94 of Volume 1 and in Appendix G in Volume 4 of the
Horst Report. After providing an illustration of the methodology used,
Doctor Horst concludes that “the probability
distributions of future spot prices actually used in my Monte Carlo
analysis do in fact reflect uranium industry forecasts of future spot prices,
not the hypothetical probability distribution of future spot prices shown in
Chart 4.”
(2) Doctors Shapiro and Sarin
[439]
In their report,
Doctors Shapiro and Sarin discuss the uranium mining industry, provide an
overview of the Appellant, discuss the Respondent’s selection of the best
method to apply in analyzing the transactions between CEL and the Appellant,
analyze CEL’s and the Appellant’s functions and risks, estimate the arm’s
length price for the services provided by the Appellant and seek to demonstrate
that functions and risks are separable and that it is incorrect to assert that arm’s
length companies would not have allowed unrelated entities to participate in
the HEU Feed Agreement. The Shapiro-Sarin Report does not specifically address
the arm’s length price of the uranium sold by the Appellant to CEL.
[440]
The principal theme of the Shapiro-Sarin Report
with respect to the intercompany transactions is that CESA/CEL was functioning
as a trader and was assuming significant price risk when it entered into the
BPCs with the Appellant. Doctors Shapiro and Sarin also provide an
analysis of why, in their view, the profit split method is not an appropriate
method for determining an arm’s length price for the uranium sold by the
Appellant to CEL and why the CUP method is the best method to apply in the
circumstances.
[441]
Doctors Shapiro and Sarin describe price risk as
follows:
. . . Price risk stems from volatility and
fluctuations in the prices of a company’s products and services. As with all
commodities, uranium prices are subject to volatility stemming from numerous
factors, including but not limited to demand for nuclear power, political and
economic conditions in uranium-producing and consuming countries, reprocessing
of used reactor fuel, re-enrichment of depleted uranium tails, sales of excess
civilian and military inventories, and production levels and costs.
[442]
According to Doctors Shapiro and Sarin, CEL was
exposed to price risk because it was often committed to buying uranium in
amounts that exceeded its commitments to sell uranium and because it purchased
uranium under predominantly base escalated price contracts but sold uranium
under predominantly market-priced contracts. If the spot price of uranium
declined, then the price obtained under its market-based sale contracts would
also fall.
[443]
CESA/CEL’s price risk meant that CESA/CEL could have
a gain or a loss on the subsequent sale of the uranium it was purchasing under
the BPCs, depending on the future price of uranium, which no one could know at the
time the BPCs were signed. The profits earned by CESA/CEL were the result of
the price risk assumed under the BPCs coupled with a significant and
unpredicted rise in the price of uranium after 2002. The services provided by
the Appellant to CESA/CEL did not alter the price risk assumed by CESA/CEL nor
did they shift the price risk to the Appellant. Conversely, by providing the
services, the Appellant did not take on any risk.
[444]
Doctors Shapiro and Sarin state that since there
is no futures market in uranium that can be used to hedge prices, fixed-price
and base escalated contracts are a common way in which to mitigate price risk.
Doctors Shapiro and Sarin illustrate the common use of such contracts in the
United States in figure 5.9:
[445]
Doctors Shapiro and Sarin opine that without the
benefit of hindsight no contracting option is unequivocally better than
another, and none is prima facie irrational. They go on to explain:
. . . Whether a supplier or consumer ends up
better off under a base-escalated contract, a pure market-price contract, or a
market-price contract with a ceiling, depends on the future price of uranium.
Only in hindsight can one know whether a particular type of contract was the
right one for a buyer or seller to enter into, and on an ex-ante basis,
any choice could be reasonable depending on counterparty preferences and other
market circumstances.
[446]
Doctors Shapiro and Sarin describe CEL’s
activities as follows:
During 2003, 2005, and 2006, CEL purchased
and aggregated uranium from both related and unrelated parties, sold uranium to
CCO [the Appellant] and indirectly to external customers (with CCI acting as a
limited-risk distributor for external non-Canadian sales), and reviewed and
ensured compliance with Swiss regulations. CEL’s key assets include its
contracts, regulatory relationships, and uranium inventory.
[447]
Doctors Shapiro and Sarin state that CEL’s
aggregation of uranium from multiple suppliers provided value to nuclear power
station operators but also exposed CEL to significant price risk:
By aggregating uranium from several sources,
CEL is able to provide uranium buyers a secure source of supply that is
insulated from the effects of an interruption to any one source of supply. A
customer relying solely on the supply of CCO would face the risk that its
supply of uranium could be disrupted by CCO production shortfalls. In contrast,
a customer buying uranium from CEL would have the security of dealing with an
aggregator with overall excess inventory and a diversity of supply, including
uranium from CCO, US Mines, Tenex, Urenco, and others.
By aggregating supplies from different
sources, CEL is able to not only provide a reliable uranium supply, but also to
cater to the varied preferences of the customers of its distributor, CCI. For
example, some end customers focus on price regardless of sources, whereas
Japanese utilities refuse uranium derived from HEU material. CEL is able to
optimize profits by offering clients what they need at the best available
price.
In summary, if a utility sourced its uranium
from a company that did not aggregate uranium from a variety of sources, it
would be more prone to single-source supply interruptions and less assured of
having its individual preferences met. By aggregating uranium, CEL thus
provides a valuable function to customers.
In its role as an aggregator, CEL was
committed to buying most of the output of CCO and US Mines for years in
advance. Typically, it also bought uranium from third parties when the
opportunity presented itself. As a result, it often had purchase commitments
that exceeded its sales commitments. This imbalance between purchases and
sales, while a significant benefit to its utility customers, came at a cost to
CEL of significant price risk. In a given period, it may not have been able to
sell all of the uranium it was committed to buy and, even if it could have, it
did not know ex ante at what price it would be able to sell this surplus
uranium. Conversely, in another period, it may not have been able to buy enough
uranium to fulfill its sales obligations and, even if it could have, it may not
have been able to purchase at low enough prices to make a profit.
[448]
Doctors Shapiro and Sarin provide the following
two tables as an illustration of the price risk exposure of CEL by virtue of
these two factors:
[449]
Doctors Shapiro and Sarin consider whether the
price forecasts prepared by the Appellant were reliable (as compared to those
prepared by others) or contributed value to CEL. Table 8.2 summarizes the
data for 1999 forecasts by the Appellant and others:
[450]
Doctors Shapiro and Sarin conclude that because
of their inaccuracy the Appellant’s price forecasts provided no marginal value
to CEL. After reviewing data regarding forecasts, Doctors Shapiro and Sarin
opine:
Forecasting uranium prices is difficult, due
to the myriad of factors affecting its supply and demand. The third-party
forecasts on which CCO relied in making its own forecasts were relatively
accurate in some years, and quite off the mark in others. For example, none of
the third parties fully anticipated the sharp price increase from 2004 on. It
is not surprising that CCO’s forecasts were broadly similar to those of the
third parties. In some years they were more accurate than those of the third
parties, and in other years they were less accurate. There is no evidence that
an organization would have been better off relying on CCO’s forecasts than
those of the third parties, or that the CCO forecasts provided any marginal
value to CEL.
[451]
Doctors Shapiro and Sarin consider whether the
pricing of the services provided by the Appellant to CESA/CEL was arm’s length
pricing. With respect to the administrative services, they apply the
transactional net margin method (“TNMM”) to data
from various arm’s length service providers and conclude that the 75th
percentile mark-up for administrative services provided in 2003, 2005 and 2006
would be 14.9%, 17.5% and 25.3% respectively. These mark-ups would have resulted
in additional income to the Appellant of CAN$8,940 in 2003, CAN$10,500 in 2005
and CAN$15,180 in 2006.
[452]
With respect to the contract administration
services, Doctors Shapiro and Sarin apply the same approach to data regarding
contract administration service providers and conclude that the mark-ups ranged
from 3.2% to 6.0% in 2003, from 3.8% to 6.1% in 2005 and from 4.4% to 6.0% in
2006. These mark-ups would result in additional income to the Appellant of CAN$18,000
in 2003, CAN$21,960 in 2005 and CAN$21,600 in 2006.
[453]
Finally, Doctors Shapiro and Sarin observe that
the Appellant did not charge CEL for market forecasting or research services. Relying
on information from Ms. Treva Klingbiel, the president of TradeTech,
they conclude that these services were worth no more than $500,000 per year.
[454]
Doctors Shapiro and Sarin summarize their
conclusions regarding the services as follows:
In the sections above we demonstrated that
CCO’s Market Forecasting and Research, Contract Administration, and General
Administrative Services were routine and warrant nominal returns. These
activities can also be contrasted with the uranium aggregation functions
provided by CEL in that the CCO services involved the incursion of little to no
risk. For example, CCO did not put significant capital at risk in performing
these functions and did not take on price, inventory, contract or other risk.
Instead, CCO merely provided services that could have been obtained in the
market for cost plus a modest return, as shown above. While CCO forecast
prices, tracked inventory, and monitored customer contracts, it was CEL, not
CCO, that would have suffered losses if uranium prices fell, if inventory were
lost, or if customers sought to renegotiate contracts.
[455]
With respect to the separation of the functions
performed by the Appellant (i.e., the above-described services) and the price
risk, Doctors Shapiro and Sarin state that price risk is an inherent
characteristic of an asset that varies depending on the degree of uncertainty
associated with the future cash flows from the asset. This risk is borne by the
owner of the asset because the owner is entitled to the future cash flows from
the asset. Potential owners of an asset will discount the price of that asset
to reflect the risk they must bear if they buy the asset. A person who manages
an asset but is not the owner of the asset does not bear the price risk.
Doctors Shapiro and Sarin go on to state:
Absent the ability and willingness of
investors to bear risk, the rate of innovation would be much lower, fewer
investment projects would be undertaken, productivity would be greatly reduced,
economic growth would be much weaker, workers would be much worse off, the rate
of saving would be much lower, and the world would be poorer and weaker.
. . .
Thus, to argue, as the CRA does, that the
provision of administrative services to investors like CEL who supply risk
capital is the equivalent of bearing the risks that capital is subject to is to
denigrate the role of risk bearing while putting the engagement in routine
functions on a pedestal. Simply put, it places the dinnerware on par with the
meal.
. . .
Hierarchical structures separate management
and control by allowing day-to-day decisions to be taken, and day-to-day
functions performed, by employees who are often several layers of management
removed from the managers directly appointed by the owners (the board of
directors). Simply put, shareholders select the board of directors and
outsource every other business function except for risk bearing.
Other techniques for separating risk bearing
from management include insurance contracts, forward and futures contracts,
swaps, and options. These contracts each serve to shift risks to entities that
are not involved with the ownership, management, or day-to-day functioning of
the company. . . .
. . .
By shifting exchange rate, interest rate,
and commodity price risks through the use of forward contracts and other
derivative instruments, companies further separate risks from functions. The
counterparties (the entities taking on the risk) do not participate in the
functions of the company shifting the risk. Rather, they bear the risk (in
exchange for compensation), leaving the company to concentrate on its core
functions.
This is the function CEL performed. CCO
performed its exploration, mining, and administrative functions and was
compensated for the associated risks and costs; CCI performed marketing services
and was compensated for the associated risks and costs; and CEL bore price risk
and was compensated for bearing this risk. The fact that CEL was not involved
in exploration, mining, administration, or marketing does not change the fact
that it bore price risk and that this risk was significant.
[456]
Doctors Shapiro and Sarin opine that, even if
the Appellant monitored and managed CEL’s risk through the various service
functions that it performed for CEL, that fact is not relevant to the question
of which company bore the price risk:
In the case of CEL and CCO, the CRA believes
that CCO monitored and managed CEL’s price risk through Contract
Administration, General Administrative, and Market Forecasting and Research
Services, and that this means that CEL could not have borne the price risk.
Even if the CRA’s assertion that CCO monitored and managed CEL’s price risk is
true, this is irrelevant to the question as to who bore the price risk. The CRA
confuses risk monitoring with risk-bearing. If an investor hires a broker who
recommends stocks based on research performed by the broker’s company, the
investor is still the one who gains (or loses) if the stock price rises (or
falls). The performance of brokerage functions does not shift investment risk
from the investor to the broker. Similarly, an investor may buy gold from a
company that also provides gold transfer and storage, but this logistics
support does not shift investment risk; the investor still bears the risk.
Likewise, a financial advisor may monitor and track the risk in an investment
portfolio and prepare investment statements, but this does not change the fact
that the investor bears the risk of the portfolio’s investments rising or
falling in value.
[457]
The final topic addressed by Doctors Shapiro and
Sarin is whether the Appellant would allow arm’s length participation in the
HEU Feed Agreement. They opine that the amount of time spent by the Appellant
negotiating the contract is not relevant to this question because the cost of
negotiation is a sunk cost and has no bearing on the expected future benefits
and costs of the HEU Feed Agreement, which are the only factors a rational
economic actor would consider.
[458]
Doctors Shapiro and Sarin identify two benefits
to the Appellant resulting from the HEU Feed Agreement: (i) the benefit of
avoiding having the HEU material flood the market and depress the value of
CCO’s uranium and (ii) the benefit of any direct contract value arising from
being able to buy the uranium at below market prices.
[459]
Doctors Shapiro and Sarin refer to the first
benefit as a socialized benefit because it would be shared by all uranium
producers and inventory holders. They contend that this benefit was the primary
reason for entering into the HEU Feed Agreement, as evidenced by
contemporaneous reactions from the business press, analysts and stakeholders
both when the tentative agreement was reached in 1997 and when the final
agreement was reached in 1999. They
summarize their position as follows:
In summary, the primary benefit of the
agreement was expected to be supply control. This benefit would be enjoyed by
all producers and inventory holders, not just the ones who signed the
agreement. As a result, there was no economic incentive for CCO to exclude
other like-minded parties from participating in the contract; CCO would benefit
whether the contract was held by it or by a company with aligned interests. In
fact, as we explain in the next section, CCO would not just have been
indifferent to sharing participation in the contract, but had a strong economic
incentive to share participation so as to spread the contract risks.
[460]
Doctors Shapiro and Sarin state that while the
HEU Feed Agreement provided the socialized benefit of stabilizing the supply of
uranium into the market, it also exposed the participants to significant risks.
These risks were borne by the parties to the HEU Feed Agreement alone and were
therefore “privatized” risks:
While the HEU agreement offered benefits, as
described above, it also exposed participants to significant risks. These risks
included 1) being compelled to exercise options under sub-optimal conditions so
as to keep the deal alive; 2) being forced to buy uranium at above-market
prices (after the options were converted to purchase obligations); and 3)
counter-party risk (Tenex may not have honored the deal).
With respect to the first two risks, for the
first three years of the agreement, participants had a purchase option.
Normally, in such a situation, the option holder would be protected from a
price drop, as it could simply not exercise the option. However, in the case of
the Tenex options, the supply security the deal would provide was so important
that CSA was prepared to exercise its options to purchase from Tenex regardless
of whether it would make a direct profit from those transactions.
[461]
Doctors Shapiro and Sarin describe what in their
view were the economic circumstances of the HEU Feed Agreement and then provide
their conclusion, as follows:
The economic circumstances of agreement
participation were thus as follows:
•
CCO would benefit from the agreement whether it
signed the agreement or not (as long as companies with aligned interests did
sign);
•
In light of the pricing, the agreement had
limited direct contract value, so CCO would not be foregoing material benefits
by sharing participation; and
•
The risks of the agreement would be borne by the
signatories, so CCO would reduce its risk by sharing participation with other
parties.
Given these unique circumstances, CCO had an
economic incentive to share participation in the agreement with parties whose
interests aligned with its interests. This would allow CCO to still enjoy the
primary expected benefit of the deal while divesting the risk of participating
in the agreement. In fact, this is what happened, as Cogema and NUKEM
participated in the agreement (without compensating CCO for its negotiating
efforts or otherwise paying CCO for the right to participate in the deal).
[462]
Doctor Barbera, Doctor Wright and Mr. Edward Kee
each wrote rebuttal reports in response to the Shapiro-Sarin Report and
Doctors Shapiro and Sarin wrote surrebuttal reports in response to those
rebuttal reports.
[463]
Doctor Barbera states that, while Doctors Shapiro
and Sarin opine that CEL bore price risk because it entered into the BPCs, they
do not establish this conclusion in any rigorous way. Specifically, the
Shapiro-Sarin Report does not consider the fact that the prices received under
the BPCs did not compensate the Appellant for all of its production,
exploration and administrative expenses in 2003, 2005 and 2006 and that an
arm’s length company would not accept such a circumstance.
[464]
Doctor Barbera opines that the corollary of
CEL bearing the price risk is that the Appellant did not bear risk. He states
in this regard:
11. Allocation of risk among related parties
is addressed through the transfer pricing arrangements among the various
entities within the group. The low risk entity charges (or pays) prices that
yield a relatively low but assured level of profit over the life of the
arrangement. The high risk entity receives whatever residual profit that
remains within the system, which could be positive or negative. The pricing
between CEL and CCI is a perfect illustration of a transfer pricing arrangement
which effectively limits CCI’s risk because CEL sells to CCI at prices that are
a discount from CCI’s resale price. This pricing structure assures that CCI
will earn a profit. But since its risks are quite low, the level of profit,
while assured, is not high or variable. To further minimize risk in CCI,
purchases occur almost contemporaneously with its sales, as revealed by the
fact that CCI reports virtually zero end-of-year inventory on its balance sheet
over the three years.
12. I suspect that Shapiro / Sarin would
agree that the CEL/CCI pricing arrangement is an effective way to allocate risk
between CEL and CCI. And it should work for CCO as it does for CCI. If CCO was
determined to be the low risk entity with regard to this transaction, sales
prices should be set so that they produce for CCO a profit level that is
definitely positive, definitely steady, but perhaps a bit lower than the profit
CCO would ordinarily have the potential to attain in a more at-risk posture.
That is, thinking of CCO as an independent party (as is necessary to determine
arm’s length prices), its investors would accept a slightly lower return on
investment if, in return, those same investors faced lower risk. So the more
risk CEL bears, the greater its potential profit (or loss). On the other hand,
the more risk CEL bears, the less risk CCO bears. And bearing less risk means
that CCO is more likely, rather than less likely, to charge prices that yield a
stable profit acceptable to its investors.
. . .
16. The point of this discussion is that, if
CEL is claimed to be bearing high price risk, then that claim also embodies a
separate claim that CCO is bearing relatively little risk. And if CCO is such
an entity, then it should be earning a low but steady profit along the lines as
described above. Shapiro / Sarin claim that CEL is the risk taker and that
justifies CEL’s profit. They must believe that CCO is the low risk entity.
Therefore, CCO should be earning a profit. Yet it bears substantial losses. So
the prices cannot be arm’s length according to Shapiro / Sarin’s own analysis.
[465] In their surrebuttal report,
Doctors Shapiro and Sarin respond that their conclusions regarding CEL’s price
risk were independent of whether CEL paid arm’s length prices to the Appellant.
The price risk resulted from the difference between CEL’s commitments to
purchase and its commitments to sell and the resulting exposure to any
fluctuation in the price of uranium. Doctors Shapiro and Sarin go on to state:
As Dr. Barbera states (paragraph 6):
Under arm’s-length purchase pricing
terms, CEL would have the right to earn additional profits, or losses, beyond
that of a typical distributors [sic] because it purchased from CCO based on
long term contracts that were generally dependent on a base price plus
inflation and resold based on shorter term contracts where pricing was
generally related to spot prices.
Dr. Barbera is correct, but what he says is
not limited to arm’s length pricing terms. Under CEL’s actual pricing terms,
whether arm’s length for income tax purposes or not, CEL had the right to earn
additional profits, or losses, beyond those of typical distributors, because it
was exposed to risk beyond that of typical distributors.
Dr. Barbera appears to be suggesting that if
CEL had paid more on its purchases from CCO, it would have had lower profits.
This is a tautology. As our affirmative report makes clear, we are not opining
on the arm’s length nature of the uranium product pricing between CCO and CEL,
but demonstrating that given the pricing in place, CEL was exposed to
significant risk.
[466]
Doctors Shapiro and Sarin state that mining
companies typically do not enter into cost-plus contracts and do not set prices
and therefore are exposed to the risk associated with fluctuating prices. Doctors
Shapiro and Sarin opine that Doctor Barbera is incorrect when he states that no
profit-maximizing company would accept pricing that did not compensate it for
all of its production, exploration and administrative expenses. First, they
assert, Doctor Barbera’s statement is contradicted by the fact that most
mining companies lost money from 2003 to 2006. Doctors Shapiro and
Sarin provide the following table to illustrate the point:
[467]
Second, companies do not have perfect foresight
regarding future expenses and may sign contracts that cover current expenses
but are insufficient to cover future expenses. Doctors Shapiro and Sarin go on
to state:
This is especially true for companies that
sell production forward, like CCO did. Dr. Barbera seems to have expected that
CCO, from 1999 to 2001, would have been prescient not only about what uranium
prices would be from 2003 to 2006, but also regarding what its costs would be
from 2003 to 2006. This was obviously impossible. That being said, CCO tried to
protect itself against the possibility of rising mining costs by including
escalation clauses in its long-term base-escalated contracts with CEL. The
escalation factors in these contracts adjusted the price of its future sales to
[CEL] CCO by a factor tied to the rate of inflation. Unforeseeably, the
increase in CCO’s mining costs outpaced these escalation rates. At the same
time, the Canadian dollar unexpectedly rose against the U.S. dollar, causing
the Canadian-dollar equivalent of CCO’s U.S.-dollar revenue (uranium is priced
in USD terms) to decline while leaving its Canadian-dollar mining costs
unchanged.
[468]
Doctors Shapiro and Sarin provide an analysis of
the margins that the Appellant would expect to earn given its own cost
estimates. The calculations suggest that the Appellant’s expected operating
margins would have been 10.8% in 2003, 3.7% to 8.0% in 2005 and 2.3% to 8.5% in
2006.
[469]
Doctors Shapiro and Sarin also state that
Doctor Barbera ignores the fact that the Appellant lost money on its base
escalated contracts with third-party customers. This
suggests that factors other than non-arm’s length prices, including an
unexpected increase in the Appellant’s mining costs and an unexpected decline
in the Canadian dollars earned due to changes in the Canada-US dollar exchange
rate, contributed to the Appellant’s losses.
[470]
Doctors Shapiro and Sarin agree that the pricing
arrangement between CEL and Cameco US effectively allocated price risk between
these two entities. However, they opine that Doctor Barbera fails to
distinguish between price risk and other risks. Doctors Shapiro and Sarin go on
to state:
. . . The pricing arrangement between CEL
and CCO was effective in limiting CCO’s price risk. By selling its production
forward in long-term contracts at mostly base-escalated prices, CCO insulated
itself from price risk and most inflation risk. Under its base-escalated
contracts with CEL, CCO would get the same (or increasing, depending on the
inflation rate) nominal revenue, and nearly the same inflation-adjusted
revenue, from its sales to CEL regardless of the future market price of
uranium.
However, the contracts did not insulate CCO
from other risks, such as foreign-exchange risk or mining cost risk. For
example, if the Canadian dollar unexpectedly appreciated against the U.S.
dollar, CCO’s revenues would decline in Canadian-dollar terms. Similarly, if
one of its mines flooded, its costs would increase. As it turned out these
things did happen, and CCO’s returns suffered.
[471]
Doctors Shapiro and Sarin state that they did
not claim that the Appellant was a low-risk entity, only that the Appellant
effectively protected itself against price risk. The Appellant remained exposed
to foreign exchange risk, mining cost risk and other risks (e.g., the risk that
its uranium deposits would be smaller, less accessible or of lower quality than
originally anticipated).
[472]
Doctor Wright summarizes her criticisms of
the Shapiro-Sarin Report as follows:
33. While I generally agree with many of the
points made by the Shapiro Report, I believe that the Report has not addressed
the right questions. The first question that should have been addressed is
whether CEL performed the functions related to managing the price risk inherent
in the uranium purchase contracts it signed (both with CCO and with unrelated
third parties). If the decision is that CEL did not perform the relevant
functions, one must ask whether CEL would have been willing to take on the
price risk associated with those contracts if it were operating as a
free-standing company unrelated to the Cameco group (all other things
unchanged). Both of these questions must be addressed before concluding that
CEL should receive the benefit of the price risk inherent in its uranium
purchase agreements. And, neither of these questions is addressed in the
Shapiro Report.
34. Second, the Shapiro Report has not
evaluated whether CCO would have been willing to make the deal it made with CEL
if CEL had been unrelated to the Cameco Group. The Shapiro Report ignores CCO’s
perspective, which must be addressed i.e., the pertinent question is whether
CCO would have been willing to sell all but its committed volumes to an
unrelated third party at prices that were effectively fixed at historically low
rates when it expected market prices to rise over the contract period and it
knew that its mining costs were rising over the same period.
35. Finally, the Shapiro Report takes the
position that the HEU agreements could be signed by any legal entity whose
goals were aligned with those of the Cameco Group. That may be true; however,
the Report does not address whether CEL, at the time the HEU contracts were
signed, was comparable to a substantial player in the uranium market such that,
at arm’s length, it would have been viewed as having aligned interests.
[473]
In their surrebuttal report, Doctors Shapiro and Sarin state that while Doctor Wright
raises potential issues she fails to provide any opinion on these issues. For
example, Doctor Wright criticizes Doctor Shapiro’s and Doctor Sarin’s
functional analysis. She correctly observes that a functional analysis is the
starting point for a transfer pricing analysis. However, she offers no
definitive opinion on which functions the Appellant performed that Doctors
Shapiro and Sarin failed to take into account, or how these functions had any
bearing on their conclusion that CEL bore price risk.
[474]
Doctors Shapiro and Sarin disagree with Doctor
Wright’s suggestion that CEL’s purchases of uranium from the Appellant were
made because employees at the Appellant determined that they met the Appellant’s
“corporate-wide” goals. They state:
This is just an assertion without economic
support and is completely irrelevant to who should receive the profits from
price risk bearing. The only relevant issue is who legally bore the price risk
and here the answer is unambiguous: It was CEL.
[475]
Doctors Shapiro and Sarin state that, contrary
to Doctor Wright’s assertion to the opposite effect, they said that
ownership and the management of risk can be and often are separated. Doctors
Shapiro and Sarin then state:
. . . The profit/loss associated with
bearing risk belongs to the party that owns the risky asset, regardless of who
“controls” the risk. If an investment advisor recommends which investments an
investor should buy, at what prices, and in what quantities, and what the
overall asset mix should be, the profit/loss associated with the portfolio’s
performance is still borne by that investor. The advisor receives a fee that is
typically a fixed-dollar amount or a percentage of the value of the assets
managed; the advisor rarely, if ever, bears the risk of the portfolio declining
in value and does not typically enjoy the gains if it increases in value.
[476]
With respect to whether an arm’s length company
would have entered into the BPCs, Doctors Shapiro and Sarin reference the
analysis they did in their main report. They reiterate their opinion that,
given the Appellant’s and the industry’s poor forecasting record, “it would be reasonable for a company to decide to lock in
future prices, thereby stabilizing its future revenues, rather than rely on its
potentially erroneous forecasts of rising prices in making pricing decisions.” They go on to state:
From a strategic
standpoint, it might well make sense to sell uranium production forward at
base-escalated prices. This insight relies on the fact that uranium is a
commodity product, selling for the same transaction-adjusted price worldwide.
As a commodity business, subject to the law of one price, the key to success
for a uranium miner is to be a low-cost producer. Uranium miners can build
competitive cost advantage all along the mining value chain, including being a
low-cost finder of uranium, developing cost-efficient mines, designing and
implementing cost-effective safety standards, controlling mining risks – such
as cave-ins and flooding – in a cost-effective manner, and extracting uranium
from its mines at a relatively low cost. However, a uranium miner has no
competitive advantage in bearing price risk. Anyone with an appetite for risk
and sufficient capital can bear that risk at the same cost. Indeed,
well-diversified investors would have a competitive advantage in bearing
uranium price risk since their portfolios would be insulated from the full
effects of a decline in the price of uranium by having other assets whose
prices would likely be uncorrelated with the price of uranium. Hence, one could
make a strong case for uranium miners sticking
to what they do best – locating and producing uranium at a relatively low cost
– and letting others bear the price risk.
[477]
With respect to whether an arm’s length company
would allow a third party to execute the HEU Feed Agreement, they assert that
Doctor Wright provides no basis for her speculation that “[i]t may be that Tenex/Urenco signed the contracts because
they viewed them to be between themselves and CCO” and “if CEL had been unrelated to the Cameco Group it may that the
HEU Agreement would never have become a CEL contract.” They opine
that no one knows whether these statements are true and that in fact Tenex did
sign the HEU Feed Agreement with CESA. As well, Nukem participated in the
agreements even though it was not as substantial a player in the industry as
the Appellant.
[478]
Mr. Kee opines that the CEL price risk
identified by Doctors Shapiro and Sarin is premised on faulty assumptions
regarding the price of uranium. He states that the analysis ignores past
uranium prices, uses an unlikely probability distribution to represent possible
future prices (i.e., $6 to $14), incorporates a flawed view of uranium price
risk and does not reflect uranium industry fundamentals.
[479]
Mr. Kee states that real and not nominal
historical prices must be used to remove the impact of inflation over time. He
provides the following graph of real prices between 1948 and the end of 1998:
[480]
On this chart he shows that the low point in the
range of prices is approximately $10. He opines that Figure 5.7 and Table 7.7
of the Shapiro-Sarin Report are misleading because they use nominal prices,
which make historical prices appear lower, and because they use 1986 as their
starting point and omit previous price spikes.
[481]
Mr. Kee states that Doctors Shapiro and
Sarin used a uniform probability distribution to represent the likelihood of prices
being above or below $10. He provides the following chart which is a histogram
of the real prices shown in Figure 1 in his rebuttal report. He opines that
the histogram provides a view of historical uranium process that is similar to
a probability distribution:
[482]
On the basis of this histogram, Mr. Kee
concludes that CEL had little or no price risk because the probability of prices
below $10 was quite low.
[483]
Mr. Kee states that future uranium prices
are uncertain but not unpredictable. He observes that none of the forecasts
cited by Doctors Shapiro and Sarin predicted spot prices below $9.59.
[484]
Mr. Kee states that Doctors Shapiro and
Sarin failed to consider that the production gap (i.e., the gap that exists
when uranium demand exceeds uranium production) and the decline in uranium
inventories since about 1990 would place upward pressure on uranium prices.
[485]
Mr. Kee opines that Doctor Shapiro and Doctor
Sarin’s suggestion that uranium prices could be lower than $10 ignores the fact
that the “cash operating costs of the lowest cost
uranium producers was close to $10/lb, so that it was unlikely that any uranium
producers would have entered into spot contracts at prices much lower than
this, which limited the possibility that spot market prices would be below
about $10 for any sustained period.”
[486]
Finally, Mr. Kee opines that the value at
risk analysis of Doctors Shapiro and Sarin describes uranium inventory as “exposure,” assumes that uranium inventory may be
worthless and ignores the potential for CEL so sell this inventory; as a result
Tables 7.3 and 7.4 of the Shapiro-Sarin Report are misleading.
[487]
In their surrebuttal report, Doctors Shapiro and Sarin state that Mr. Kee’s rebuttal
contains several mischaracterizations of their analysis. In particular, they
explain that the premise in the Shapiro-Sarin Report that CEL faced financial
risk due to uncertain uranium spot market prices was not based on specific
expectations about future prices, but on the fact that CEL’s returns depended
on future prices, and future uranium prices were uncertain.
[488] Doctors Shapiro and Sarin opine that if,
as Mr. Kee suggests, the market knew that future uranium prices would be
higher, then the market would have behaved accordingly, which would have
resulted in a significant rise in base escalated prices.
[489]
Doctors Shapiro and Sarin opine that, whether
prices are presented in real or nominal terms, the figures show significant
fluctuations in the price of uranium. In addition, if earlier prices are
factored into the analysis the fluctuation is even greater. In particular,
between June 1978 and May 1992 the price fell 82 percent, from $43.40 to
$7.73, in nominal terms, and it fell 91 percent from September 1976 to
October 1991 in real terms. Doctors Shapiro and Sarin go on to state:
The (real) market price of uranium was lower
in 1986 than it was in 1948 (as shown in Dr. Kee’s Figure 1), so by
starting our graph in 1986 instead of 1948, we understate the true magnitude of
prior declines in market uranium prices.
In terms of assessing rational expectations
as of the time CCO entered into its long-term sales contracts with CEL, it is
Dr. Kee’s graph that is misleading. Dr. Kee’s Figure 1 shows market
uranium prices from July 1948 to July 1998, and Dr. Kee states
(paragraph 13) “that real uranium market prices have an all-time low level at
about $10/lb.” Market uranium prices may have hit a then-all-time low
of about $10/lb. in the first half of 1998, but what Dr. Kee neglects to
show or discuss is that market uranium prices continued to fall. By
December 1998, the price (in constant January 1, 1999 dollars,
as Dr. Kee prefers to use) was $8.79, having declined by 17 percent from
the July 1998 price of $10.59.
After rising in early 1999, the price resumed
its decline and did not hit bottom until December 2000. At that point the
price was $6.84 (in constant January 1, 1999 dollars). This was 35.4 percent
below the price in July 1998; the last price shown in Dr. Kee’s
Figure 1. The price remained below the July 1998 price until May 2003.
This clearly demonstrates that uranium prices, even after periods of steep
decline, can fall even further, and that prices do not necessarily increase
just because they have recently fallen or have been relatively low for a period
of time.
[490]
With respect to the price probability distribution,
Doctors Shapiro and Sarin state that the range they used was not a prediction
of future prices but an illustration of the effect of price movements. They
state:
Dr. Kee ignores the fact that past prices
are no guarantee of future prices, and that prices sometimes move below prior
lows. Indeed, there is substantial empirical evidence in the financial
economics literature that asset prices follow a random walk; that is, at any
point in time, they are just as likely to go down as up. The reason for this
phenomenon turns out to be simple: What moves prices is new information, which
by definition is unpredictable; otherwise, it would not be new. It is only in
hindsight that we perceive patterns in the data. We would also note that
Dr. Kee skews his results by stopping his analysis in July 1998,
thereby missing the significant price decline from July 1998 to
December 2000. In real terms, prices fell from $10.59 to $6.84 during this
time, a decline of 35 percent. A company that relied on historical uranium
price distributions as of July 1998 to make bets about future prices would
have lost money; if it bet the company on these forecasts, it could have gone
bankrupt.
[491]
With respect to Mr. Kee’s contention that
none of the forecasts predicted lower prices and that Tables 8.1 to 8.4 of the
Shapiro –Sarin Report suggest that CEL was guaranteed profits, Doctors Shapiro
and Sarin state:
Dr. Kee adds (paragraph 32) that “None
of the uranium spot market forecasts discussed by Shapiro/Sarin predicted spot
market prices below the $9.59/lb breakeven price that Shapiro/Sarin calculated
for CEL.” Our point is that these predictions were all wrong, and that CCO’s
predictions were less accurate than most of the others. The forecasts could
have just as easily been wrong on the downside as on the upside.
Dr. Kee then states (paragraph 33) that
the uranium price forecasts in our Tables 8.1 through 8.4 “all indicated that
CEL profits were guaranteed as a result of its mix of base-escalated uranium
purchase contracts and market-related sale contracts.” (Emphasis added.) This failure to
distinguish between predictions and guarantees permeates Dr. Kee’s
analysis and encapsulates the difference between our view of the issue at hand
and his. Projected profits and guaranteed profits are two different things. If
forecasted prices were always correct, there would be no risk, because nobody
would enter into any business activity for which profits are not forecast.
Dr. Kee’s argument also ignores the way markets work. Guaranteed profits
from trading strategies tend to be arbitraged away almost instantaneously,
resulting in new prices from which profits can only be earned by bearing risk.
[492]
With respect to failure to consider industry
fundamentals, Doctors Shapiro and Sarin state that, regardless how predictive
the statistics cited by Mr. Kee are, in fact prices fell from 1998 to 2000
and then remained below their 1998 level until 2003.
[493]
With respect to industry views, Doctors Shapiro
and Sarin state:
The Ux Weekly from August 21, 2000
does include a discussion about whether uranium prices have reached a bottom,
but states that most industry participants thought prices had further to fall.
The discussion is based on a survey that UxC conducted in July and August 2000
that involved 62 companies (including utilities and suppliers). The survey
showed that more than two-thirds of supplier respondents, and more than half of
all respondents, thought the uranium price had not yet hit bottom. Less than 40
percent of respondents thought that prices would turn higher during the next 12
months.
The main message in this survey is
that price could still fall further, with about half of the respondents
believing it would end the year below $8.00 (The survey was conducted during a
period when price was in the $8.00-$8.50 range.)
Contrary to Dr. Kee’s implication,
there was not a consensus (or even a preponderance of belief) among suppliers
or utilities that prices were about to increase.
(3) Doctor Barbera
[494]
In his expert report,
Doctor Barbera reviews the Cameco Group’s uranium business, provides a functional
analysis of the Appellant, Cameco US and CEL, provides a summary of the
intercompany transactions that he reviewed and provides a description of the
arm’s length principle and the 1995 Guidelines. With respect to the arm’s
length principle, Doctor Barbera states:
The standard applied in this analysis to
test the transfer prices between CCO and CEL is the arm’s-length principle as
set forth in the OECD’s 1995 Transfer Pricing Guidelines for Multinational
Enterprises and Tax Administrations and Article 9 of the OECD Model Tax
Convention, hereafter referred to as the “OECD Guidelines.” Under the OECD
Guidelines, a controlled transaction meets the arm’s-length principle if the
results of the transaction are consistent with the results that would have been
realized if uncontrolled taxpayers had engaged in comparable transactions under
comparable circumstances. In order to be “comparable” to a controlled
transaction, an uncontrolled transaction need not be identical to the
controlled transaction, but must only be sufficiently similar that it provides
a reliable measure of an arm’s length result.
[495]
On the basis of his functional analysis,
Doctor Barbera opines that CEL is a distributor and that the business of
CEL relating to its purchases of uranium from the Appellant can be viewed as
two separate types of buy-sell operations. The
first involves CEL purchasing U3O8
from the Appellant under base escalated and market-based contracts and selling it to Cameco US under the same contract structure.
Doctor Barbera opines that this segment of CEL’s operations is essentially
identical to what a routine distributor does.
Doctor Barbera goes on to state:
66. . . . A routine distributor buys
products, holds modest levels of inventory, and then resells those products.
Such distributors typically buy and sell products with stable prices over time.
Given an economic environment of stable prices, routine distributors do not
have an incentive to speculate as to the timing of their purchases and resales
or the level of inventory that may or may not optimize profits. Routine
distributors neither own valuable and unique technology, nor are they in the
process of developing such technology. Routine distributors neither own nor are
in the process of developing unique and valuable trademarks or brands.
[496]
The second type of buy-sell operation involves
CEL purchasing U3O8 from the
Appellant under base escalated contracts and selling it to Cameco US under
market-based contracts. Doctor Barbera states in this regard:
67. . . . This second entity is functionally
similar to the first entity (i.e., routine distributor). This entity is,
however, buying solely under BE and selling solely under MKT, when market
prices are expected to increase this type of entity has an incentive to 1) take
on greater levels of inventory, and 2) purchase well in advance of resale if it
is believed prices will rise over the intervening period.
68. Even though this second type of buy sell
operation is performing similar functions as a routine distributor, it cannot
be classified as a routine distributor. The reason is it assumes additional
risks than a typical distributor (i.e. inventory and market price speculation)
in order to take advantage of the potential upside of price changes. This [is] speculation
that buying under different pricing terms will result in above routine
distribution profits if market prices do rise over a specified period. However,
if market prices fall, this type of buy sell operation is liable to earn below
routine distribution profits, or earn operating losses as well.
[497]
Doctor Barbera uses three methodologies to
evaluate the arm’s length nature of the prices that the Appellant charged on its
sales of U3O8 to CEL over the 2003 through 2006 period:
the RPM, the cost-plus method (“CPM”) and a
third method not identified in the 1995 Guidelines that he calls the valuation
method (“VM”). Doctor Barbera opines that
of these three methods the CPM is most appropriate for those transactions.
[498]
Under the VM, Doctor Barbera computes a
fixed price for the terms of the BPCs based on the discounted present value of
the profit expected to be earned over the terms of the BPCs. The expected
profit is in turn based on the Appellant’s forecast of future realized prices around the times the BPCs were entered into. To determine this
profit, the expected revenues are discounted by 10% to reflect the risk of the
hypothetical arrangement and are also reduced by the costs of CEL and Cameco US
and by a routine profit (based on certain arm’s length indicators) for their
functions and capital investments. These costs and routine profit collectively
required a further discount of 3.5%. The result is a fixed price of $14.96 for
the two BPCs dated October 25, 1999 and May 3, 2000 and $12.43
for the balance of the BPCs. These prices are then increased each year by the
rate of inflation. The revenues computed using these prices are then compared
to the actual revenues from the BPCs to determine the adjustment. The total
adjustment for the Taxation Years is an increase in the income of the Appellant
of CAN $241.3 million.
[499]
Under the RPM, Doctor Barbera compares the
sales by the Appellant to CEL under the BPCs to the sales by CEL to Cameco US,
which he views as arm’s length because they mirror Cameco US sales to third-party
customers. Doctor Barbera breaks CEL’s sales down into three categories-CEL
buys from the Appellant and sells to Cameco US under base escalated pricing
terms (“CEL-BE”), CEL buys and sells under
market pricing terms (“CEL-MKT”) and CEL buys
under base escalated pricing terms and sells under market terms (“CEL-MB”)–and then computes for each year from 2003
through 2006 CEL’s gross discount from CEL’s sale price to Cameco US for each
category. CEL-BE, CEL-MKT and CEL-MB account for 15%, 30% and 55% respectively of
CEL’s sales of the uranium purchased under the BPCs.
[500]
Doctor Barbera describes the CEL-BE sales
as a traditional buy-sell business similar to that of Cameco US and determines,
on the basis of the margin paid to distributors in other industries, that 1.7%
(plus 0.5% to 0.6% to cover CEL’s expenses) of the sale price to Cameco US is
appropriate compensation for CEL’s services.
[501]
Doctor Barbera states that the same
approach and result apply to the CEL-MKT sales. Doctor Barbera does not apply
the RPM to the CEL-MB sales. The total proposed adjustment to the income of the
Appellant for the Taxation Years is an increase of CAN $252.4 million. Doctor Barbera subsequently revised his total RPM adjustment
downward to $258.9 million for the years 2003 through 2006, but he does not
indicate how this overall adjustment affects the adjustments for the Taxation
Years.
[502]
Under the CPM, Doctor Barbera compares the Appellant’s mark-up on sales of U3O8
to CEL under the BPCs with the Appellant’s mark-up on sales of U3O8
to customers under 16 contracts entered into or amended between 1999 and 2001. The details of the
16 contracts are set out in Appendix A to the Barbera Addendum. The
results of the CPM analysis are set out in Table 1 of the Barbera Update as
follows:
[503]
Doctor Barbera uses the mark-up on the
sales to third parties to calculate adjustments to the income of the Appellant
of CAN$18.0 million, CAN$76.8 million and CAN$121.3 million for 2003, 2005 and
2006 respectively, or a total of CAN$216.1 million.
[504]
In addition, Doctor Barbera performs a CPM
calculation for 4.1 million pounds of U3O8 that CEL
loaned to the Appellant in 2005 (3.4 million pounds) and 2006 (0.7 million
pounds) and that the Appellant subsequently sold to CEL. This calculation
yields a further upward adjustment to the Appellant’s income of CAN$16.5 million
in 2005 and CAN$5.4 million in 2006, for a total of CAN$22 million. The total adjustments are summarized in Table 3 of the
Barbera Update as follows:
[505]
Doctor Barbera also performs an economic
analysis of the arrangement between CEL and Tenex and the arrangement between
CEL and Urenco to determine if the Appellant transferred value to CEL by
allowing CEL (then CESA) to enter into these arrangements.
[506]
With respect to the CEL-Tenex arrangement,
Doctor Barbera reviews the history leading up to the HEU Feed Agreement
and poses the question: “Would [the Appellant] have
entered into this Tenex related arrangement with an unrelated party under terms
that provided [the Appellant] with no compensation beyond a routine
distribution profit in return?” Doctor Barbera opines that the answer
depends on the Appellant’s expectation regarding the future profit generated by
the HEU Feed Agreement.
[507]
Doctor Barbera uses the Appellant’s price
forecasts circa 1998 less expected operating expenses to determine the profit the
Appellant would expect from the contract with Tenex. The calculations yield an
annual operating margin of 33.4% of the resale price. On the basis of these
calculations, Doctor Barbera concludes that the Appellant would not have
transferred the HEU Feed Agreement to an arm’s length party without
compensation equal to the expected profit less the compensation an arm’s length
distributor would require in the circumstances. Doctor Barbera determines
that an arm’s length distributor would have required a margin of 1.9% of the
resale value of the Tenex source uranium, which equates to 5.7% of the total
profit from the sale of Tenex source uranium. The resulting adjustments proposed by Doctor Barbera are set
out in Table VIII-5, as follows:
[508]
Doctor Barbera conducts essentially the
same analysis for the CEL-Urenco arrangement. In that case, the 1.9% margin
attributed to CEL equates to 7.2% of the total profit from the sale of Urenco
source uranium. The resulting adjustments proposed by Doctor Barbera are set
out in Table IX-2, as follows:
[509]
Doctor Horst and Doctors Shapiro and Sarin
each wrote rebuttal reports in response to the Barbera Report and
Doctor Barbera wrote surrebuttal reports in response to these rebuttal
reports. Doctor Horst wrote a separate rebuttal regarding the revised
CPM method described in the Barbera Addendum and the Barbera Update.
[510]
Doctor Horst opines that the three methods
used by Doctor Barbera to value the transactions under the BPCs overstate
that value.
[511]
With respect to the VM, Doctor Horst states
that it does not yield reliable results for two reasons. First, the initial base
escalated price suggested by the valuation analysis exceeds the contemporaneous
TradeTech long-term indicator by 34%. Doctor Horst suggests that a
wholesale purchaser would not have paid such a premium. Second, the valuation
method is a form of transactional profit method, which is not as reliable as
the traditional transaction methods.
[512]
With respect to the RPM used by
Doctor Barbera, Doctor Horst states that this method uses the actual
prices under the 2003 to 2006 transactions between the Appellant and CEL and
between CEL and Cameco US. He criticizes the fact that Doctor Barbera
makes no adjustment for the change in market circumstances between the dates
the BPCs were entered into and the dates of the actual transactions.
[513]
Doctor Horst’s rebuttal of the CPM consists
of a modification of Doctor Barbera’s approach-which, Doctor Horst
says, streamlines the analysis by eliminating any reference to the Appellant’s
cost of sales, gross profits and margin and shows that Doctor Barbera’s approach
is akin to a CUP method–and a critique of that approach. Doctor Horst
raises issues regarding the comparability of the 16 contracts as follows:
1. The three base escalated agreements in the sample used by
Doctor Barbera include a legacy premium and
therefore overstate the arm’s length price;
2. Five of the thirteen market agreements in the sample are capped
market price agreements with a pricing formula broadly similar to the market
pricing formula used in some of the BPCs. Doctor Horst opines that the actual
price paid under those agreements is not a reliable comparable because of the
trade-off, in any capped market price agreement, between the level of the
discount allowed from current spot prices and the level of the ceiling price.
3. The remaining eight market contracts in the sample use pricing
methods that are fundamentally different from the market-based formulas used in
the relevant BPCs. Doctor Barbera does not make any adjustment for these
differences.
4. With respect to all the market-based contracts in the sample,
because buyers and sellers cannot predict what actual contract prices will be
in any year, comparing the prices under the BPCs with the prices under the third-party
contracts assumes that the parties knew what the prices would be and amounts to
the use of hindsight.
[514]
In addition, Doctor Horst raises two further
issues regarding Doctor Barbera’s CPM:
1. Doctor Barbera does not account for the differences in the
pricing mechanisms used in the sample contracts and the BPCs. The majority of
the sample contracts use predominantly market-based price mechanisms while the
majority of the BPCs use base escalated price mechanisms. The failure to make
any adjustment for this ignores the contractual terms and restructures the base
escalated pricing formulas of the BPCs to mirror the pricing mechanisms in the
13 market price agreements in the sample.
2. Doctor Horst opines that for various reasons the RPM analysis he
uses in the Horst Report provides a more reliable basis for comparing the
Appellant’s transfer pricing formulas with the comparable formulas in the
relevant third-party agreements than does Doctor Barbera’s CPM.
[515]
Doctor Horst’s criticism of Doctor Barbera’s
analysis of the arrangements with Tenex and Urenco is summarized in the
Horst Rebuttal of Barbera as follows:
The principal points on which I disagree
with the Barbera Tenex Analysis are as follows. The decisions made by all three
of the Western Consortium – CEL, Cogema and Nukem – before and after the Tenex
Agreement was signed in March 1999 – are contrary to what the Barbera Valuation
Method concludes a “profit-maximizing” company would do. To be specific, if the
three Western Consortium companies – CEL, Cogema and Nukem – had in fact viewed
the rights to purchase UF6 as a high-value intangible asset, it is
hard to understand:
•
In negotiating the terms of the 1999 Tenex
Agreement, why were the Western Consortium companies unwilling to commit
themselves in advance to purchasing 100% of the UF6 that Tenex was
offering?
•
Once the 1999 Tenex Agreement was signed, why
did they not issue multi-year First Option Exercise Notices (“FOENs”) to
purchase 100% of the UF6 that Tenex was offering?
•
In May 2001, when Tenex was threatening to
terminate the 1999 Agreement, why did the Western Consortium companies not then
issue multi-year FOENs to purchase 100% of the UF6 that Tenex was
offering?
•
What was Tenex thinking when it agreed in
November 2001 to make substantial (but temporary) reductions in the
escalated base prices available to the Western Consortium companies?
In my view, the most plausible explanation
of the actual decisions made by the three Western Consortium companies and by
Tenex is that, given the more or less continuous decline in uranium spot prices
between 1996 and early 2001, the Western Consortium companies and Tenex were
understandably skeptical of forecasts predicting that spot prices would
increase sharply in the near future. I think it is more reasonable to assume
that the Western Consortium companies would have evaluated the escalated base
prices that they would pay under the Base Price Mechanism of the 1999 Tenex
Agreement by reference not to forecasts of future spot prices, but rather to
the escalated base prices at which they could resell the Tenex-supplied UF6
to their retail customers. That is to say, they reasonably relied on simpler
apples-to-apples comparisons of one Escalated Base Price (“EBP”) formula to
another EBP formula, rather than on an apples-to-bananas comparison of an EBP
formula to a forecasted spot price. Because the EBP prices payable to Tenex
were 92% of the most recent TradeTech Long-Term Indicator, the valuation issue
is simple – was the 8% discount that Tenex allowed from the TradeTech Long-Term
Indicator greater than an arm’s length gross margin for CEL and CCI’s
distribution functions?
As noted, the Barbera Tenex Analysis applies
a TNMM to conclude that an arm’s length gross margin for CEL and CCI’s
distribution functions is 3.6% of net sales. In my view, the resale price
method, which is one of the three traditional transaction methods, provides a
more reliable estimate of the arm’s length gross margin for CEL and CCI’s
combined activities than the Barbera Report TNMM does. In particular, I believe
that the gross margin should be based on the projected results of Nukem’s
back-to-back agreements relating to resales of U3O8
supplied by Kazatomprom (Stepnoye) and Sepva-Navoi, respectively. In my Expert
Report, I determined that these projected gross margins ranged from a low of
7.4% to a high of 18.0%. The 8% discount from the TradeTech Long-Term Indicator
allowed under the 1999 Tenex Agreement is near the lower end of the range based
on Nukem’s back-to-back agreements.
My conclusion is that CEL’s right to
purchase UF6 under the 1999 Tenex Agreement under an EBP formula
with an initial base price that reflected an 8% discount from the most recent
TradeTech (“TT”) Long Term Indicator was not a valuable intangible asset. An
important corollary of that conclusion is that the prices that CEL paid to
Tenex, with whom it was dealing at arm’s length, can and should be used in
applying the Comparable Uncontrolled Price (“CUP”) method to determine whether
the transfer prices that CEL paid to CCO had arm’s length values.
. . .
As noted, Section III of my Rebuttal Report
addresses the Barbera Urenco Analysis. In summary, the Barbera Report uses the
same general method to evaluate the 1999 Urenco Agreement as it applies to the
1999 Tenex Agreement. Accordingly, I have the same basic objections to the
Barbera Urenco Analysis as I just described regarding the 1999 Tenex
Agreement.
Also, as I explain in Section III(B) below,
the Barbera Urenco Analysis focuses on the 1999 Urenco Agreement and does not
consider any of its significant substantive amendments or the series of
carve-out agreements that fixed the price that CEL would pay for UF6
that CCI then resold under designated back-to-back agreements with its nuclear
power plant operator (“NPPO”) customers. The omission is significant because
the formula provided by the 1999 Urenco Agreement actually applied only to
CEL’s 1999 purchases. CEL’s purchases during the years at issue were all at
prices determined under amendments or carve-out agreements made in later years,
none of which are considered in the Barbera Report. Given the renegotiation of
the Urenco pricing formulas in 2000 and again in 2001 that resulted from
declining uranium prices, I am dubious of the Barbera Report’s conclusion that
CCO is entitled, by virtue of its role in securing the original 1999 Urenco
Agreement, to a share of CEL and CCI’s combined gross margin on sales made in
2003, 2005 and 2006. Given the history of the 1999 Urenco Agreement described
above, I would think it would be more reasonable to attribute any excess
profits to CEL’s and CCI’s marketing efforts, rather than to CCO’s role in
negotiating the terms of the original 1999 Urenco Agreement.
Finally, the Barbera Urenco Analysis makes
no mention of, and thus no adjustment for two factors that may have depressed
the wholesale prices that CEL paid and the retail prices that CCI received for
the Urenco UF6. The first is the fact that the Urenco UF6
was Russian-source and could generally not be sold to U.S. nuclear power plant
operators. The second and more significant is the fact that Tenex had no firm
contractual obligation to supply the re-enriched UF6 to Urenco,
which resulted in Urenco’s having a contractual obligation to supply CEL only
if Tenex supplied by [sic] Urenco. Given the history of the 1999 Urenco
Agreement described above, I would think it would be more reasonable to
attribute any excess profits to CEL’s and CCI’s marketing efforts, rather than
to CCO’s role in negotiating the terms of the original 1999 Urenco Agreement.
[516]
In his surrebuttal report addressing
Doctor Horst’s rebuttal report,
Doctor Barbera summarizes his criticism of Doctor Horst’s rebuttal of his use
of the CPM analysis as follows:
Dr. Horst’s CUP analysis concluded that
the actual contracts CCO signed with CEL produced results that diverged from
the arm’s length standard by 1.5% of total sales revenue. It follows that Dr.
Horst has concluded that CCO’s CP on sales to CEL over the years 2003, 2005 and
2006 should be negative. The implication of his CUP analysis along with his critique
of my CP analysis is that CCO would be willing to sign contracts that generate
gross losses over the entire contract term.
Dr. Horst’s critique lacks economic
merit. He offers no evidence to support his assertion, either explicit or
implicit, that CCO, under arm’s-length conditions, would have accepted
continuous operating losses. Such conduct is contrary to the arm’s-length
principle and CCO’s objectives and interests. Therefore, I stand by my CP
analysis.
[517]
Doctor Barbera submitted two further surrebuttal
reports one of which addresses the rebuttal reports of Doctor Horst and of
Doctors Shapiro and Sarin and one of which addresses only the rebuttal report
of Doctors Shapiro and Sarin. I will summarize these two surrebuttal reports
after summarizing the rebuttal report of Doctors Shapiro and Sarin.
[518]
In the Shapiro-Sarin Rebuttal of Barbera,
Doctors Shapiro and Sarin opine that the 2.2% to 2.4% discount used by Doctor Barbera
to determine the profitability of CEL is based on returns earned by distributors
that are not remotely comparable to CEL in terms of risk borne. They state, for
example, that one of the distributors on Doctor Barbera’s list of
comparable distributors hedged its price risk, which CEL was not able to do
because of the absence of a futures market in uranium. They also state that
Doctor Barbera contradicts his own conclusion when he finds that CEL was
not a routine distributor when it bought and sold under different contract
structures, because it took on additional risk, but applies the routine
distributor margin to all the transactions. Doctors Shapiro and Sarin opine
that CEL was not a routine distributor because it took on significant price
risk.
[519]
Doctors Shapiro and Sarin criticize Doctor Barbera’s
VM on the grounds that in 1999 to 2001 the Appellant had no reason to believe
that its forecast prices were accurate, that an economically rational actor
would realize that there was tremendous uncertainty regarding forecast uranium prices
and would accept a lower contract price in exchange for the elimination of this
uncertainty, and that the discount on the forecast price stream of revenues
would be higher than on the fixed price stream because the forecast stream is uncertain.
[520]
Doctors Shapiro and Sarin opine that
Doctor Barbera fails to understand how an arm’s length party would
actually behave in the face of an optimistic forecast. They state:
By failing to account for the expectations
of other market participants, Dr. Barbera fails to understand how an arm’s
length party would actually behave in the face of an optimistic forecast.
Specifically, if a company believes the price of a product it seeks to acquire
and sell is going to rise, it does not necessarily mean the company will try to
purchase the product on a fixed-price (base-escalated) basis and sell it on a
market basis. If the company’s price expectations are shared by the market,
these expectations will be priced into the market. That is, the base-escalated
and market prices available in the market will reflect these expectations. The
base price in base-escalated contracts would likely be higher in these
circumstances than in an environment in which expectations were for prices to
decline. CEL’s contracting preferences would depend on several factors,
including its price expectations relative to the price expectations of other
market participants, its risk tolerance, and the risk tolerances and other
preferences of its counterparties.
. . .
Dr. Barbera’s assertion that a company
would not be willing to sell at long-term fixed prices if the value of the
resulting revenue were less than the revenue that could be obtained by selling
at forecast uranium prices, and indeed his entire analysis, completely ignores
the value companies place on avoiding uncertainty. A tenet of finance (and
behavioral psychology) is that people prefer certainty and are . . . willing to
pay a premium for it. Failure to account for the risk inherent in accepting an
uncertain set of cash flows plagues Dr. Barbera’s entire analysis.
Dr. Barbera also does not take into
account that, without the benefit of hindsight, no contracting option is
unequivocally better than another. Whether CCO would have been better off
selling under a base-escalated or market contract depends on the future price
of uranium, the price of avoiding risk, counter-party preferences, and other
market circumstances.
Indeed, despite CCO’s repeated forecasts of
rising prices, in some instances, CEL was indifferent between entering into
market or base-escalated price contracts and offered (indirectly, through CCI)
potential clients both options. As we note in our affirmative report, we
identified 18 situations in 2003 in which customers were offered the choice of
fixed, market, and/or hybrid terms.
[521]
Doctors Shapiro and Sarin opine that
Doctor Barbera’s VM results for 2003 are unreasonably high given the
market prices suggested by his own analysis, and they illustrate the point in Table
6.6 as follows:
[522]
Doctors Shapiro and Sarin criticize Doctor Barbera’s
use of the CPM as follows:
Dr. Barbera uses the cost plus method
to analyze CCO’s sales to CEL even though this method is usually applied to
transactions involving the provision of services or the sale of semi-finished
goods. Further, arm’s length uranium transactions are rarely if ever priced on
a cost-plus basis. This is not surprising, as uranium is a commodity. It
follows the Law of One Price. That is, irrespective of the cost of production,
uranium can only be sold at the prevailing market price. If uranium were priced
on a cost-plus basis, uranium that was extracted more efficiently would be sold
at lower prices than uranium that was more expensive to mine, and uranium
sellers with lower costs of goods sold (“COGS”) would have lower revenues than
sellers with higher COGS. This would be contrary to the Law of One Price, and
common sense. There is no reason for uranium to be priced, or for uranium
transactions to be evaluated, on a cost-plus basis. Rather than being a pricing
mechanism, the markup over cost is simply an ex-post calculation that
determines what the miner’s profit margin is.
Further, miners frequently lose money, in
part because they are price takers. Because they are price takers, they cannot
charge on a cost-plus basis. If they could, they would not experience the
volatile returns, and frequent losses, which they do.
[523]
Doctors Shapiro and Sarin criticize Doctor Barbera’s
Tenex analysis for vastly overstating the expected profits from the HEU Feed
Agreement and underestimating the compensation required in order for CEL to
enter into the agreement. They also state that Doctor Barbera’s conclusion
is contrary to the actual behaviour of parties acting at arm’s length and to
contemporaneous statements by Cameco and the business press.
[524]
Doctors Shapiro and Sarin state that
Doctor Barbera does not explain the distinctions among the forecasts he
uses to value the HEU Feed Agreement, does not explain his basis for selecting
among the four forecasts that he identifies, appears to misstate which forecast
he uses in his analysis, and does not examine whether his selected forecast
data are applicable to forecasting an estimated sales price for Tenex source
uranium. Doctors Shapiro and Sarin also state that Doctor Barbera does not
appear to have taken into account the potential implications of the fact that there
was a restricted and an unrestricted market for uranium and that a discount
applied to uranium sold in the unrestricted market.
[525]
Doctors Shapiro and Sarin state that, contrary
to Doctor Barbera’s assumption that CESA adopted the base escalated
pricing option and paid US$29, CESA could not purchase uranium under the HEU
Feed Agreement for US$29. Rather, the formula required payment of the greater
of US$29 and 92% of the then long-term price, which would have yielded a price
higher than US$29. In any event, CESA did not exercise its option to purchase
uranium under the base escalated price option. Accordingly, Doctor Barbera’s
fundamental assumption as to which option would be selected is simply wrong,
rendering his subsequent conclusions moot. In addition, Doctor Barbera
fails to account for the price risk that CESA would have taken on if it had exercised
the option. After analyzing the approach taken by Doctor Barbera, Doctors Shapiro
and Sarin summarize their position on Doctor Barbera’s Tenex analysis as
follows:
Dr. Barbera’s analysis of expected
returns from the Tenex transactions is deeply flawed. Under the Tenex contract,
CEL could maintain option flexibility by purchasing HEU for 92 percent of the
market price or could lock in prices using the BE mechanism. Under the first
alternative it would have reasonably expected gross margins of 8 percent (6
percent after paying CCI its 2 percent fee). Under the second alternative, which
it did not exercise, it would pay more than the $29 assumed by Dr. Barbera,
and, moreover, it would be exposed to price risk. Its risk-adjusted return
would likely have been negative. Under no mechanism could CEL have paid just
$29 and received risk-free returns, as asserted by Dr. Barbera.
Further, Dr. Barbera’s conclusion of
expected gross margins of 35 percent is contradicted by actual behavior (CEL
did not exercise the BE pricing mechanism option) as well as by contemporaneous
statements by the Cameco Group (expected gross margins of 4 to 6 percent) and
of the business press and analysts (which focused on the supply control aspects
of the transaction, rather than any expected direct contract value). Lastly,
Dr. Barbera’s conclusion is completely inconsistent with economic logic.
If the terms of the Tenex transactions were such that CEL were expected to
receive risk-free gross profits of 35 percent (and operating profits of 33
percent), Tenex, negotiating at arm’s length, would not agree to such terms, and
CCO, acting in its interests, would not have sought to partner with unrelated
parties.
[526]
Doctors Shapiro and Sarin opine that, under
Doctor Barbera’s own analysis, the Appellant would not require any consideration
from CESA/CEL with respect to the HEU Fed Agreement:
Dr. Barbera outlines the conditions under
which no compensation would be due to CCO as a result of CEL signing the
agreement with Tenex. He states (paragraph 219)
CCO would agree to enter into an
arrangement with a third party without further consideration or compensation if
the only profits expected from the deal were expected to be equivalent to
routine distribution profits. Such an arrangement would indeed shift routine
profit from CCO to the third party. But the arrangement also shifts the burden
of performing the necessary functions and raising capital from CCO to the third
party. In this case, CCO loses the associated routine distributor profit, but
is also freed of the burden of necessary incremental functional and financial
investment.
As demonstrated above, this is exactly the situation
here. That is, the profits expected from the deal were expected to be
equivalent to routine distribution profits. In fact, they may have been less.
The expected profits from the deal were at most 6 percent, and the “routine”
distribution profits required by CEL were 6 percent as estimated by Dr. Wright,
and would be even higher if one accounted for the additional risk CEL bore as a
result of the unique circumstances of the Tenex transaction. Given these
expectations and risks, CCO would be happy to forego expected profits of, at
most, 6 percent, to free itself “of the burden of necessary incremental
function and financial investment.”
[527]
Doctors Shapiro and Sarin criticize Doctor Barbera’s
analysis of the Urenco agreement on the ground that he makes no effort to
identify who performed the activities that led to the trading profits.
[528]
As noted above, Doctor Barbera wrote two
surrebuttal reports that addressed the rebuttal report of Doctors Shapiro and Sarin. In
the Barbera Surrebuttal of Shapiro/Sarin, Doctor Barbera states that
Doctors Shapiro and Sarin were wrong when they opined that in his VM analysis
Doctor Barbera should have used a higher discount rate for the forecast
revenue stream. He further states:
. . . Fixed price revenues lead to more
certain cash-flow streams only in the case where both the fixed revenues and
the costs are denominated in the same currency. When the fixed price revenue
stream is denominated in US dollars, and the costs associated with that revenue
stream are denominated in Canadian dollars, however, the resulting Canadian
dollar cash-flow stream becomes highly uncertain, thus rendering Shapiro’s /
Sarin’s claim to be untrue. A fixed price US dollar stream does not produce a
relatively certain Canadian dollar profit/cash flow stream for CCO, as Shapiro
/ Sarin assert in their rebuttal. Therefore, my use of the same discount rate
is justified, and my resulting Valuation Analysis adjustment is correct.
[529]
With respect to the discount rates suggested by
Doctors Shapiro and Sarin, Doctor Barbera opines that a rate in
excess of 10% is wildly inappropriate given that in 1997 the Appellant used of
rates of 8.5% or 10% to evaluate the Tenex transaction.
[530]
With respect to his RPM analysis, Doctor Barbera
rejects the assertion that he used incomplete data. Doctor Barbera states:
The authors are correct in that I did not
use in my RPM analysis all of the volumes CEL sold to CCO over the 2003 through
2006 period. The authors also correctly point out that the volumes I excluded
were from UF6 supply contracts (see top of page 10 of Shapiro / Sarin’s
rebuttal report). There is a good reason for this. I clearly state that my RPM
analysis is only evaluating the arm’s-length nature of CCO’s sales of U308 to
CEL. The volume and sales I use in my RPM analysis relate only to CEL’s resales
to CCI of U308 purchased from CCO. These resales equaled 59.6% of CEL’s total
sales to CCI over the 2003 through 2006 period. Since I’m using consistent data
throughout, which comprises over 50% of CEL’s total volumes of sales to CCI, it
is correct to use only CEL’s volumes and resales of U308 acquired from CCO in
my RPM analysis. My RPM analysis, therefore, is wholly reliable as a
result, contrary to the authors’ assertion.
Based on actual CEL to CCI invoice data
provided to me, CEL’s average sales price for non-CCO sourced uranium is lower
than the average CEL sales price for CCO sourced material in 2003, but higher
in 2004, 2005 and 2006. Therefore, the net impact of including the non-CCO
sourced transactions in the RPM analysis would lead to a higher adjustment than
that shown in my expert report: not lower as the authors claim.
[531]
In the Barbera Urenco Surrebuttal, Doctor
Barbera states:
Dr. Horst asserts that any excess profits
should be attributed to CEL’s and CCI’s efforts, given that the prices from the
original agreement had nothing to do with the actual purchases under the
agreement. I disagree with this claim. Any incremental “excess profits” as a
result of the amendments was possible only because CCO’s 1999 negotiation of
the original agreement included a termination clause. Dr. Horst and Shapiro /
Sarin overlook the most important feature of the original 1999 agreement which
allowed CEL to amend or terminate the agreement, solely at CEL’s option, when
the “spot price… remains below a stipulated floor price for six consecutive
months” (Horst, page 30). The amendments and carve-outs that CEL negotiated
were possible only because of CEL’s right to terminate. This right gave CEL the
leverage to renegotiate much improved
pricing terms. Of course, it is possible that neither
CCO nor CEL actually anticipated spot prices to fall below the stipulated floor
price for six consecutive months. Yet, this fact could have no bearing on the
arrangements that CCO would require of a third party distributor in 1999 to
execute the contract.
I view the profit split analysis as a
sensible vehicle for CCO to protect its stockholders. There was nothing wrong (from
an economic perspective) with CCO selecting a third party distributor to
execute the Urenco agreement as long as that distributor earned an arm’s length
profit. The fact that CCO negotiated terms under which CCO (or a third party
distributor) could amend the Urenco agreement to its benefit is just one aspect
of protecting CCO’s stockholders. This term makes sense because it provided CCO
(or a third party distributor) with the flexibility to amend the contract to
make it more likely to generate profits.
Dr. Horst refers to the fact that the market
value of the Urenco agreement “vanished” (Horst, 30) soon after the parties
entered into the agreement because CEL could have exercised its right as buyer
to terminate the agreement but instead ultimately amended it to lower CEL’s
purchase price as market spot prices declined. As previously remarked, the
amendment was possible only because of the right to terminate. A contract
without the termination clause may or may not have been valuable. If not, then
CCO would have seen little if any profit from my analysis. The profit split
model does not require high margins to produce the correct answer. That is, if
system profits (i.e., overall profit derived from the deal) are very low, then
CCO receives very little profit from the profit split along with CEL. When
there are losses, CCO bears the largest burden of those losses.
[532]
With respect to the risks assumed by CESA/CEL,
Doctor Barbera opines:
I do not agree with Shapiro / Sarin, or Dr.
Horst’s conclusions that CEL was required to perform additional activities and
bear more risk beyond that of a normal trader because there was uncertainty in
the available volume CEL could purchase year over year under the Urenco
Agreement. On page 38 of their rebuttal, Shapiro / Sarin even quote the terms
of the Urenco Agreement that in October, Urenco was to provide CEL with a
non-binding notice of the best estimate of the delivery quantity for the
following year, and suggests [sic] that CEL faced all this risk of
supply uncertainty. Importantly, Shapiro / Sarin omitted to mention another
clause in the agreement that a binding notice was to be provided to CEL on or
before January 1 for each year. Shapiro / Sarin’s characterization of the risk
associated with volume uncertainty is inaccurate. As a function of the binding
notice, CEL can manage these risks by scheduling and committing to sales based
on the binding notice amounts. These activities performed by CEL do not appear
to be substantially different than those performed by typical traders.
CCO’s forecasts and the original Urenco
contract terms were such that CCO clearly had expectations that the Urenco
contract, over the full term, could be quite valuable. The potential profit
returns resulting from CCO’s projections were more than sufficient to entice
CCO to assume the associated pricing and market risks; otherwise the contract
would not have been consummated. Given CCO’s expectations, under arm’s-length
conditions CCO would have accepted the original pricing terms and the associated
market risks, and would not have allowed a third-party distributor to earn all
of the non-routine profits that Dr. Horst and Shapiro / Sarin claim were the
result of those risks.
[533] With respect to the assertion that the
CPM is not appropriate in the circumstances, Doctor Barbera states that there
is nothing in the 1995 Guidelines that says the CPM cannot be used for
manufacturers of finished goods and that the 1995 Guidelines note that the CPM
“probably is most useful” when one is evaluating
“long-term buy-and-supply arrangements”, which
perfectly describes the Appellant’s sale of U3O8 to CEL.
[534]
With respect to the assertion that he did not
explain the source of the data used, Doctor Barbera states that he
discussed the sources of the data used in his CPM analysis at paragraphs 165
and 166 of his report and that he did not show invoice-by-invoice data because
the data provided to him did not include that level of detail.
[535]
Doctor Barbera rejects the assertion that
the gross margin he used was above the Cameco Group average of 29.5% and
asserts that in fact the cost-plus mark-up used was 14.9%, which translates into
a gross margin of 13%.
[536]
With respect to the assertion that the results
of the CPM analysis are unreasonable, Doctor Barbera states that Doctors
Shapiro and Sarin omitted in their calculations the uranium sold by the
Appellant to CEL and then loaned by CEL to the Appellant.
(4) Doctor Wright
[537]
In her report,
Doctor Wright states that she was asked by the Department of Justice to
prepare an economic analysis that addresses the transactions between the
Appellant and CESA/CEL and the transactions between CESA/CEL and third parties
(most notably, Tenex and Urenco) and to opine on whether the prices in the
transactions between the Appellant and CEL were arm’s length prices. For both
sets of transactions, Doctor Wright was asked by the Department of Justice
to assume three different factual scenarios:
a. CEL performed
no functions relevant to its purchase and sale of uranium;
b. CEL performed
some functions relevant to its purchase and sale of uranium; and,
c. CEL performed all functions relevant to
its purchase and sale of uranium.
[538]
Doctor Wright provides the following
description of how to obtain a reliable transfer price:
. . . reliable transfer prices depend on much
more than just finding a price for a particular product. The circumstances
surrounding the proposed comparable, including market conditions in which the
transaction takes place, may require an analysis quite different from pricing
products in markets without those circumstances. In other words, the whole
picture must be known and taken into consideration. What may, superficially,
appear to be a reliable comparable transaction may turn out to be completely
unreliable when all aspects of the transaction and its market are known.
[539]
Doctor Wright identifies the following two
steps in a transfer price analysis:
1. Identify the aspects of the industry (or the industry
characteristics) that are relevant to properly determine arm’s length transfer
prices. The important industry characteristics are those that explain prices or
margins and/or fluctuations in prices or margins.
2. Identify the business activities (functions) that each party to the
transaction performs, the risks that are assumed by each party and the assets
(especially intangible assets) that each owns. This allows the analyst to
determine the value added by each legal entity involved in the transaction. The
value added by a party in turn determines that party’s bargaining power (i.e.,
ability to secure profit from the transaction).
[540]
Doctor Wright reviews the transfer pricing
methodologies described in the 1995 Guidelines and then states:
Once intercompany prices are determined, it
is imperative to ask whether the result is reasonable under the circumstances. This
is ordinarily accomplished by evaluating the income statements that result from
application of the recommended pricing (i.e., income statements for the
transaction in question for each related party that participates in the subject
intercompany transaction). The goal is to ensure that the margins shown on
those income statements (for all parties to the transaction) are consistent
with both the industry and functional analyses.
[541]
Doctor Wright describes the functions and
risks of CEL and her mandate as follows:
CEL functioned as a uranium intermediary. It
purchased uranium from CCO, Tenex, Urenco, and other third parties. It sold
uranium to CCO and CCI. The Department of Justice has provided me with a list
of functions that the Cameco Group has advised that CEL performed in 2003
through 2006 (See Appendix 3). As stated, I have been asked to opine on
different scenarios that vary depending on which functions CEL performed. Some
of the scenarios are based on the assumption that CEL did not perform all the functions
in the list. The specific functions relevant to each scenario are further
discussed in the analysis section.
Doctor Wright then performs a transfer
pricing analysis of each scenario, which yields the results stated in the
executive summary of her report.
[542]
With respect to the choice of transfer pricing
methodology for the scenario in which CEL does not perform all of the functions
related to a uranium trading business, Doctor Wright states:
As is the case in all transfer pricing analyses, the
CUP method is the best method if it can be applied. In this case, no comparable
transactions are publicly available to allow application of the method; hence,
it cannot be used to determine an arm’s length return to CEL under this
scenario. Comparable transactions to allow application of the resale price
method do exist, and for this reason, the resale price method is the best
method. The cost plus method is not typically used to compensate traders;
therefore, this method is not used. And, because comparable transactions can be
used to apply the resale price method, I do not consider using TNMM because
public information does not exist to allow me to determine operating margins
for the limited risk portion of a trader’s portfolio.
[543]
With respect to the choice of transfer pricing
methodology for the scenario in which CEL performs all the functions associated
with a uranium trading business, Doctor Wright states:
160. Under this scenario, it is determined
that CEL performed all functions needed to obtain and manage contracts relating
to the purchase and sale of uranium from/to both related and unrelated parties,
including all functions related to the management of the risks associated with
the contracts.
161. This scenario differs from the previous
scenarios because it assumes that CEL independently performed all of the
functions necessary to act as a trader, including negotiating prices with CCO
and CCI, developing and maintain [sic] relationships with third parties,
including Tenex and Urenco, negotiating all prices with these entities, and
maintaining control and management of inventory levels and decision-making
relating to whether or not to enter deals as well as determining what volumes
to purchase and sell. In particular, this scenario assumes that CEL, with little, if any, assistance from either CCO or CCI, controls and manages price risk
through the functions described in Appendix 3. In fact, this scenario
assumes that CEL’s functions exceed those listed in Appendix 3 especially as it
pertains to the Tenex, Urenco, and other third-party contracts. In essence,
this scenario assumes that CEL takes on all the functions and risks of an independent
trading company, and developed and managed all of the agreements it signed.
162. To value this scenario, I use two
separate approaches. The first uses two of the largest uranium traders and the
second uses broader-based trading companies.
. . .
163. Because no contracts between unrelated
parties are available that could be used to apply a transaction-based method, I
use comparable trading companies to benchmark the margins that CEL would have
received had it been operating at arm’s length with its related parties. The
pricing method is the TNMM with gross margin as well as operating margin as the
profit level indicators. The transaction-based method (CUP, resale price, and
cost plus) could not be used because comparable transactions are not publicly
available.
[544]
For the first approach, Doctor Wright
reviews the information that was in the public domain and concludes that one
company, Nufcor, is available for the TNMM analysis.
[545]
For the second approach, Doctor Wright
concludes that the TNMM is the preferred methodology in view of the information
available regarding “comparable Asian trading companies”.
Doctor Wright explains her reasons for this as follows:
Because this analysis relies on comparables
that are companies rather than transactions, the CUP method cannot be used.
Either the resale price method or the TNMM could be selected as the best
method, however, I use TNMM because (a) I use comparable companies (not
comparable transactions) and (b) the use of operating marge [sic] as the
profit level indicator does not require me to address the accounting issues
associated with use of the gross margin, which would be required under a resale
price method. I do not use the cost plus method because traders are typically
not compensated based on a markup on their costs.
[546]
Finally, Doctor Wright performed a “sanity check” in which she compared the operating
margins of CEL with the operating margins of the Cameco Group’s uranium
business computed using data from the Cameco Group Annual Reports. Doctor Wright
reported the results of this analysis in Chart 3:
[547]
Doctor Wright summarizes her conclusions
from her transfer pricing analyses as follows:
The factual scenarios upon which the
valuations are based and the results of my valuations are as follows.
a. For the
situation where CEL performed no functions, no compensation is due if CEL
performs no functions.
b. For the
situation where CEL performed some functions, the compensation due is related
to the nature of the value created. For example,
•
If CEL performs functions unrelated to the
uranium contracts that it owns, but does perform functions that provide a
benefit to the Cameco Group, then CEL should receive compensation equal to a
markup on the total cost of rendering the beneficial services. The operating margin
resulting from the application of the arm’s length markup is between 0.0
percent and 0.1 percent of revenue. In fact, CEL’s operating margins were 10.5
percent in 2003, 32.2 percent in 2005, and 34.9 percent in 2006, which exceed
the arm’s length margins in all three years.
•
If CEL performs functions related to one of [sic]
more of the transaction flows, but the functions performed are limited to
negotiating and signing agreements and are not related to management of the
contracts after signing, then CEL should receive compensation relating to the
investment that it made in connection with the contracts. That compensation is
an operating margin between 1.0 percent and 2.8 percent of revenue. In fact,
CEL’s operating margins exceed the arm’s length margins in all three years.
•
If CEL performs the functions outlined in the
previous bullet and, in addition, performs some, but not all, of the functions
needed to manage its uranium purchase and sale agreements, then its
compensation should be similar to that of a limited-risk trader and its gross
margin should be 6.0 percent of revenue, which converts to an operating margin
of between 5.4 percent and 5.5 percent of revenue depending on the year in
question. In fact, CEL’s operating margins exceed the arm’s length margins in
all three years.
c. For the
situation where CEL performed all functions relevant to its purchase and sale
of uranium, its gross margin should be consistent with the benchmark rate of
6.2 percent in 2003, 25 percent in 2005, and 15.8 percent in 2006. This
converts to operating margins consistent with 5.7 percent for 2003, 24.4
percent for 2005, and 15.3 percent for 2006. These margins are higher than the
Asian company margins, therefore I do not use the results of the Asian
comparables analysis in these conclusions. In fact, CEL’s operating margins
were 10.5 percent in 2003, 32.2 percent in 2005, and 34.9 percent in 2006. CEL’s
operating margins exceeded the arm’s length benchmark in 2003, 2005 and 2006.
[548]
Doctors Shapiro and Sarin wrote a rebuttal
report in response to Doctor Wright’s report. Doctor
Wright did not write a surrebuttal report.
[549]
Doctors Shapiro and Sarin summarize their
criticisms of the Wright Report as follows:
Dr. Wright estimates a benchmark rate of
compensation for CEL under different assumptions regarding CEL’s functions and
risks. She concludes that CEL’s reported operating margins exceed the arm’s
length benchmarks for all three years for all scenarios.
Much of Dr. Wright’s report is not relevant
to the assessment of pricing between CEL and CCO because it is based on assumed
scenarios that are not similar to the facts. In her first four scenarios, Dr.
Wright assumes CEL bore no risk or, at most, acted as a limited-risk trader.
Dr. Wright makes no attempt to independently reach these conclusions regarding
CEL’s functions and risks. She does not conduct a functional analysis of CEL
and instead simply presents analysis under function and risk assumptions that
are incorrect. As we show in our affirmative report, CEL did not simply broker
transactions between other parties, but took significant price risk. Its
returns were very sensitive to changes in the market price of uranium, and it
could have suffered losses if the market price had declined.
The only scenario analyzed by Dr. Wright
that is of relevance to the matter at hand is her fifth, in which she assumes
CEL took on all of the functions and risks of an independent trading company.
Dr. Wright’s findings with respect to this scenario are flawed. As we
demonstrate below, Dr. Wright does not adequately explain her selection of the
transfer pricing method she applies to analyze this scenario. Moreover, her
computation of CEL’s arm’s length return through the large-uranium-trader
analysis contains several errors, including failing to identify a set of
comparable companies, using incorrect data for the one potential comparable
identified, failing to account for the effect of related-party transactions on
the results of the identified comparable company’s returns, and failing to
account for significant differences in the risks borne by CEL and the
identified comparable company.
Dr. Wright also analyzes the full-risk
scenario using a broader trading company approach, but this method suffers from
significant flaws and cannot be used to meaningfully assess CEL’s returns. It
uses data from conglomerates engaged in a wide variety of intertwined
businesses. The data used in the broader-trading-company analysis are not
specific to trading activities, but are from segments that engage in many non-comparable
activities, including mining, manufacturing, and energy production. The
analysis does not account for these non-comparable activities, and the data it
relies on are not reflective of returns for the activities performed or risks
borne by CEL.
[550]
With respect to Doctor Wright’s rejection
of the CUP method, Doctors Shapiro and Sarin state that Doctor Wright does not
explain why the transactions involving the same or similar services would have
to be from public sources when some of the contracts used for her RPM analysis
were not publicly available, nor does Doctor Wright explain why none of
the Cameco Group’s contracts with third parties were comparable for the
purposes of a CUP analysis. Doctors Shapiro and Sarin opine that there is no
requirement that the comparable transactions be publicly available.
[551]
Doctors Shapiro and Sarin reiterate their
position that CEL bore significant price risk and opine that in light of this
risk Doctor Wright’s no function and some functions scenarios are
irrelevant. With respect to Doctor Wright’s all functions scenario,
Doctors Shapiro and Sarin state that Doctor Wright “mischaracterizes CEL’s functions and risks and chooses wholly
non-comparable companies in trying to assess CEL’s arm’s length returns”.
[552]
With respect to the first of the two approaches
to the all functions scenario, Doctors Shapiro and Sarin opine that no
meaningful conclusions can be drawn from a TNMM analysis that uses a sample of
one company (Nufcor) and that:
. . . Comparing the returns of two uranium
traders says nothing about whether one of them was purchasing uranium at arm’s
length prices. Companies in the same industry would not be expected to have the
same returns due to the myriad factors that determine returns and that differ
from one company to another.
[553]
Doctors Shapiro and Sarin also state that
Doctor Wright misinterpreted Nufcor’s results for 2006, failed to account
for the fact that in 2005 and 2006 Nufcor sold the majority of its uranium to
related parties, and also failed to account for the possibility that CEL and
Nufcor were exposed to different levels of risk.
[554]
Doctors Shapiro and Sarin state that Nufcor’s
2006 financial statements include a charge for future losses on forward
contracts. This charge related to anticipated losses by Nufcor in future years.
If the charge is excluded, Nufcor’s gross margin for 2006 is 32.5% compared to
35.3% for CEL.
[555]
Doctors Shapiro and Sarin opine that Nufcor’s
related-party transactions make Nufcor unsuitable as a benchmark company.
[556]
With respect to the comparison of CEL to a
broader range of trading companies, Doctors Shapiro and Sarin identify three
concerns:
There are several significant problems with
Dr. Wright’s analysis. First, she does not explain how or why she selected
these six companies for inclusion in her broad trading company sample. Second,
it is not clear that these companies were comparable to CEL in terms of
functions performed or risks borne. Lastly, the companies were engaged in so
many non-comparable activities that their returns are not useful in assessing
trading returns.
[557]
Doctors Shapiro and Sarin then provide a more
detailed review of these issues and conclude:
It is not clear why Dr. Wright includes
these companies given these differences. They are not comparable to CEL in
terms of functions performed or risks borne, and their returns tell us nothing
about whether CEL’s returns were arm’s length.
. . .
Dr. Wright does not appear to have tried to
isolate these companies’ trading returns from their profits and losses from
these significant other activities. Given their extensive transactions with
entities in which they held interests or with which they participated in other
ventures, obtaining financial data for their arm’s length trading transactions
may well have been impossible. This explains why Dr. Wright excluded these
companies from her initial sample of trading companies. These companies should
not have been included in a sample of general trading companies because they
are too dissimilar from [sic] CEL in terms of functions performed and
risks borne, and because their financial data, even their segmented financial
data, are largely related to non-trading activities and/or transactions with
parties with which it has other relationships.
[558]
While agreeing, that the principal benefit of
the HEU Feed Agreement was control of the uranium supply, Doctors Shapiro and
Sarin disagree with Doctor Wright’s analysis of that agreement on the
basis that CEL took on the price risk and other risks associated with owning
the agreement. The uranium supplied under the agreement was not inexpensive and
CEL bore the risk of “1) being compelled to exercise
options under sub-optimal conditions so as to keep the deal alive, 2) being
required to buy uranium at above-market prices (after the options were
converted to purchase obligations), and 3) counter-party risk (i.e., Tenex may
not have honored the deal).” Doctors
Shapiro and Sarin opine that it is the bearing of the price risk that entitles CEL
to the returns from the HEU Feed Agreement:
Dr. Wright is correct that as contract
owner, CEL is entitled to income attributable to owning the contracts. As
owner, CEL was bearing the price risk associated with the contracts. If market
prices fell such that money would be lost by purchasing uranium at
pre-determined prices that were now above market, CEL would bear those losses.
And if market prices rose such that money would be made by buying uranium at
pre-determined prices that were now below market, CEL would enjoy those
profits.
Doctor Wright acknowledges that CEL was
owner of these contracts, but then awards it only risk-free returns. Dr. Wright
seems to misunderstand what ownership entails. Specifically, she distorts the
meaning of ownership by taking away the most important element of ownership of
an asset – namely, receiving the gains and losses associated with that asset.
Doctor Wright’s confusion seems to stem
from failing to account for the fact that risk is borne by the contract owner,
not the party providing contract administration, forecasting, and other
services. CCO performed certain administrative functions for CEL. For example,
it kept financial records about uranium transactions, issued uranium market forecasts
(which, as we demonstrate in our affirmative report, were no more accurate than
commercially available analyses), and prepared payrolls, and is entitled to
arm’s length returns for performing these functions.
However, these functions are unrelated to
the prices at which CEL bought or sold uranium ore and do not affect which
party realizes the gains or losses associated with these prices. Administering
the contracts did not entail bearing the risk associated with the contracts. To
repeat an analogy from our affirmative report, an investor may employ a wealth
manager to provide services related to his or her investment portfolio. The
wealth manager may monitor the risk of the investment portfolio, administer the
portfolio, keep records associated with the portfolio, broker the transactions,
and provide the investor with market research including buy and sell
recommendations. However, it is the owner of the investments (the investor) who
bears the risk associated with the portfolio. If the portfolio shrinks by 50
percent, the investor suffers the loss and, at most, the wealth manager sees a
cut in his or her fee revenue. Correspondingly, if the portfolio doubles, the
investor enjoys the gain.
Similarly, even though CCO provided services
related to CEL’s contracts, CEL, as owner, bore the risks associated with those
contracts and is entitled to the returns for bearing those risks.
[559]
Doctors Shapiro and Sarin disagree with
Doctor Wright’s assertion that at arm’s length a company would not agree
to take on manageable risks that it does not control. In this regard, Doctors
Shapiro and Sarin point to the routine transfer of manageable risks demonstrated
by the use of forward contracts, options, swaps and other derivatives.
(5) Carol Hansell
[560]
Ms. Hansell begins her report by stating
that she has conducted a benchmarking study of comparator organizations (the “Benchmarking Study”) and
a review of publications by the Government of Canada, academics and other
commentators (the “Literature Review”). She follows this with a statement of the assumed facts on which her
opinions are based.
[561]
Ms. Hansell then offers the following
opinions regarding MNEs:
[1.] MNEs carry on business in more than one country. The parent
company typically has subsidiaries formed in foreign jurisdictions (i.e.
countries other than the country in which the parent company was formed or has
its head office). 85% of the comparators in the Benchmarking Study disclosed
that they had foreign subsidiaries in 2006, as did Cameco.
[2.] The decision to carry on aspects of a business through a
subsidiary (whether domestic or foreign) as well as the jurisdiction of
incorporation of the subsidiary can be driven by a variety of considerations,
including tax, accounting, legal, regulatory, liability and compensation as
well as proximity to customers, suppliers, financial markets and the necessary
work force.
[3.] It is not unusual for a parent to incorporate subsidiaries
in [favourable tax jurisdictions] where that choice is available.
[4.] The fact that CEL’s business was confined to one stage in
the process that ultimately culminated in the sale of uranium to a customer is
consistent with the commercial integration referred to [by the Organisation for
Economic Co-operation and Development and Export Development Canada (“EDC”)].
[5.] It is common in an MNE for administrative functions to be
centralized and shared across the enterprise.
[6.] It is common for entities in an MNE to document the basis on
which they share services.
[7.] It is common for entities within an MNE to provide financing
for other members of the MNE or for one to guarantee the obligations of
another.
[8.] The fact that Cameco Ireland made certain financial
arrangements available to [CESA] and CEL, including by way of a revolving
credit facility, and that Cameco provided guarantees for its subsidiaries’
obligations (including the obligations of [CESA] and CEL to suppliers) is
consistent with the financial interdependence across an MNE reflected in the
Benchmarking Study.
[9.] The composition of the board of directors and management
team of a subsidiary can be driven by a number of factors, including local
requirements, the significance of where the directing mind of the organization
is located, and the availability of management and oversight functions in other
parts of the global family. It is common for boards of directors of
subsidiaries to include individuals who have been board members or members of
management in other parts of the MNE. Those individuals are conversant with the
business, values and culture of the organization and have the confidence of
other decision makers across the MNE.
[10.] There are not always clear lines of responsibility between a
board of directors and the CEO. In the absence of detailed mandates and
position descriptions, it is generally accepted that the CEO operates the
business in the ordinary course and the board oversees the CEO’s discharge of
his responsibilities. In addition, the board takes any other action that is
required of it by law, such as the approval of the financial statements.
[11.] It is not unusual to appoint an individual as an officer of a
corporation for the purposes of facilitating the execution of documents.
[12.] It is not unusual for a board of directors that was aware of
an agreement that the corporation was planning to sign, to ratify the execution
and delivery of that agreement, after the date of execution.
[13.] The integration and interdependence of entities within a MNE
is reflected in both financial reporting and disclosure requirements under
Canadian securities laws.
[14.] A parent company and its subsidiaries are viewed as a single
economic entity for financial reporting purposes. A parent company is required
to issue consolidated financial statements, combining its own financial
statements and the financial statements of its subsidiaries. The parent
exercises its control and influence over the subsidiary in order to be
confident about the quality of financial information presented in the
consolidated financial statements.
[15.] A parent company elects the subsidiary’s board of directors.
The board of directors (and the management team) then manage the business.
While this is the legal structure, commercial integration across the MNE . . . and
the accountability of the parent company to investors and regulators
. . . requires cooperation and coordination across the entities
forming the MNE. This cooperation and coordination is not inconsistent with the
legal structure.
[16.] A commercially normal relationship between a parent
corporation and a subsidiary corporation within a large, complex MNE during the
Relevant Period would have involved common goals, coordinated efforts,
commercial interdependence and governance integration.
[562]
Ms. Hansell concludes as follows:
The Assumed Facts discussed in Part II of
this report, above, and the information contained in the documents set out in
Schedule A, were consistent with a commercially normal relationship between a
parent corporation and a subsidiary corporation in a large, complex MNE during
the Relevant Period. On this basis, it is my view that the relationship between
Cameco and CEL would be considered commercially normal.
(6) Thomas Hayslett
[563]
Mr. Hayslett’s expert report addresses two
questions regarding the BPCs:
1)
Are the types of commercial terms in the
contracts similar to the types of terms that would normally be present in
uranium sales contracts concluded by industry participants?
2)
With respect to the specific values for the commercial
terms in the contracts, are such values generally consistent with the range of
values seen in uranium sales contracts offered and/or concluded by industry
participants around the time the nine contracts were concluded?
[564]
Mr. Hayslett first provides an overview of
the nuclear fuel cycle and uranium contracting. Mr. Hayslett identifies
the following terms as typically being included in contracts for the purchase
and sale of U3O8 or UF6:
•
Contract term
•
Quantity flexibility
•
Delivery schedule, notices, flexibility
•
Delivery location(s), method
•
Material origin
•
Material specifications
•
Pricing
•
Payment terms
[565]
Mr. Hayslett goes on to state:
The specific manner in which these items are
addressed in any single contract will be determined based on the objectives
(e.g., long term vs. short term commitment, large vs. small quantity
commitment, predictable pricing vs. market exposure) and agreements of the
contracting parties. Utility buyers have consistently indicated that in
evaluating offers price and reliability of supply are the two dominant factors.
While other terms, such as quantity flexibility and delivery notice
requirements, may have value, they are typically viewed as “tie-breakers”
between offers that are considered essentially equivalent as to supply
reliability and price.
[566]
Mr. Hayslett then reviews the terms in each
of the BPCs in detail and concludes as follows:
Based upon the review which I have conducted
of the nine contracts I would conclude that the contracts contain commercial
terms similar to the types of terms that would normally be present in uranium
sales contracts concluded by industry participants. While in some instances the
specific value or treatment of a commercial term might seem to be more
favorable to one party than the predominant treatment at that time, in my
opinion they are generally consistent with the range of values commercially
attainable during the time period late 1999 through early 2001.
[567]
With respect to specific contract terms,
Mr. Hayslett opines that the contract durations were within the range of
durations of long-term contracts identified by Ux for the years 1999 to 2001, that
it is not unusual for sellers to offer a right to extend a contract duration or
for a buyer to negotiate such a right, that the annual quantities in all but
two of the BPCs were larger than the amounts most utilities would contract for
under a single contract, that the flex ranges were generally consistent with
the ranges in the market at the time the BPCs were executed, that the notice
requirements are “fairly common”, that the
delivery flexibility provided is not typical but rather is more favourable to
the buyer than was typical at the time the BPCs were executed, that the
delivery terms, the material origin terms and the material specifications terms
are consistent with general industry practice, that the pricing terms are
consistent with industry practice and that the payment terms are typical of
such terms circa 1999 to 2001.
(7) Doctor Chambers
[568]
Doctor Chambers’ expert report addressed the creditworthiness of CEL from 2002 through 2006. He
concluded that in 2002, on a stand-alone basis, CEL would most likely have had
a credit rating of BB+ or BB on the Standard & Poor’s (“S&P”) scale, or a similar Ba1 or Ba2 rating on the
Moody’s scale. As a result of profits and the resulting repayment of debt,
these ratings would likely have improved to investment grade ratings by 2004.
[569]
Doctor Chambers opined that CEL, as a core
subsidiary of the Appellant, could have expected to see its credit rating
raised either to match the Appellant’s credit rating or to one level below the
Appellant’s credit rating. In 2002, the Appellant’s publicly available credit
rating was A- on the S&P rating scale and A3 on the Moody’s rating scale.
In 2003, the Appellant’s S&P and Moody’s credit ratings were reduced one
level to BBB+ and Baa1 respectively, and remained at that level through 2006.
[570]
Doctor Chambers opined that if in 2002
CEL’s “raised” credit rating was one level below
that of the Appellant, it is very likely it would have been equal to the
Appellant’s credit rating by 2004.
F. Position of the Appellant
[571]
The Appellant submits that the Reassessments have
no basis in fact or in law. With respect to the three alternative assessing
positions adopted by the Minister in these appeals, the Appellant submits as
follows.
(1) Sham
[572]
The reorganization that took place in 1999 and
the uranium purchase and sale contracts to which CEL was a party are what they
appear on their face to be. There is no deception and no sham. CEL’s trading
profits did not result from any functions performed by the Appellant but from
CEL’s bona fide trading activity pursuant to which it entered into legally
effective and commercially normal contracts to purchase uranium from the
Appellant and third parties and to resell that uranium at market prices.
(2) Transfer Pricing
[573]
The Appellant submits that the Court should
respect the clearly stated limitations in the statutory language and should
reject any interpretation of subsection 247(2) that fails to respect the need
for certainty, predictability, and fairness. The Appellant submits that the
Minister is applying subsection 247(2) in an unprincipled and arbitrary manner
and in so doing is taxing the Appellant on the basis of an artificial reconstruction
of its corporate structure and its transactions that is not justified on the
facts. Moreover, subsection 247(2) is being applied to arm’s length
transactions and to transactions to which no Canadian taxpayer is a party.
Finally, subsection 247(2) is being applied in a manner that is at odds with
the regime in the ITA applicable to foreign affiliates.
[574]
The transfer pricing recharacterization rule in
paragraphs 247(2)(b) and (d) (the “TPRR”) does
not apply to the transactions in issue in these appeals. The TPRR is intended
to be applied sparingly and only in those exceptional circumstances where the
transactions in issue are commercially irrational and cannot be priced under
the arm’s length principle. CEL’s profits are the result of commercially normal
transactions for the purchase and sale of a commodity that can be priced by
reference to market analogs. As a result, the exceptional circumstances
contemplated by the TPRR are absent and the TPRR does not apply. Moreover,
there is nothing in the text, context or purpose of the TPRR that permits the
corporate structure of the Cameco Group to be ignored, or that moves all of the
profits of CEL to the Appellant.
[575]
The Minister made no effort to determine the
arm’s length terms and conditions of the intercompany contracts in issue, or to
avoid applying the TPRR to arm’s length transactions that are plainly beyond
its reach. The transfer pricing adjustments included in the schedules to the
Minister’s Replies (the “Schedules”) are not
supported by the evidence of the Respondent’s expert witnesses. The evidence
presented by the Appellant demonstrates that the terms and conditions of all of
the intercompany agreements in issue satisfy the arm’s length principle,
subject to minor adjustments. Consequently, there is no basis in fact or in law
for making any further transfer pricing adjustments.
(3) Resource
Allowance
[576]
The Appellant submits that the losses incurred
by the Appellant on the sale of uranium purchased from CESA/CEL are properly
excluded from the computation of resource profit and requests that $98,012,595
be added back to the Appellant’s resource profit for 2005 and that $183,935,259
be added back to the Appellant’s resource profit for 2006. By way of clarification
in this regard, it should be mentioned that the Appellant is claiming the
lesser of the amount the Minister deducted in computing the Appellant’s
resource profits for the year and the amount of the Appellant’s loss for the
year from the sale of purchased uranium. For 2005, the former is the lesser amount
and for 2006 the latter is the lesser amount.
G. Position of the Respondent
[577]
The Respondent submits that when an MNE decides
to set up a business abroad, it must respect two fundamental principles. First,
the business activity must, in fact, be transferred. It is not enough to simply
put all the contracts into the name of the foreign subsidiary and claim that
the business is now that of the foreign subsidiary. The significant functions
and activities relating to that business must also be transferred and performed
by the foreign subsidiary-paper signing is not sufficient. Second, any transfer
of goods and services to the foreign subsidiary must be done on an arm’s length
basis. The Respondent submits that the Appellant failed to respect both of
these principles.
[578]
The Respondent submits that the transactions
undertaken by CESA/CEL were a sham. For the doctrine of sham to apply to a
transaction, it is sufficient that the parties to the transaction present that
transaction in a manner that is different from what they know it to be. The
Appellant presented the transactions involving CESA/CEL in such a fashion.
Following the reorganization in 1999, all of the important functions and all of
the strategic decisions for the uranium-trading business continued to be performed
and made by the Appellant in Saskatoon. Although on paper the uranium-trading
business was transferred to CESA/CEL, CESA/CEL did little more than rubberstamp
the paperwork. The Appellant created an illusion that its uranium-trading
activities were moved to Switzerland when in reality the Appellant continued to
control and carry on the uranium-trading business regardless of the corporate
reorganization or of who held title to the uranium. Instead of engaging in any
uranium-trading business, CESA/CEL’s only employee was preoccupied with
ensuring the illusion was sufficiently documented to deceive the CRA.
[579]
The Respondent submits that the TPRR permits the
Minister to make adjustments based on the existence of a transaction that
differs from the taxpayer’s actual transaction. The Respondent submits that a
textual, contextual and purposive interpretation of the relevant provisions
supports this application of the TPRR to transactions such as the Appellant’s
that are not commercially rational. The TPRR permits the Minister to base the assessment
of the Appellant’s tax on what would have been commercially rational
transactions.
[580]
The Respondent submits that, if the TPRR does
not apply, the transfer pricing adjustments in the Schedules should be applied.
An arm’s length party would not agree to terms or conditions that would result
in any amounts being allocated to CEL.
[581]
The Respondent submits that the losses incurred
by the Appellant on the sale of uranium purchased from CESA/CEL must be
deducted in computing resource profits under paragraph 1204(1.1)(a) of the Income
Tax Regulations (the “ITR”) and that the
exclusion in subparagraph 1204(1.1)(a)(v) does not apply to these losses.
Analysis
A. Is there a Sham?
[582]
The origin of the modern concept of sham can be
traced to the decision in Snook v. London & West
Riding Investments, Ltd., [1967] 1 All E.R. 518 (“Snook”),
in which Diplock L.J. states:
As regards the contention of the plaintiff
that the transactions between himself, Auto-Finance, Ltd. and the defendants
were a “sham”, it is, I think, necessary to consider what, if any, legal
concept is involved in the use of this popular and pejorative word. I apprehend
that, if it has any meaning in law, it means acts done or documents executed
by the parties to the “sham” which are intended by them to give to third
parties or to the court the appearance of creating between the parties legal
rights and obligations different from the actual legal rights and obligations
(if any) which the parties intend to create. One thing I think, however, is
clear in legal principle, morality and the authorities . . . that for acts or
documents to be a “sham”, with whatever legal consequences follow from this, all
the parties thereto must have a common intention that the acts or documents
are not to create the legal rights and obligations which they give the
appearance of creating. No unexpressed intentions of a “shammer” affect the
rights of a party whom he deceived. . . .
[Emphasis added.]
[583]
The Supreme Court of Canada adopted this
description of sham in M.N.R. v. Cameron, [1974] S.C.R. 1062 at page
1068 (“Cameron”). Ten years later, in Stubart
Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536 (“Stubart”), Estey J. stated:
. . . A sham transaction: This expression
comes to us from decisions in the United Kingdom, and it has been generally
taken to mean (but not without ambiguity) a transaction conducted with an
element of deceit so as to create an illusion calculated to lead the tax
collector away from the taxpayer or the true nature of the transaction; or,
simple deception whereby the taxpayer creates a facade of reality quite
different from the disguised reality. . . .
[Emphasis added.]
[584]
In concurring reasons, Wilson J. states:
As I understand it, a sham transaction as
applied in Canadian tax cases is one that does not have the legal
consequences that it purports on its face to have. . . .
[Emphasis added.]
[585]
In Continental Bank Leasing Corp. v. Canada,
[1998] 2 S.C.R. 298 (“Continental Bank”),
the Supreme Court of Canada interpreted Estey J.’s comments in Stubart
to mean that the “sham doctrine will not be applied
unless there is an element of deceit in the way a transaction was either constructed
or conducted.”
[586]
The Court in Continental Bank held that
the determination of whether a sham exists precedes and is distinct from the
correct legal characterization of a transaction. If the transaction is a sham,
the true nature of the transaction must be determined from extrinsic evidence
(i.e., evidence other than the document(s) papering the transaction). If the
transaction is not a sham, the correct legal characterization of the
transaction can be determined with reference to the document(s) papering the
transaction.
[587]
Canada is not the only commonwealth jurisdiction
in which the highest court has adopted the concept of sham described in Snook.
In Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue,
[2008] NZSC 115, the New Zealand Supreme Court cites Snook and two New
Zealand Court of Appeal cases
and then provides the following description of a sham:
. . . In essence, a sham is a pretence. It
is possible to derive the following propositions from the leading authorities. A
document will be a sham when it does not evidence the true common intention of
the parties. They either intend to create different rights and obligations
from those evidenced by the document or they do not intend to create any rights
or obligations, whether of the kind evidenced by the document or at all. A
document which originally records the true common intention of the parties may
become a sham if the parties later agree to change their arrangement but leave
the original document standing and continue to represent it as an accurate
reflection of their arrangement. A sham in the taxation context is designed
to lead the taxation authorities to view the documentation as representing what
the parties have agreed when it does not record their true agreement. The
purpose is to obtain a more favourable taxation outcome than that which would
have eventuated if documents reflecting the true nature of the parties’
transaction had been submitted to the Revenue authorities.
It is important to keep firmly in mind the
difference between sham and avoidance. A sham exists when documents do not
reflect the true nature of what the parties have agreed. Avoidance occurs,
even though the documents may accurately reflect the transaction which the
parties intend to implement, when, for reasons to be discussed more fully
below, the arrangement entered into gives a tax advantage which Parliament
regards as unacceptable.
[Emphasis added.]
[588]
In Faraggi v. The Queen, 2007 TCC 286 (“Faraggi”), the Tax Court judge stated:
For a sham to exist, the taxpayers must have
acted in such a way as to deceive the tax authority as to their real legal
relationships. The taxpayer creates an appearance that does not conform to
the reality of the situation.
[Emphasis added.]
[589]
On appeal to the Federal Court of Appeal, Noлl
J.A. (as he then was) stated:
The concepts of “sham” and “abuse” are not
the same. I do not believe that the few words of Iacobucci J. in Antosko,
supra, cited by the TCC judge (Reasons, para. 87, note 34), were
intended to alter this view. Nowhere in the extensive case law dealing with the
concept of “sham” is it suggested that “sham” and “abuse” are analogous.
Iacobucci J.’s brief comment, which was part of a discussion on the principles
of statutory interpretation, cannot be read as bringing about such a radical
change.
Subject to the invocation of the GAAR in a
particular case, taxpayers are entitled to arrange their affairs in such a way
as to minimize their tax burden, even if in doing so, they resort to elaborate
plans that give rise to results which Parliament did not anticipate. . . .
However, courts have always felt authorized
to intervene when confronted with what can properly be labelled as a sham. The
classic definition of “sham” is that formulated by Lord Diplock in Snook,
supra, and reiterated by the Supreme Court on a number of occasions
since. In Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536,
Estey J. said the following (page 545):
. . . This expression comes to us
from decisions in the United Kingdom, and it has been generally taken to mean
(but not without ambiguity) a transaction conducted with an element of deceit
so as to create an illusion calculated to lead the tax collector away from the
taxpayer or the true nature of the transaction; or, simple deception whereby
the taxpayer creates a facade of reality quite different from the disguised
reality.
This passage is also quoted with approval in
Continental Bank Leasing Corp. v. Canada, [1998] 2 S.C.R. 298, at
paragraph 20.
In Cameron, supra, the Supreme
Court adopted the following passage from Snook, supra, to define
“sham” in Canadian law (page 1068):
. . . [I]t means acts done or
documents executed by the parties to the “sham” which are intended by them to
give to third parties or to the court the appearance of creating between the
parties legal rights and obligations different from the actual legal rights and
obligations (if any) which the parties intend to create.
The same excerpt was quoted by Estey J.
in Stubart, supra, at page 572.
It follows from the above definitions
that the existence of a sham under Canadian law requires an element of deceit
which generally manifests itself by a misrepresentation by the parties of the
actual transaction taking place between them. When confronted
with this situation, courts will consider the real transaction and disregard
the one that was represented as being the real one.
[Emphasis added.]
[590]
In Antle v. The Queen, 2010 FCA 280 (“Antle”), Noлl J.A. (as he then was) again
reviewed the concept of sham, this time in the context of a trust deed that on
its face gave discretion to the trustee. After reviewing the findings of fact
of the trial judge, Noлl J.A. states:
The Tax Court judge found as a fact that
both the appellant and the trustee knew with absolute certainty that the
latter had no discretion or control over the shares. Yet both signed a document
saying the opposite. The Tax Court judge nevertheless held that they did not
have the requisite intention to deceive.
In so holding, the Tax Court judge
misconstrued the notion of intentional deception in the context of a sham. The
required intent or state of mind is not equivalent to mens rea and need
not go so far as to give rise to what is known at common law as the tort of
deceit (compare MacKinnon v. Regent Trust Company
Limited, (2005), J.L. Rev. 198 (CA) at para. 20). It suffices that
parties to a transaction present it as being different from what they know it
to be. That is precisely what the Tax Court judge found.
When regard is had to the reasons as a
whole, it is apparent that the only reason why the Tax Court judge reached the
conclusion that he did is his finding that the appellant and the trustee-as
well as all participants in the plan-could say “with some legitimacy” that they
believed that the trustee had discretion over the shares (Reasons, para. 71).
While the claim to “some legitimacy” may show that there was no criminal intent
to deceive (as would be required in a prosecution pursuant to subsection 239(1)
of the Act) and perhaps no tortious deceit, it does not detract from the Tax
Court judge’s finding that both the appellant and
the trustee gave a false impression of the
rights and obligations created between them. Nothing more was
required in order to hold that the Trust was a sham.
I respectfully conclude that the Tax Court
judge was bound to hold that the Trust was a sham based on the findings that he
made.
[Emphasis added.]
[591]
Noлl J.A.’s finding of sham in Antle
turns on the finding of fact by the trial judge that the parties “knew with absolute certainty that the trustee would not say
no” and that “both the appellant and the trustee
gave a false impression of the rights and obligations created between them”.
Absolute certainty that the trustee would act in a certain fashion was
inconsistent with the representation in the trust deed that the trustee had discretion
to act as he saw fit. This inconsistency led inexorably to the conclusion that
the settlor and the trustee did not intend the trustee to have any discretion
but nevertheless entered into a trust deed that stated that the trustee did
have discretion. As the trial judge found, “both the
appellant and the trustee gave a false impression of the rights and obligations
created between them”. The factual misrepresentation of the actual legal
rights constituted the sham.
[592]
It can be seen from the foregoing authorities
that a transaction is a sham when the parties to the transaction present the
legal rights and obligations of the parties to the transaction in a manner that
does not reflect the legal rights and obligations, if any, that the parties
intend to create. To be a sham, the factual presentation of the legal rights
and obligations of the parties to the sham must be different from what the
parties know those legal rights and obligations, if any, to be. The deceit is
the factual representation of the existence of legal rights when the parties
know those legal rights either do not exist or are different from the
representation thereof.
[593]
In Antle, Noлl J.A. distinguishes
the level of deceit required for a sham from the level of deceit required for
the “tort
of deceit” (or “tort of civil fraud”, as it is also known). Four years
after Antle, the Supreme Court of Canada held in Bruno Appliance and
Furniture, Inc. v. Hryniak, 2014 SCC 8 that the tort of civil fraud has
four elements that must be satisfied:
From this jurisprudential history, I
summarize the following four elements of the tort of civil fraud: (1) a false
representation made by the defendant; (2) some level of knowledge of the
falsehood of the representation on the part of the defendant (whether through
knowledge or recklessness); (3) the false representation caused the plaintiff
to act; and (4) the plaintiff’s actions resulted in a loss.[753]
[594]
The first element of civil fraud is
indistinguishable from the requirement under the doctrine of sham that the
parties to a transaction factually misrepresent the legal rights and
obligations, if any, created by the parties. The second element of civil fraud
arguably establishes a lower bar than the doctrine of sham in that the mental
element in civil fraud requires only some level of knowledge of the falsehood
of the representation whether through knowledge or recklessness. The reference
to recklessness implies that the parties need only be subjectively aware of the
possibility that there is a false representation but proceed in any event.
[595]
The third and fourth elements of civil fraud are
not elements of the doctrine of sham.
[596]
The relevant standard of proof in both sham and
civil fraud cases is the civil standard of proof.
[597]
Since Antle was decided four years before
Bruno Appliance, I do not read Justice Noël’s comments regarding
tortious deceit as suggesting that the mental element for sham is lower than
the mental element for civil fraud described in Bruno Appliance. Justice
Noël explicitly states that the mental element for a finding of sham requires
that the parties know that their factual presentation is
false. Accordingly, for a transaction to be a sham, the facts (assumed or
proven) must establish that the parties to the transaction presented their
legal rights and obligations differently from what they know those legal
rights, if any, to be.
[598]
As observed in Continental Bank, the
factual presentation of the legal rights and obligations of parties to a
transaction is not the same as the legal characterization of that transaction. Consequently,
a sham does not exist if the parties present the legal rights and obligations
to the outside world in a factually accurate manner (i.e., in a manner that
reflects the true intentions of the parties) but identify the legal character of
the transaction incorrectly. For example, calling a contract a lease when its
actual legal effect is a sale is not evidence of a sham provided the terms and
conditions of the contract accurately reflect the legal rights and obligations
intended by the parties.
[599]
Finally, in considering whether a transaction is
a sham, it is helpful to keep in mind the comments of the Supreme Court of
Canada in Neuman v. M.N.R., [1998] 1 S.C.R. 770 (“Neuman”):
Finally, the
requirement of a legitimate contribution is in some ways an attempt to invite a
review of the transactions in issue in accordance with the doctrines of sham or
artificiality. Implicit in the distinction between non-arm’s length and arm’s
length transactions is the assumption that non-arm’s length transactions lend
themselves to the creation of corporate structures which exist for the sole
purpose of avoiding tax and therefore should be caught by s. 56(2). However, as
mentioned above, taxpayers are entitled to arrange their affairs for the sole
purpose of achieving a favourable position regarding taxation and no
distinction is to be made in the application of this principle between arm’s
length and non-arm’s length transactions (see Stubart, supra).
The ITA has many specific anti-avoidance provisions and rules governing
the treatment of non-arm’s length transactions. We should not be quick to
embellish the provision at issue here when it is open for the legislator to be
precise and specific with respect to any mischief to be avoided.
[600]
The Appellant submits that the burden of proof
is on the Minister to prove that the contracts to which CESA/CEL was a party
are false documents that conceal legal rights and relationships. In my view,
the burden of proof where the Minister alleges sham in support of an assessment
of tax is no different than in any other tax case. The Minister may rely on
assumptions of fact in support of an assessment based on sham provided (1) the
assumptions are made at the time of the assessment or confirmation of the
assessment, and (2) the Minister accurately pleads these assumptions in the
Minister’s Reply.[755]
Assuming these requirements are met then the principles regarding burden of
proof stated in House v. The Queen, 2011 FCA 234 apply.[756]
[601]
It is worth noting, however, that which party
bears the burden of proof is ultimately only relevant,
if on the evidentiary record as a whole (including the assumption of fact), the
positions of the parties are evenly supported. The role of the burden of proof
is described by the Privy Council in Robins v. National Trust Co.,
[1927] A.C. 515 as follows (at page 520):
. . . But onus as a determining factor of
the whole case can only arise if the tribunal finds the evidence pro and con so
evenly balanced that it can come to no such conclusion. Then the onus will
determine the matter. But if the tribunal, after hearing and weighing the
evidence, comes to a determinate conclusion, the onus has nothing to do with
it, and need not be further considered.
[602]
The Respondent submits that the Appellant created
the illusion that the uranium-trading business of the Appellant was transferred
to CESA/CEL when in fact the control and the essential functions of that
business remained with the Appellant. According to the Respondent, the written
agreements entered into by CESA/CEL were a façade and the functions that
generated the profits in CESA/CEL remained with the Appellant.
[603]
In my view, the Respondent’s position reflects a
fundamental misunderstanding of the concept of sham. I have heard no evidence
to suggest that the written terms and conditions of the many contracts entered
into by the Appellant, Cameco US and CESA/CEL between 1999 and the end of 2006
do not reflect the true intentions of the parties to those contracts, or that
the contracts presented the resulting transactions in a manner different from
what the parties knew the transactions to be.
[604]
Quite the contrary, I find as a fact that the
Appellant, Cameco US and CESA/CEL entered into numerous contracts to create the
very legal relationships described by those contracts. The arrangements created
by the contracts were not a façade but were the legal foundation of the
implementation of the Appellant’s tax plan.
[605]
The Appellant’s motivation for these
arrangements may have been tax-related, but a tax motivation does not transform
the arrangements among the Appellant, Cameco US and CESA/CEL into a sham. As
stated by Noлl J.A. (as he then was) in Faraggi:
Subject to the invocation of the GAAR in a
particular case, taxpayers are entitled to arrange their affairs in such a way
as to minimize their tax burden, even if in doing so, they resort to elaborate
plans that give rise to results which Parliament did not anticipate
[606]
Under its numerous purchase and sale contracts,
CESA/CEL agreed either to buy uranium or to sell uranium on the terms specified
in the contracts, and the evidence overwhelmingly supports my finding that
CESA/CEL did in fact buy or sell uranium in accordance with the terms of the
contracts.
[607]
CESA and CEL were each a properly constituted
corporate entity resident in Luxembourg and Switzerland respectively. CESA and
CEL each had a properly constituted and functioning board of directors that met
regularly to address board-level matters. The fact that the boards approved
transactions that were clearly in the best interests of the Cameco Group as a
whole does not detract from the legitimacy of their role in directing the
affairs of CESA or CEL. No reasonable person would expect a wholly owned
subsidiary to act in a manner that is at odds with the interests of the
ultimate parent corporation or of the broader corporate group.
[608]
BfE (the Swiss nuclear regulatory authority) and
Euratom (the European nuclear regulatory authority) expressly authorized
CESA/CEL to carry out the transactions under its numerous purchase and sale
contracts. Initially, BfE required CESA/CEL to obtain authorization for each
purchase or sale of UF6 but, effective January 1, 2003,
Mr. Glattes secured a global authorization from BfE. Trading in uranium is
a serious business that is subject to worldwide regulation and scrutiny and it is
beyond belief that this regulatory authority would authorize what the
Respondent in substance alleges are fictitious transactions.
[609]
CESA and CEL each had at least one senior
employee with extensive experience in the uranium industry. CESA and CEL also
had the assistance of a third-party service provider, which included the
dedicated services of Mr. Bopp. Mr. Bopp eventually became an
employee of CEL. Mr. Murphy testified that two persons were more than
sufficient to address the number of contracts entered into by CEL.
[610]
There is no evidence that the intentions of the
parties to the contracts executed by CESA/CEL changed yet they left these
contracts unamended to present for the future a false picture of the transactions
under the contracts. In the case of eight of the BPCs, the Appellant and
CESA/CEL agreed to amend the contracts in 2004 and 2007 to defer certain
deliveries and then acted on the amended terms and conditions of those
contracts. CESA/CEL’s contracts with third parties were also amended on a
number of occasions.
[611]
Under the Services Agreement, the Appellant
agreed to provide a list of services to CESA/CEL. Mr. Belosowsky
testified that the Appellant and CESA/CEL did not sign the Services Agreement
until March 2001 and that the fees under the Services Agreement were not “paid” until that same year. However, the initial
request for services was set out in a letter from Mr. Glattes to the
Appellant dated August 25, 1999 and the Appellant provided an initial
proposal to CESA/CEL by letter dated September 22, 1999. Mr. Glattes
explained that it took time to settle the terms of the Services Agreement and
that the Appellant provided to CESA in 1999 and 2000 the services contemplated
by the concluded agreement. I accept Mr. Glattes’ explanation.
[612]
CESA’s annual accounts for the years ending
December 31, 1999 and December 31, 2000 show the accrual of
the cost of the services as being US$1,432,134 and US$1,214,633 respectively. There
is no requirement in the ITA that an agreement to provide services be in
writing, but in any event the Services Agreement was in place long before the
first taxation year in issue in these appeals.
[613]
Several contract administrators testified as to
the services provided by the Appellant, and the services described in that
testimony are consistent with the terms of the Services Agreement. There is no
evidence to support the conclusion that the Appellant was performing the
services for its own account rather than for the benefit of CESA/CEL. Canadian
law has long recognized that a corporation may undertake activities through its
own employees or through independent contractors acting on its behalf.
[614]
The evidence does indicate that on rare occasions
a contract administrator overstepped the bounds of the authority given to the
Appellant by the Services Agreement. However, that fact does not in any way
support the conclusion that the Services Agreement, or the services provided
under that agreement, constituted a sham. The evidence clearly establishes that
no one in authority within the Cameco Group condoned or tolerated these
transgressions. In fact, in his private notes to himself, Mr. Murphy
expressed in very colourful terms his concern with a single suggestion that
CESA/CEL destroy a contract. Mr. Murphy rejected the request and took
steps to ensure that CESA/CEL implemented an appropriate alternative solution.
[615]
The Respondent submits that the Appellant concluded
contracts on behalf of CESA/CEL and treated CESA/CEL’s inventory as its own.
There is evidence that Mr. Grandey had high-level discussions with Kazatomprom
and Tenex and that individuals other than Mr. Glattes and Mr. Murphy
very occasionally made spur-of-the-moment decisions, but this was almost invariably
in exigent circumstances.
[616]
The de minimis examples provided by the
Respondent do not support a finding of sham, nor do they support the suggestion
that the Appellant routinely concluded contracts on behalf of CESA/CEL and
treated CESA/CEL’s inventory as its own.
I am not aware of any principle that states that the chief executive officer of
the parent of a multinational group of corporations is precluded from holding
high-level discussions on behalf of members of the multinational group.
[617]
Section 2.1 of the Services Agreement
states that the services provided by the Appellant to CESA/CEL do not include
the conclusion of contractual terms on behalf of CESA/CEL.
[618]
Mr. Glattes testified that, although this
was not explicitly stated, the services described in Appendix A of the
Services Agreement included the making of routine decisions about which of
CESA/CEL’s inventory would be allocated to uranium sales contracts. However,
more important issues would be reported to Bernie Del Frari, who
would raise the issues in the twice-weekly sales meetings. Mr. Glattes
testified that the role of allocating CESA/CEL’s inventory to the sales
contracts fell under the general language of item 2 of Appendix A to the
Services Agreement.
[619]
Mr. Murphy testified that the Appellant did
not conclude contractual terms on behalf of CESA/CEL. Mr. Assie testified
that neither the Appellant nor Cameco US made decisions regarding the purchase
and sale of uranium by CESA/CEL.
[620]
The Respondent submits that the failure of
Mr. Assie, Mr. Glattes and Mr. Murphy to take or keep notes of
the sales meetings requires that I draw an adverse inference as to the content
of those meetings.
[621]
The uncontradicted evidence of Mr. Assie, Mr. Glattes
and Mr. Murphy is that the terms of all contracts relevant to the
Appellant, Cameco US and CESA/CEL were discussed and agreed to during the sales
meetings held twice‑weekly, or more frequently if the circumstances warranted.
Mr. Wilyman and Mr. Mayers testified that discussions regarding the
uranium market and potential sales to third parties did take place during the sales
meetings and that Mr. Glattes and Mr. Murphy participated in those
discussions. The terms of the sales to third parties in turn determined
the terms of the back-to-back contracts between Cameco US and CESA/CEL.
[622]
Mr. Glattes and Mr. Murphy were both
experienced participants in the uranium industry and in my view clearly had the
knowledge and experience to understand and participate in the sales meetings,
and to meaningfully contribute to those meetings. Mr. Newton, in
cross-examination, spoke in glowing terms of Mr. Glattes’ expertise and
experience in the uranium industry, as did other witnesses. Even without such
testimony, Mr. Glattes’ résumé
and years of experience speak for themselves. Mr. Murphy, for his part,
had extensive relevant experience with the Cameco Group before he became the
president of CEL. My clear impression of Mr. Glattes and Mr. Murphy is
that they are both strong personalities and experts in the Uranium business
carried on my the Cameco Group and that they would not and did not act as mere
figureheads who simply followed the explicit directions of the Appellant.
[623]
The evidence of several witnesses was that the
marketing group prepared bimonthly activity reports that, in the words of
Ms. Kerr, included “all of our RFQs, all of our
pending business, everything that was going on in each of our market regions so
that everybody was aware exactly where we were at”, and that
Mr. Glattes and Mr. Murphy received copies of these reports. Mr. Murphy
began to prepare his own activity reports for CEL shortly after he became
president of that corporation in 2004. There was clearly no need for notes or e‑mails
confirming the discussions at the sales meetings since everything of importance
to the Cameco Group was already documented in the regular activity reports. In
any event, some of Mr. Assie’s notes did address the sales meetings.
[624]
The Respondent also submits that I should draw
an adverse inference from the fact that Cameco US did not seek CESA/CEL’s
express agreement to each of the back-to-back contracts. However,
Mr. Assie, Mr. Glattes and Mr. Murphy each testified that the
understanding was that, to the extent that Cameco US agreed to sell uranium to
a customer on terms discussed during the sales meetings, CESA/CEL agreed to
sell uranium to Cameco US on the same terms less 2% of the sale price to the
customer. The terms and conditions of the contracts between CESA/CEL and Cameco
US accurately reflected this understanding. It would have been cumbersome and
redundant for Cameco US to seek CESA/CEL’s agreement to each individual
contract when the terms of the arrangement were so clear and practical.
[625]
The Respondent submits that, because the
Appellant continued to play an important role in the gathering of market
intelligence and the administration of the various contracts entered into by
CESA/CEL and because the decision making by CESA/CEL, the Appellant and Cameco
US was collaborative rather than adversarial, the overall arrangement was a
deliberate deception of the Minister because the Appellant was doing
everything. However, there was nothing unusual about the way in which the
Cameco Group operated. Carol Hansell opined that it is common in an MNE
such as the Cameco Group for administrative functions to be centralized and
shared across the enterprise and that commercial integration across the MNE and
the accountability of the parent company to investors and regulators requires
cooperation and coordination across the entities forming the MNE.
[626]
The holding of the twice-weekly sales meetings
strikes me as a reasonable way to ensure that all members of the Cameco Group were
working together in the best interests of the Cameco Group as a whole. The
Respondent’s suggestion that CESA/CEL failed to act as if unrelated to the
Cameco Group is neither relevant to the Respondent’s allegation of sham nor
reflective of how MNEs operate. It is worth noting that the same
misunderstanding of how MNEs function fuelled many of Mr. Murphy’s more
colourful comments in his notes to himself.
[627]
The Respondent alleges that the Appellant
coached or told witnesses what to say. This allegation is based primarily on
the extremely flimsy proposition that some witnesses used similar words, such
as the word “collaborative” to describe the
twice-weekly sales meetings. One has only to consult Webster’s New World
Roget’s A-Z Thesaurus (on-line:
http://thesaurus.yourdictionary.com/collaborate) to see that there are only a
limited number of synonyms for “collaborate”
those given being: “work together”, “collude” and “team up”. Collude is not an
appropriate alternative and neither of the other two alternatives is an
effective way to communicate collaboration. I find no evidence of coaching and,
as stated at the outset, I found every witness to be credible.
[628]
I agree with the Appellant that it is contrary
to the rule in Browne v. Dunn (1893), 6 R. 67 (HL) to raise an
allegation of coaching in argument without providing the witnesses with the
opportunity to address the allegation. While there is no fixed remedy, I am not
required to provide a remedy in this instance because I reject the allegation
out of hand.
[629]
The Respondent submits that little changed
following the reorganization and that that supports a finding of sham. Even if
I accepted the premise of that submission, which I do not, the fact that little
changed does not support a finding of sham. In Stubart the taxpayer
transferred its food production business to a related corporation that had
losses (Grover). The taxpayer and Grover executed an agency agreement pursuant
to which the taxpayer continued to carry on the transferred business for the
benefit of Grover. In effect, nothing changed except the beneficial ownership
of the transferred business, which, after the transactions, rested with Grover.
The Supreme Court of Canada held that such an arrangement was not a sham
because there was no false representation of the arrangements. Estey J.
states:
. . . The transaction and the form in which
it was cast by the parties and their legal and accounting advisers cannot be
said to have been so constructed as to create a false impression in the eyes of
a third party, specifically the taxing authority. The appearance created by
the documentation is precisely the reality. Obligations created in the
documents were legal obligations in the sense that they were fully enforceable
at law.
. . .
There is, in short, a total absence of the
element of deceit, which is the heart and core of a sham. The parties, by
their agreement, accomplish their announced purpose. The transaction was
presented by the taxpayer to the tax authority for a determination of the tax
consequence according to the law. I find no basis for the application in
these circumstances of the doctrine of sham as it has developed in the case law
of this country.
[Emphasis added.]
[630]
In concurring reasons, Wilson J. states:
. . . I cannot see how a sham can be said to
result where parties intend to create certain legal relations (in this case the
purchase and sale of a business and a nominee arrangement to operate it) and
are successful in creating those legal relations.
[631]
As in Stubart, the parties to the
transactions in issue in these appeals, by their various agreements, created
precisely the legal relations that they wished to create and presented those
relations to the Minister for a determination of the tax consequence according
to the law, including the transfer pricing provisions in the ITA.
[632]
The evidence does indicate that on a few
occasions the date on intercompany contracts signed by CESA/CEL did not clearly
reflect the actual date the contract was signed. However, I have concluded that
these occurrences cannot reasonably be viewed as a deliberate attempt by
CESA/CEL or the Appellant to mislead the outside world as to the true intent or
agreement of the parties to the contracts, or to present the legal rights and
obligations created by those agreements as something different from what the
parties knew those legal rights and obligations to be. I will nevertheless
review the details of these occurrences.
[633]
With respect to Exhibit A163425, Mr. Glattes
agreed that the contract was signed after its effective date of
January 1, 2004, and the evidence reviewed with Mr. Assie
suggested that the contract was signed around January 28, 2004. The
proposal summary for the contract was dated November 3, 2003, was prepared
by Mr. Del Frari and was signed on behalf of the Appellant by
Mr. Assie and Mr. Grandey. Mr. Assie could not recall when he
signed the proposal summary and Mr. Grandey was not asked about the
proposal summary.
[634]
Mr. Glattes testified that his “vague recollection” was that the terms of the agreement
were agreed to during twice-weekly sales meetings that were held in November
2003. Mr. Glattes also stated that the contract would only stand out in
his mind if the usual procedure for such agreements had not been followed.
[635]
The evidence of Mr. Assie, Mr. Glattes
and Mr. Murphy establishes to my satisfaction that the protocol for such
agreements was to discuss the terms during the sales meetings. The existence and purpose of
the sales meetings as described by these three witnesses is amply supported by
the testimony of other witnesses.
Mr. Glattes testified that, although he only had a vague recollection of the
discussions regarding this contract, which would have taken place some 13 years
prior to his testimony, the agreement would only have stood out in his mind if such
discussions had not occurred.
[636]
I do not expect Mr. Glattes to have a clear
recollection of events that took place in late 2003. There is no evidence to
suggest that the terms of Exhibit A163425 were not discussed and agreed to
at one or more sales meetings in late 2003. The time frame between the proposal
summary and the execution of the contract was approximately two months, and the
delay between the effective date of the contract and the date of signing was
less than one month. The language of the agreement is that it was signed “as at” the date on the first page of the contract,
which states that the “agreement is made with effect as
of” January 1, 2004. This language is ambiguous as to when the
contract was in fact signed.
[637]
In my view, the evidence taken as a whole does
not support the conclusion that the effective date stated on Exhibit A163425
was intended to deceive. I find that the signing of this Long-term Contract
approximately 28 days after its effective date was most likely the consequence
of the preparation of the formal documentation evidencing the agreement reached
in late 2003 stalling during the holiday season and that the minor delay
between the effective date and the actual signature date is not evidence of
deceit on the part of the parties to the contract.
[638]
With respect to Exhibit R-001399, Mr.
Glattes agreed that the contract was signed by Mr. Murphy shortly after
its effective date of August 20, 2004. The proposal summary setting
out the terms of the contract was dated August 16, 2004. Mr. Glattes and
Mr. Murphy testified that the offer and contract were signed after the effective
date only because Mr. Murphy was in the process of moving to Switzerland
on the effective date and that Mr. Murphy signed the offer upon arriving
in Zug on August 27 or 28, 2004 and signed the contract shortly
after he formally took occupancy of the office in Zug on September 1, 2004. In
a different context, Mr. Murphy stated that his understanding was that
parties could agree to execute a contract after its effective date as long as
the agreement was reached before that date.
The language used to describe the date of signature is the same as that in Exhibit
A163425.
[639]
For much the same reasons as for Exhibit A163425,
I find that the signing of this contract a few days after its effective date
was not done to deceive but was simply the result of Mr. Murphy not being
available to sign the contract on the effective date stipulated in the contract
because he was in the process of relocating to Switzerland. The terms of the
contract were settled on August 16, 2004, which is several days
before the effective date of the contract.
[640]
Mr. Glattes provided no explanation why Exhibits A225935,
A165040, A016549 and A154147, all of which involve conversion services, had
effective dates prior to the dates the contracts were signed. Exhibits A225935
and A016549 do not mention any date on the signature page but rather state “the Parties hereto have executed this Agreement under the
hands of their proper officers duly authorized in that behalf.”
[641]
Mr. Glattes testified that the issue of how
to optimize the use of CESA/CEL’s conversion credits came up frequently but
that it was “nothing of commercial -- really big
commercial importance.” The conversion services arrangements in these
contracts were for the most part driven by the demands of customers of Cameco
US and I accept that these demands would have been a topic of conversation at the
twice-weekly sales meetings. In any event, the role of these contracts in the
business of CESA/CEL was clearly not material and I find that the sloppiness
surrounding the contracts reflects the lack of priority accorded such
arrangements and not an attempt to deceive the outside world regarding the conversion
credit transactions.
[642]
With respect to Exhibit A154086, Mr. Glattes
conceded that he was not aware of the loan of uranium described in that
contract until after the effective date of the loan, which took place on
April 14, 2003, and that he was sent signature copies of the contract
on July 21, 2003. Mr. Assie testified that the Appellant’s
uranium account was overdrawn on April 14, 2003 and that the loan
from CEL to the Appellant was put in place after that date to address the
shortfall. The contract reflects a one-time fix for an unusual circumstance. It
is not deceitful for parties to choose to characterize an overdrawn account as
a loan–such a characterization is entirely consistent with such circumstances.
[643]
I note with respect to each of the above
contracts that there was no evidence to suggest that the Appellant, CESA/CEL or
Cameco US garnered any economic or other benefit from the sloppiness
surrounding the preparation and execution of these contracts. To place these
contracts in perspective, the evidence is that CESA/CEL executed approximately
210 contracts from March 1999 to the end of 2006. These five
contracts therefore represent less than 2.4% of the total number of contracts
and a much smaller percentage in terms of the dollar value of all the contracts.
It defies logic and common sense to suggest that the relatively minor issues
with these few contracts, establishes the existence of a sham from 1999 to
2006.
[644]
The Respondent also raised with Mr. Murphy the
timing of the signing of several contracts but, for all but one of the
contracts, re-examination established that the agreement evidenced by the
contract was reached by the parties before the effective date of the contract.
[645]
The one exception was an amended and restated UF6
conversion agreement–Exhibit A217602-which amended Exhibit A021444. In
that case, the evidence on cross-examination was that there was a proposal
summary for the amended agreement dated one day before the July 20, 2005
effective date of the contract. Mr. Murphy agreed that an e-mail showed
that Exhibit A217602 remained unsigned as of December 7, 2005. Nevertheless,
the agreement was in place as of July 19, 2005, when the terms were
settled.
[646]
Mr. Murphy testified that he would look at
the effective date of the contract only and that he relied on the Appellant’s
legal department to ensure that the terminology used in the contract was
correct since the legal department drafted the contract. Parenthetically, I
note that Mr. Murphy had made clear in his testimony that he viewed
backdating as placing an effective date on a contract that was prior to the
existence of the agreement that the contract documented.
[647]
Notwithstanding that I have concluded that the
foregoing contracts do not support the conclusion that the Appellant, Cameco US
and CESA/CEL were perpetrating a sham, it is nevertheless important to say that
taxpayers must be extremely careful not to give the impression that an
agreement exists before it does in fact exist. While I have found as a fact
that such was not the case here, the senior officers of the Appellant, CESA and
CEL can each be faulted for executing Exhibits A225935, A165040, A016549,
A154147 and A154086 with effective dates that precede the date of execution
without stating on the face of the contract that the execution date differs
from the effective date. Such a practice must be avoided.
[648]
In addition to the foregoing contracts, there is
also evidence that, particularly during the tenure of Mr. Glattes, there
was a somewhat cavalier attitude toward the administration of the contracts to
which CESA/CEL was a party. This cavalier attitude is reflected in the fact
that various notices required by the terms of the contracts were regularly
backdated by the personnel administering CESA/CEL’s contracts. Mr. Glattes
admitted that various notices were backdated to give the appearance that
everything was in order.
[649]
The evidence, however, is that the intercompany
binding and non-binding delivery notices and delivery schedules (“delivery notices”) had no actual function or effect
beyond redundantly papering events that were for the most part dictated by the
customers of Cameco US.
[650]
For example, the typical flow of delivery
notices was from the third-party customer to Cameco US and then from Cameco US
to CESA/CEL. The delivery notices from the third-party customer to Cameco US
determined when CESA/CEL had to deliver uranium to Cameco US under the
back-to-back agreement between CESA/CEL and Cameco US. The contract
administrators acting for CESA/CEL under the Services Agreement already had all
the information required to meet CESA/CEL’s obligation to Cameco US because
they received the delivery notices directly from the third-party customers of
Cameco US. Consequently, a delivery notice from Cameco US to CESA/CEL performed
no meaningful function and the delivery of such a notice to CESA/CEL was merely
the perfunctory performance of a technical requirement in the intercompany
contract. Certainly, there was no fiscal consequence if Cameco US submitted its
intercompany delivery notices to CESA/CEL late, or not at all. I therefore
reject the submission of the Respondent that the backdating of delivery notices
was intended to deceive the CRA because nothing turned on the date of these
notices.
[651]
Both Mr. Glattes and Mr. Murphy
testified that they fought a losing battle with the contract administrators on
the issue of timely delivery notices, although it is clear that Mr. Murphy
took the issue more seriously than Mr. Glattes and made considerably more
headway in bringing about change.
[652]
In addition to the delivery notices, there were
also issues with flex notices. A flex notice was required when CESA/CEL
exercised an upward or downward flex option under a BPC.
[653]
Mr. Assie testified that the general
understanding was that, if the price under a BPC was reasonably expected to be
below the market price at the time of delivery, then the upward flex option
would be exercised on behalf of CESA/CEL by the contract administrators.
[654]
Mr. Glattes testified that the contract
administrators had standing instructions to exercise the flex option under a
BPC if it made commercial sense, which generally meant that the price under the
BPC was lower than the market price. If it was a close call, the contract
administrators were instructed to consult their supervisor and ask for guidance,
and if it was a really close call the issue would be addressed during a sales
meeting.
[655]
Mr. Murphy testified that the contract
administrators acting on behalf of CESA/CEL under the Services Contract
understood that if the market price was above the price in the BPC then they
were to issue to the Appellant a flex notice exercising CESA/CEL’s upward flex
option. However, if the prices were close then the matter had to be discussed
and a decision had to be made.
[656]
Mr. Assie and Mr. Glattes testified that
flex notices had been issued late and were backdated. Mr. Assie testified
that he believed the decisions to exercise the flex options were made in a
timely manner, but the documentation was not always prepared in a timely
manner. Mr. Assie testified that he did not know why the backdating of
flex notices occurred but that the Cameco Group did not seek or obtain any
commercial advantage because of flex notices being late or backdated.
[657]
Mr. Glattes testified that the delivery of
a flex notice was a formality required by the terms of the BPCs once the
decision to exercise the flex option had been made and that the notice lacked
relevance for the same reasons as the delivery notices, i.e., the contract
administrators were notifying themselves. Mr. Glattes also testified that
CESA/CEL did not receive any economic benefit from late flex notices and that
CESA/CEL did not deliberately issue backdated flex notices to see how the
market would play out.
[658]
The evidence did not reveal any economic, fiscal
or other benefit from late flex notices.
[659]
With respect to notices in general, Mr. Assie
testified that Cameco management did not give any instructions to backdate
either flex notices or delivery notices and that people were instructed not to
backdate documents. Mr. Glattes testified that senior personnel did not
encourage or condone the backdating of notices but that it nevertheless
persisted.
[660]
Mr. Murphy was clearly disturbed about the
backdating of notices and did his best to rectify the situation. Mr. Murphy’s
notes to himself, on which he was extensively cross-examined, clearly reveal
the frustration he felt. I accept without reservation Mr. Murphy’s
explanation that some of his more inflammatory comments were fuelled by his
frustration arising from the timeliness issues already described and his
misunderstanding of the general concepts involved, and I find as a fact that
these notes are not evidence of deception on the part of the Appellant,
CESA/CEL or Cameco US. If anything, these notes reveal Mr. Murphy’s desire
to have every “i” dotted and every “t” crossed in conformity with the detailed terms and
conditions of the intercompany contracts.
[661]
In conclusion, I find as a fact that the
backdating of some delivery notices and flex notices is not evidence of a false
representation of the true intentions of the parties to the approximately 210
contracts executed by CESA/CEL between March 1999 and the end of 2006.
Rather, the late delivery and flex notices resulted from the failure of the
persons charged with the administration of the intercompany contracts to abide
by two technical requirements in those contracts notwithstanding clear
instructions to the contrary.
[662]
The fact that Mr. Murphy, and to a lesser
extent Mr. Glattes, attempted to rectify the situation reinforces the point
that the intention of CESA/CEL was that the contracts be carried out according
to their terms. While none of the notices should have been backdated, the
backdating of some notices does not support the existence of a sham. The
failure on occasion to meet the more technical terms of a contract is not
evidence that the factual presentation of the terms and obligations of the
agreement is different from what the parties know the agreement to be. Rather,
it is evidence of carelessness or incompetence on the part of those charged
with meeting those technical requirements.
[663]
The correct approach to addressing a failure of
a taxpayer to take formal steps is to tax in accordance with the legal result
brought about by that failure,
not by alleging that the failure is evidence of a sham. Here, there is no
evidence that the failure on occasion to take certain formal steps dictated by
the intercompany contracts, such as the issuance of timely delivery notices,
had any impact on the fiscal position of the Appellant. While none of the
notices should have been backdated, the fact that some were backdated does not
support a finding of sham.
[664]
The intercompany contracts are not the only
contracts entered into by CESA/CEL. CESA/CEL entered into contracts with arm’s
length third parties, including Tenex and Urenco. There has been no suggestion
that the rights and obligations of the parties to those contracts were falsely
described in the contracts, or that the rights and obligations described in those
contracts do not in fact exist.
[665]
Quite the contrary, the evidence discloses that
the terms and conditions of those contracts were the result of hard bargaining
and that where the parties no longer accepted the existing terms and conditions
they negotiated amendments to the contracts to reflect the new agreement of the
parties. The evidence does show that Mr. Grandey was the lead negotiator
of the HEU Feed Agreement and the amendments to that agreement and
that John Britt and Mr. Assie were the lead negotiators of the Urenco
Agreement and the amendments to that agreement. However, those facts do not
support a finding of sham. Sham is focused on the existence of deception in the
description of the legal rights and obligations of parties to arrangements, not
on who negotiated the agreements creating those arrangements.
[666]
As a final remark on sham, I observe that the
Respondent cites Dominion Bridge Co. v. Canada, [1975] F.C.J. No. 316 (QL)(FCTD)
(“Dominion Bridge”) in support of her
position on sham. Notably, on the appeal of that decision to the Federal Court
of Appeal, that Court refused to overturn what it characterized as a finding of
fact of the trial judge. The Court did not mention sham, or any other
anti-avoidance doctrines considered by the trial judge. Instead, the Federal Court
of Appeal stated (at paragraphs 4 and 5):
In my view, arrived at after the best
consideration that I have been able to give to the appellant’s submissions,
this finding was a finding of fact that was open to the learned Trial Judge on
the evidence before him and there is no ground for interfering with it.
It follows from that finding of fact, that
the appellant’s costs of the steel in question must be computed by reference to
the costs incurred by Span on behalf of the appellant and not by
reference to amounts shown by the companies’ books and papers as having been
paid by the appellant to Span for it. My understanding is that this was the
basis of the re-assessments as far as the items in question are concerned. No
question was raised as to the amounts of those items.
[Emphasis and double
emphasis added.]
[667]
The Federal Court of Appeal’s description of the
result of the trial judge’s finding of fact is at odds with a finding that Span
should be disregarded as being a sham corporation. Rather, the description used
by the Court of Appeal reflects an implicit understanding that Span acted as
the agent of Dominion Bridge and therefore the costs incurred by Span should be
treated as the costs of Dominion Bridge. This, as noted by the Court of Appeal,
appears to have been the basis of the Minister’s assessment of Dominion Bridge.
[668]
In addition, many of the factors considered by
the trial judge in reaching his finding of fact in Dominion Bridge are
of dubious relevance today considering the subsequent decisions of the Supreme
Court of Canada in Stubart, Neuman, Canada v. Antosko,
[1994] 2 S.C.R. 312 and Shell Canada Ltd. v. Canada, [1999] 3 S.C.R.
622, among others, addressing the roles of sham, business purpose, economic
substance over form, and tax motive in taxation matters.
[669]
Finally, even if Dominion Bridge is still
good law in Canada, the factual circumstances found to exist in that case bear
no resemblance to CESA/CEL’s and the Appellant’s factual circumstances. Span
was literally an empty shell corporation, and its parent corporation, which was
its only client, directed, controlled and carried out all its activities. Even with those facts one
might conclude that Span’s legal relationships were as they purported to be but
that Span was resident in Canada and was carrying on its activities in Canada
through the actions of its parent’s employee and therefore was itself subject
to Canadian tax. Alternatively, one might conclude that the predecessor provision
to subsection 69(2) addressed the pricing arrangements.
[670]
In summary, I find as a fact that the Appellant,
Cameco US and CESA/CEL did not factually represent the numerous legal
arrangements that they entered into in a manner different from what they knew
those arrangements to be, nor did they factually represent the transactions
created by those arrangements in a manner different from what they knew those
arrangements to be, consequently, the element of deceit required to find sham
is simply not present.
B. Transfer Pricing
[671]
The Respondent’s second and third position is
that the transfer pricing rules in subsection 247(2) apply to either
recharacterize the transactions or to reprice the transactions. In interpreting
subsection 247(2), I must adhere to the principles of statutory interpretation
enunciated by the Supreme Court of Canada in cases such as Stubart
and Canada Trustco Mortgage Co. v. Canada, 2005 SCC 54, [2005] 2
S.C.R. 601 (“Canada Trustco”).
[672]
Subsection 247(2) states:
Where a taxpayer or a partnership and a
non-resident person with whom the taxpayer or the partnership, or a member of
the partnership, does not deal at arm’s length (or a partnership of which the
non-resident person is a member) are participants in a transaction or a series
of transactions and
(a) the terms or
conditions made or imposed, in respect of the transaction or series, between
any of the participants in the transaction or series differ from those that
would have been made between persons dealing at arm’s length, or
(b) the
transaction or series
(i) would not
have been entered into between persons dealing at arm’s length, and
(ii) can
reasonably be considered not to have been entered into primarily for bona
fide purposes other than to obtain a tax benefit,
any amounts that, but for this section and section
245, would be determined for the purposes of this Act in respect of the
taxpayer or the partnership for a taxation year or fiscal period shall be
adjusted (in this section referred to as an “adjustment”) to the quantum or
nature of the amounts that would have been determined if,
(c) where only
paragraph (a) applies, the terms and conditions made or imposed, in respect of
the transaction or series, between the participants in the transaction or
series had been those that would have been made between persons dealing at arm’s
length, or
(d) where
paragraph (b) applies, the transaction or series entered into between the
participants had been the transaction or series that would have been entered
into between persons dealing at arm’s length, under terms and conditions that
would have been made between persons dealing at arm’s length.
[673] Subsection 247(2) was added to the ITA by subsection 238(1) of the Income
Tax Amendments Act, 1997 effective for fiscal periods that begin after
1997. The Department of Finance’s December 1997 explanatory notes
for proposed subsection 247(2) state:
In general terms, proposed new subsection
247(2) requires that, for tax purposes, non-arm’s length parties conduct their
transactions under terms and conditions that would have prevailed if the parties
had been dealing at arm’s length with each other. Therefore, proposed new
subsection 247(2) embodies the arm’s length principle.
More specifically, proposed new subsection
247(2) applies in situations where a taxpayer or a partnership and a
non-resident person with whom the taxpayer, the partnership or a member of the
partnership does not deal at arm’s length (or a partnership of which the
non-resident person is a member) are participants in a transaction or a series
of transactions and
•
the terms or conditions of the transaction or
series differ from those that would have been made between persons dealing at
arm’s length, or
•
the transaction or series would not have been
entered into between persons dealing at arm’s length and may reasonably be
considered not to have been entered into primarily for bona fide purposes other
than to obtain a tax benefit.
Where these conditions are met, proposed new
subsection 247(2) may adjust any amounts that, but for that subsection and the
general anti-avoidance rule in section 245, would have been determined for the
purposes of the Act in respect of the taxpayer or the partnership. Such amounts
may be adjusted to reflect the quantum or nature of the amounts that would have
been determined if the participants had been dealing at arm’s length with each
other.
[674]
Several cases have applied the transfer pricing
rules in paragraphs 247(2)(a) and (c). However,
this is the first case in which the application of the transfer pricing rules
in paragraphs 247(2)(b) and (d) is in issue (I will refer to the rules in
paragraphs 247(2)(a) through (d) collectively as the “transfer
pricing rules”). Since one of the fundamental principles of statutory
interpretation is to read the text of legislation in context and with a view to
its purpose, I will first address the interpretation of subsection 247(2) in
its entirety.
[675]
The introductory words of subsection 247(2) (the
“preamble”) impose the condition that a taxpayer or a partnership and a non-resident person with
whom the taxpayer or the partnership, or a member of the partnership, does not
deal at arm’s length (or a partnership of which the non-resident person is a
member) be participants in a transaction or a series of transactions. No
partnerships are in issue in these appeals, so the relevant portion of the
preamble can be distilled to require that:
a taxpayer . . . and a non-resident person
with whom the taxpayer . . . does not deal at arm’s length . . . [be]
participants in a transaction or a series of transactions.
[676]
The preamble requires the identification of a
transaction or series of transactions (hereinafter, the “transaction or series”) and the identification of the
participants in that transaction or series.
[677]
“Taxpayer”
includes “any person whether or not liable to pay tax”, a “transaction” includes “an arrangement or event” and
a “participant” is “one
who takes part in, possesses, or experiences something in common with others”. An “arrangement” includes an
informal agreement or a plan, whether legally enforceable or not, and an “event” includes “anything that happens”.
[678]
Under common law, a transaction is part of a
series of transactions if each transaction in the series is preordained to
produce a result. Subsection 248(10) expands this meaning to include “any related transactions or events completed in contemplation
of the series”, which allows either prospective or retrospective
connection of a related transaction to a common law series of transactions.
[679]
The participants in the transaction or series
must include the taxpayer and at least one non-resident person with whom the
taxpayer does not deal at arm’s length (I will refer to any such person as a “non-arm’s length non-resident”).
[680]
The preamble does not require that the taxpayer
and a non-arm’s length non-resident be the only participants in the transaction
or series. However, when the preamble is read in the context of the balance of
subsection 247(2), the clear focus of the transfer pricing rules is a
transaction or a series between a taxpayer and a non-arm’s length non-resident.
The subsection does not apply to a transaction or a series between a taxpayer
and one or more arm’s length persons, or to a transaction or series between a
non-resident and another non-resident where neither is a taxpayer. However, the
existence of such a transaction or series and the terms and conditions of that
transaction or series may be relevant facts when applying the transfer pricing
rules to a transaction or series between a taxpayer and a non-arm’s length
non-resident. The scope of the preamble is addressed in more detail under the
heading “Preamble” below.
[681]
The words between paragraphs 247(2)(b) and (c)
(the “mid-amble”) authorize the Minister to
adjust the amounts determined for the purposes of the ITA to the quantum or
nature of the amounts determined in accordance with paragraph 247(2)(c) or (d)
(an “adjustment”). The use of the word “nature” allows the recharacterization of an amount,
but only if paragraph 247(2)(c) or (d) permits such an adjustment.
[682]
If the condition in the preamble that a taxpayer
and a non-arm’s length non-resident be participants in a transaction or series
is met, paragraph 247(2)(c) states that it applies “where only paragraph (a) applies” while paragraph
247(2)(d) states that it applies “where paragraph (b)
applies”.
[683]
It is a well-accepted rule of statutory
interpretation that every word in an enactment serves a purpose and must be
given a meaning.
The question therefore is why is the word “only”
included in paragraph 247(2)(c) and not in paragraph 247(2)(d)?
[684]
In my view, the inclusion of the word “only” in paragraph 247(2)(c) emphasizes Parliament’s
intention that paragraph 247(2)(c) apply only if the condition in paragraph
247(2)(a) alone is satisfied. This ensures that paragraph 247(2)(c) does not
apply in the unlikely event that the conditions in both paragraph 247(2)(a) and
paragraph 247(2)(b) are satisfied. In contrast, paragraph 247(2)(d) may apply
where the conditions in paragraph 247(2)(b) are satisfied and where the
conditions in both paragraph 247(2)(a) and paragraph 247(2)(b) are satisfied,
but not where the condition in paragraph 247(2)(a) alone is satisfied.
[685]
Paragraph 247(2)(a) applies where the terms or
conditions made or imposed in respect of the transaction or series differ from
those that would have been made by arm’s length parties.
[686]
The assumption underlying paragraph 247(2)(a) is
that arm’s length parties would enter into the transaction or series but on
different terms or conditions. Paragraph 247(2)(c) reinforces this interpretation
by requiring that the determination of any adjustment
be based on the assumption that the terms and
conditions of the transaction or series are the terms and conditions that
would have been made between persons dealing at arm’s length.
[687]
In GE Capital, Noлl J.A., as he
then was, explains the concept underlying paragraphs 247(2)(a) and (c) and the
limitations implicit in that concept:
The concept underlying subsection 69(2) and
paragraphs 247(2)(a) and (c) is simple. The task in any given
case is to ascertain the price that would have been paid in the same
circumstances if the parties had been dealing at arm’s length. This
involves taking into account all the circumstances which bear on the price
whether they arise from the relationship or otherwise.
This interpretation flows from the normal
use of the words as well as the statutory objective which is to prevent the
avoidance of tax resulting from price distortions which can arise in the
context of non arm’s length relationships by reason of the community of
interest shared by related parties. The elimination of
these distortions by reference to objective benchmarks is all that is
required to achieve the statutory objective. Otherwise all the factors
which an arm’s length person in the same circumstances as the respondent would
consider relevant should be taken into account.
[Emphasis and double
emphasis added.]
[688]
Paragraph 247(2)(c) permits an adjustment to the
quantum of an amount but does not permit an adjustment of the nature of an
amount. This flows from the fact that a change to the nature of an amount would
be an impermissible recharacterization of the transaction or series rather than
an adjustment based on the terms and conditions of the transaction or series,
amended solely to reflect an objective arm’s length benchmark. Paragraph
247(2)(c) does not permit the Minister to recharacterize the transaction or
series by substituting terms and conditions that have that effect.
[689]
Paragraph 247(2)(b) applies where the
transaction or series would not have been entered into by arm’s length parties
and the transaction or series can reasonably be considered not to have been
entered into primarily for bona fide purposes other than to obtain a tax
benefit.
[690]
The assumption underlying paragraph 247(2)(b) is
that arm’s length parties would not enter into the transaction or series
identified in the preamble on any terms or conditions but that in the
circumstances there is an alternative transaction or series that arm’s length
parties would enter into on arm’s length terms and conditions in place of the
transaction or series. Paragraph 247(2)(d) reinforces this interpretation by
requiring that the determination of any adjustment be based on the assumptions
that (i) the transaction or series entered into is
instead the transaction or series that would have been entered into between
persons dealing at arm’s length
and (ii) the terms and conditions of that assumed transaction or series are the
terms and conditions that would have been made between persons dealing at arm’s
length. As with paragraph 247(2)(c), it is implicit in paragraph 247(2)(d) that
the determination of whether an alternative transaction or series exists is
made with due regard to the circumstances in which the actual transaction or
series exists.
[691]
Since the existence of such a transaction or
series is a question of fact and the Minister is in no better position to know
that fact than the taxpayer, the Minister can assume the existence of an
alternative transaction or series and the taxpayer must then “demolish” the assumption.
[692]
The term “tax benefit”
is defined in subsection 247(1) to have the same meaning as it does under the
general anti-avoidance rule in section 245 (the “GAAR”). However, the words “the transaction or series . . . can reasonably be considered
not to have been entered into primarily for bona fide purposes other than to
obtain a tax benefit” impose a subtly different test than subsection
245(3) of the GAAR.
Specifically, the test in subparagraph 247(2)(b)(ii) asks about the purpose of the
transaction or the series (as opposed to the purpose of a transaction in
the series).
[693] In addressing the similarly worded test in subsection 245(3), the
Supreme Court of Canada stated in Canada Trustco:
While the
inquiry proceeds on the premise that both tax and non-tax purposes can be
identified, these can be intertwined in the particular circumstances of the
transaction at issue. It is not helpful to speak of the threshold imposed by s.
245(3) as high or low. The words of the section simply contemplate an objective
assessment of the relative importance of the driving forces of the transaction.
Again, this is
a factual inquiry. The taxpayer cannot avoid the application of the GAAR by
merely stating that the transaction was undertaken or arranged primarily for a
non-tax purpose. The Tax Court judge must weigh the evidence to determine
whether it is reasonable to conclude that the transaction was not undertaken or
arranged primarily for a non-tax purpose. The determination invokes
reasonableness, suggesting that the possibility of different interpretations of
the events must be objectively considered.
[Emphasis added.]
[694] In the case of subparagraph 247(2)(b)(ii), I must weigh the evidence
and make an objective assessment of the relative importance of the driving
forces behind the transaction or the series to determine whether it is
reasonable to consider that the transaction or the series was not entered into
primarily for bona fide purposes other than to obtain a tax benefit.
[695] The two-prong test in paragraph 247(2)(b) recognizes that non-arm’s
length parties may enter into a transaction or series that arm’s length parties
would not. Paragraph 247(2)(b) will not capture such a transaction or series
provided the condition in subparagraph 247(2)(b)(ii) is not satisfied. This
approach appears to reflect a general observation in paragraph 1.10 of the 1995
Guidelines:
1.10 A practical difficulty in applying the arm’s length principle
is that associated enterprises may engage in transactions that independent
enterprises would not undertake. Such transactions may not necessarily be
motivated by tax avoidance but may occur because in transacting business
with each other, members of an MNE group face different commercial
circumstances than would independent enterprises. . . .
[Emphasis added.]
[696]
Paragraph 247(2)(d) is sometimes referred to as
a recharacterization rule.
However, strictly speaking, paragraph 247(2)(d) does not authorize the Minister
to recharacterize the transaction or series identified in the preamble. Rather,
paragraph 247(2)(d) authorizes the Minister to identify an alternative
transaction or series that in the same circumstances would be entered into by
arm’s length parties in place of the transaction or series and then to make an
adjustment that reflects arm’s length terms and conditions for that alternative
transaction or series.
Because the adjustment is based on the arm’s length terms and conditions of an
alternative transaction or series, the adjustment may alter the quantum or the
nature of an amount.
[697]
The 1995 Guidelines recognize and explain the
difference between the recharacterization of a transaction and the use of an
alternatively structured transaction as a comparable uncontrolled transaction. Only the latter approach is
taken in paragraph 247(2)(d).
[698]
The 1995 Guidelines also state that the arm’s
length principle, as expressed in Article 9 of the OECD Model Tax Convention (the
“Model Convention”), permits the
recharacterization of a transaction in exceptional circumstances. However, the text of Article
9 is quite different from the text of subsection 247(2). The 1995 Guidelines
reproduce a condensed (but accurate) version of Article 9 as follows:
[When] conditions are made or imposed
between . . . two [associated] enterprises in their commercial or financial relations
which differ from those which would be made between independent enterprises,
then any profits which would, but for those conditions, have accrued to one of
the enterprises, but, by reason of those conditions, have not so accrued, may
be included in the profits of that enterprise and taxed accordingly.
[699]
While it is true that the purpose of subsection
247(2) is to implement the arm’s length principle in Canada’s domestic tax law
in order to protect Canada’s tax base, Parliament has chosen text that is quite
different from the text in Article 9 of the Model Convention. Consequently,
although the general thrust of Canada’s domestic transfer pricing rule is no
doubt consistent with the arm’s length principle described in the Model
Convention, regardless of the meaning given to Article 9 by the 1995
Guidelines, the determination of the application and scope of the domestic
transfer pricing rules must be based on the text chosen by Parliament, interpreted
according to accepted principles of statutory interpretation. As stated by the
Supreme Court of Canada in Canada v. GlaxoSmithKline Inc., 2012 SCC 52,
[2012] 3 S.C.R. 3 (“GlaxoSmithKline”) the
objective is to interpret the domestic law, and in that regard the 1995
Guidelines are not controlling as if a Canadian statute.
(1) The Preamble
[700]
The preamble asks whether a taxpayer and a
non-arm’s length non-resident are participants in a transaction or series or
transactions. The Appellant is a taxpayer and CESA/CEL and Cameco US are non-arm’s
length non-residents.
[701]
The Respondent submits that all the transactions
undertaken by the Appellant and/or CESA/CEL are part of a single series that
started with the reorganization in 1999 and that this series must be tested
against the transfer pricing rules. While the text of the preamble read in
isolation might support such an interpretation, the rules of statutory
interpretation require that the text of the preamble be read in context and
with regard to the purpose of section 247:
[T]he words of an Act are to be read in
their entire context and in their grammatical and ordinary sense harmoniously
with the scheme of the Act, the object of the Act, and the intention of
Parliament.
[702]
Paragraph 247(2)(a) asks if the terms and
conditions made or imposed in respect of the transaction or in respect of the
series depart from arm’s length terms and conditions. Paragraph 247(2)(b) asks
about the purpose of the transaction or series and whether arm’s length persons
would enter into the transaction or the series. Paragraphs 247(2)(c) and (d)
each require a substitution of the terms and conditions that arm’s length
persons would agree upon in the circumstances, determined either by reference
to the actual transaction or series or by reference to an alternative
transaction or series.
[703]
The focus of paragraphs 247(2)(a) through (d) on
a comparative and substitutive analysis is the hallmark of the arm’s length
principle as explained in the 2010 Guidelines:
By seeking to adjust profits by reference to
the conditions which would have obtained between independent enterprises in
comparable transactions and comparable circumstances (i.e. in
“comparable uncontrolled transactions”), the arm’s length principle follows the
approach of treating the members of an MNE group as operating as separate
entities rather than as inseparable parts of a single unified business. Because
the separate entity approach treats the members of an MNE group as if they were
independent entities, attention is focused on the nature of the transactions
between those members and on whether the conditions thereof differ from the
conditions that would be obtained in comparable uncontrolled transactions. Such
an analysis of the controlled and uncontrolled transactions, which is referred
to as a “comparability analysis”, is at the heart of the application of the
arm’s length principle.
[Emphasis added.]
[704]
To allow for a meaningful comparative or
substitutive analysis, the transaction or the series identified in the preamble
must be susceptible of such an analysis. An overly broad series renders the
analysis required by the transfer pricing rules impractical or even impossible
by unduly narrowing (possibly to zero) the set of comparable circumstances and
substitutable terms and conditions.
[705]
The series identified by the Respondent includes
a wide range of transactions, some of which are between a taxpayer and a
non-arm’s length non-resident (e.g., the Appellant and CESA/CEL), some of which
are between non-resident persons dealing at arm’s length (e.g., CESA/CEL and
Tenex and CESA/CEL and Urenco) and some of which are between non-arm’s length
non-residents that are not taxpayers
(e.g., CESA/CEL and Cameco US and CESA/CEL and the US Subsidiaries). How does
one apply the analysis required by the transfer pricing rules to such a series?
[706]
The answer is not that one simply disregards all
the transactions that did take place and taxes the Appellant as if nothing in
fact occurred because arm’s length persons would not have entered into the
series. Such an approach uses the series to define the result and in so doing
completely disregards the purpose and focus of the transfer pricing rules by
circumventing the comparability analysis that is at the heart of the rules.
[707]
An interpretation of the preamble that
identifies transactions and/or series susceptible of the analysis dictated by
paragraphs 247(2)(a) through (d) allows a meaningful, predictable and practical
application of the arm’s length principle embodied in subsection 247(2), which
in turn promotes certainty, predictability and fairness.
[708]
Importantly, the identification of a particular
transaction or a particular series does not preclude consideration of the
broader circumstances in applying the analysis required by paragraphs 247(2)(a)
through (d) to that transaction or series. The jurisprudence of the Supreme
Court of Canada and the Federal Court of Appeal makes clear the fact that all
relevant circumstances must be considered in the application of the current and
past versions of the transfer pricing rules in the ITA.
[709]
Consistent with my interpretation of subsection
247(2), I have identified the following transactions or series of transactions:
1. The series of transactions comprised
of the incorporation of CESA, the decision by the Appellant to designate CESA
as the Cameco Group signatory to the HEU Feed Agreement, CESA’s execution of
the HEU Feed Agreement and the Appellant’s guarantee with respect to CESA’s
obligations under the HEU Feed Agreement (the “Tenex Series”).
2. The
series of transactions comprised of the incorporation of CESA, the decision by
the Appellant to designate CESA as the Cameco Group signatory to the Urenco
Agreement, CESA’s execution of the Urenco Agreement and the Appellant’s guarantee
with respect to CESA’s obligations under the Urenco Agreement (the “Urenco
Series”).
3. The
transactions consisting of the Appellant and CESA/CEL entering into the BPCs
and the Appellant delivering uranium to CESA/CEL under the BPCs (the “BPC
Transactions”). In identifying each sale under the BPCs as a separate
transaction, I am cognizant of the fact that I could classify the Appellant’s
deliveries of uranium under each BPC as a series of transactions. However, I
have concluded that the most effective way to test these deliveries against the
arm’s length principle is to address each delivery separately. In my view, identifying each
delivery as a separate transaction does not preclude an analysis of the terms
and conditions of the BPCs having regard to all deliveries contemplated by
those contracts since, in conducting any transfer pricing analysis, all the
relevant circumstances must be considered.
4. The
transactions consisting of the Appellant and CESA/CEL entering into the CC
Contracts and CESA/CEL delivering uranium to the Appellant under the CC Contracts
(the “CC Transactions”).
[710]
I will refer to the Tenex Series and the Urenco Series,
collectively, as the “Series” and to the BPC
Transactions and the CC Transactions collectively as the “Transactions”.
[711]
With respect to the Tenex Series, the Appellant
submits that the decision to allow CESA to become a signatory to the HEU Feed
Agreement and CESA signing the HEU Feed Agreement are events without tax
attributes and therefore cannot be subject to the transfer pricing rules.
[712]
I disagree. I can appropriately apply the
transfer pricing rules to the series of transactions by which the Appellant
brought about CESA/CEL’s participation in the transactions with Tenex and
Urenco. The question raised by the transfer pricing rules in this context is
whether the Appellant’s placement in CESA/CEL of the future transactions with
Tenex and Urenco warrants an adjustment. The fact that that placement occurs
through a series of transactions that does not involve a specific transaction
that is susceptible of adjustment is not a bar to the application of the
transfer pricing rules because in this case the rules are addressing the series
of transactions by which that placement occurred and not the individual transactions
comprising the series. Also, while the Series took place prior to the Taxation
Years, an adjustment required under the transfer pricing rules could apply to
the Taxation Years.
(2) Paragraphs 247(2)(b) and (d)
a) Introduction
[713]
The question asked by subparagraph 247(2)(b)(i) is
whether the Transactions or the Series would have been entered into by persons
dealing at arm’s length.
[714]
In my view, subparagraph 247(2)(b)(i) is not
asking the Court to speculate as to what arm’s length persons might or might
not have done in the circumstances. Rather, the subparagraph is asking whether
the transaction or series under scrutiny would have been entered into by arm’s
length persons acting in a commercially rational manner. The focus of the test
is the commercial rationality (or irrationality) of the transaction or series,
taking into consideration all relevant circumstances. The determination of whether
a transaction or a series is commercially rational requires an objective
assessment of the transaction or series, and that assessment may be aided by
expert opinion.
[715]
If a transaction or series is commercially
rational then it is reasonable to assume that arm’s length persons would enter
into the transaction or series. The fact that the transaction or series is
uncommon or even unique does not alter this assumption. If a transaction or
series is not commercially rational then it is reasonable to assume that arm’s
length persons would not enter into the transaction or series.
[716]
If a taxpayer and a non-arm’s length
non-resident enter into a transaction or series that is not commercially
rational, then subparagraph 247(2)(b)(ii) comes into play. As recognized in the
1995 Guidelines, non-arm’s length persons may enter into transactions or series
that arm’s length persons would not.
Subparagraph 247(2)(b)(ii) ensures that that fact alone does not trigger the
Minister’s right to substitute an alternative arm’s length transaction or
series for the actual transaction or series.
b) The Application of Paragraphs 247(2)(b) and (d) to the Series and
the Transactions
i.
The Series
[717]
With respect to the Series, one’s initial
reaction might be: why would any person pass up the business opportunity represented
by the HEU Feed Agreement and the Urenco Agreement? The expert evidence of
Doctors Shapiro and Sarin explains why that reaction is simply wrong.
[718]
The analysis on this point in the Shapiro-Sarin Report is summarized earlier in these
reasons.
In his examination in chief, Doctor Sarin succinctly summarizes the point as
follows:
Any entity would be willing to give up a
business opportunity as long as they are fairly compensated for giving up that
opportunity. So the only question really is: What’s the appropriate arm’s-length
price for that opportunity?
[719]
I accept this opinion and conclude that it is
commercially rational for a person to give up a business opportunity and that
the correct focus in such a situation is the compensation received for doing so.
The issue of arm’s length compensation is addressed by paragraphs 247(2)(a) and
(c).
[720]
The Appellant originally sought to secure its
own a deal with Tenex and commenced negotiations with Tenex in early 1993. At
some point in 1996, the Appellant decided to team up with Cogema, an arm’s length competitor,
and the Appellant and Cogema submitted a joint proposal to Tenex on
January 27, 1997. A short time later, Nukem, an arm’s length uranium
trader and a smaller player in the uranium industry, was added to the proposal
as a ten percent participant. This resulted in the first tentative
agreement with Tenex in August 1997.
[721]
The Appellant’s reason for entering into the
arrangement with Cogema and Nukem was to mitigate financial risk. The Appellant
joined forces with Cogema and Nukem even though a joint proposal would result
in a dilution of the Appellant’s share of any agreement reached with Tenex.
Cogema and Nukem had been negotiating with Tenex, so their decision to join
forces with the Appellant also entailed a decision to accept a smaller
percentage of any agreement reached with Tenex. In short, everyone involved
gave up a business opportunity to achieve other objectives.
[722]
The United States Tax Court has held that a U.S.
parent of a corporate group is free to establish subsidiaries and to decide
which among its subsidiaries will earn income, and that the mere power to do so
cannot justify reallocating the income earned by that subsidiary. Implicit in the
United States Tax Court’s view is that the behaviour of the parent corporation
in establishing subsidiaries and placing business opportunities in those
subsidiaries is not commercially irrational. I would go so far as to suggest
that such behaviour is a core function of the parent of a multinational
enterprise.
[723]
The foreign affiliate regime in the ITA
contemplates Canadian corporations establishing subsidiaries (foreign
affiliates) in foreign jurisdictions to carry on active businesses in those
jurisdictions. The general thrust of the regime is that a foreign affiliate
resident in a jurisdiction with which Canada has an income tax convention (a “treaty jurisdiction”) may earn income from an active
business carried on in that treaty jurisdiction or in another treaty
jurisdiction without attracting Canadian income tax either at the time the
income is earned or at the time the income is returned to its Canadian resident
parent corporation as dividends.
[724]
Canada’s foreign affiliate regime has complex
rules that ensure that only income from an active business is exempt from
Canadian tax. Income from other sources is foreign accrual property income
(FAPI) that is taxed in Canada in the hands of the Canadian parent corporation.
CESA/CEL’s sales of UF6 to the Appellant are an example of an
activity that is deemed by the foreign affiliate regime to give rise to FAPI.
[725]
The purpose of the foreign affiliate regime is
to allow Canadian multinationals to compete in international markets through
foreign subsidiaries without attracting Canadian income tax. The tax plan
conceived and implemented by the Appellant sought to take advantage of the
foreign affiliate regime by having a contract with an arm’s length non-resident
person (Tenex) executed by a controlled foreign affiliate of the Appellant.
[726]
There is nothing exceptional, unusual or
inappropriate about the Appellant’s decision to incorporate CESA and have CESA
execute the HEU Feed Agreement. To the extent that the Appellant’s
implementation of the decision raises transfer pricing concerns, paragraphs
247(2)(a) and (c) address those concerns. The application of the extraordinary
remedy in paragraphs 247(2)(b) and (d) is neither warranted nor appropriate in
the circumstances.
[727]
Doctor Wright provides the following
criticism of the Shapiro-Sarin Report’s analysis of the arrangements with
Tenex:
30. The Shapiro Report states that the
primary value of the HEU Agreement was control over the market. I agree. Then,
the Shapiro Report states that because the benefit was socialized (i.e., the
contract benefited the entire industry), it did not matter which company signed
the contract as long as it was someone with “aligned interests.” I agree to the
extent that the signer could be any company that had substantial uranium
business and was recognized as such in the industry. However, the Shapiro
Report does not address whether CEL, at the time the Tenex and Urenco deals
were signed, was a substantial player in the uranium industry, whether CEL was
viewed as such by the industry, and, more important, by Tenex/Urenco.
31. In fact, at the time that the HEU
Agreement was signed, neither Tenex nor Urenco was willing to sign a contract
with CEL without a CCO performance guarantee. It may be that Tenex/Urenco
signed the contracts because they viewed them to be between themselves and CCO
(through the guarantee); however, if CEL had been unrelated to the Cameco Group
it may be that the HEU Agreement would never have become a CEL contract. This
is a judgment, based on the facts, that is necessary before the benefits
attributable to the HEU Agreement can be placed in CEL.
32. Once again, the Shapiro Report discusses
this issue in the context of third-party arrangements without addressing
whether CEL was similar to the hypothetical third-party participant in the
transactions discussed.
[728]
Doctor Wright does not challenge the
commercial rationality of allowing another person to enter into the HEU Feed
Agreement. In fact, Doctor Wright suggests that an appropriate arm’s
length entity could have signed the HEU Feed Agreement instead of the
Appellant.
[729]
Doctor Barbera does not question the
commercial rationality of having CESA/CEL enter into the HEU Feed Agreement but
rather focuses on the appropriate compensation to the Appellant.
[730]
In light of the foregoing, I conclude that the
Tenex Series is not described in subparagraph 247(2)(b)(i). The same analysis
and conclusion applies to the Urenco Series.
ii.
The Transactions
[731]
The Transactions involve the making of contracts
providing for the purchase and sale of uranium and the subsequent delivery of
uranium under those contracts.
[732]
The BPCs are long-term contracts providing for
the delivery of volumes of uranium ranging from 300,000 lb to 5,000,000 lb per
year. Mr. Hayslett states in the Hayslett Report that the duration of the
BPCs is within the range reported by Ux for long-term contracts made in 1999
through 2001 but that the volumes of uranium sold under some of the BPCs
exceeded the typical demands of even large uranium consumers, which only occasionally
exceeded 1,000,000 lb per year under a single contract.
[733]
Mr. Assie testified that the Appellant deliberately
chose to enter into thirteen Long-term Contracts because it did not want to
enter into 15 to 20 contracts per year to sell its uncommitted uranium to
CESA/CEL. While this decision may have resulted in the volumes under some of
the BPCs being outside the volume range of typical retail contracts, the
volumes under those BPCs are not excessive when compared to arm’s length
wholesale contracts made during the same period. For example, the transaction
summary
for the Urenco Agreement sets out the following annual volumes:
[734]
With one relatively minor exception, the other
terms and conditions of the Appellant’s sales of uranium to CESA/CEL under the
BPCs are generally consistent with practices in the uranium industry. Mr. Hayslett states:
Based upon the review which I have conducted
of the nine contracts I would conclude that the contracts contain commercial
terms similar to the types of terms that would normally be present in uranium
sales contracts concluded by industry participants. While in some instances the
specific value or treatment of a commercial term might seem to be more
favorable to one party than the predominant treatment at that time, in my
opinion they are generally consistent with the range of values commercially
attainable during the time period late 1999 through early 2001.
[735]
The Long-term Contracts of which the BPCs are a
subset sold all of the Appellant’s uncommitted uranium production to CESA/CEL.
Doctors Shapiro and Sarin opine that a commodity producer may sell
production under a base escalated contract to secure a guaranteed revenue
stream for that production even if the expectation is that prices will move
higher.
Doctors Shapiro and Sarin describe the finance concept that explains such
behaviour:
There is a well-established concept in
finance, known as the “Certainty Equivalent,” which clearly suggests that
rational actors will accept a lower guaranteed amount in lieu of a higher
expected, but riskier, cash flow. For example, in a textbook, I explain that
The certainty equivalent of a risky
cash flow is defined as that certain amount of money that the decision maker
would just be willing to accept in lieu of the risky amount. For example,
suppose a person would be willing to trade for $15,000 a lottery ticket having
a 25 percent chance of winning $100,000 and a 75 percent chance of winning
nothing (an expected value of $25,000). We would say that the certain
equivalent of this lottery ticket is $15,000.
[736]
Doctor Barbera and Doctor Wright do not
suggest that the Appellant’s decision to sell its uncommitted uranium
production to CESA/CEL was commercially irrational. Doctor Barbera considered
the appropriate level of compensation to the Appellant for the sales and Doctor
Wright considered hypothetical scenarios based on various assumptions regarding
the functions performed by CESA/CEL.
[737]
On the basis of the foregoing, I conclude that
the BPC Transactions are not described in subparagraph 247(2)(b)(i).
[738]
The CC Transactions involved for the most part
the entering into of contracts for the sale by CESA/CEL to the Appellant of
uranium at fixed or market-based prices and the delivery by CESA/CEL to the
Appellant of uranium under those contracts. The contracts are either for single
deliveries or for deliveries over a relatively short period of time. I can
discern nothing commercially irrational about the CC Transactions. Accordingly,
I have concluded that the CC Transactions are not described in subparagraph
247(2)(b)(i).
[739]
Although the foregoing dispenses with the
application of paragraphs 247(2)(b) and (d), to be complete, I will also
address subparagraph 247(2)(b)(ii). The question asked by subparagraph
247(2)(b)(ii) is whether the purpose of the transaction or the series of
transactions was primarily to save tax. This determination must be made having
regard to all the relevant circumstances.
[740]
Mr. Assie and Mr. Goheen freely admitted that
the impetus behind, and the object of, the reorganization undertaken in 1999
was to increase the after-tax profit of the Cameco Group by reducing the incidence
of tax on profits from the sale of uranium. No doubt the Appellant considered
other factors, such as the best jurisdiction for CESA/CEL, in determining how
best to implement the reorganization. However, such considerations do not alter
the purpose of the reorganization, which was to save tax and thereby increase
after-tax profit. To state it another way, it is clear that the Appellant would
not have implemented the reorganization were it not for the expectation of tax
savings. I do not believe the Appellant suggests otherwise.
[741]
Considering this context, I find as a fact that
the primary purpose of the Series was to save the tax that would have been
payable in Canada if the Appellant had entered into the contracts with Tenex
and Urenco directly. In fact, the only reason for the Tenex Series, as
evidenced by the initial focus of the tax plan conceived by Mr. Goheen,
was to save Canadian tax. Although the tax would only be saved if a profit was
earned from the agreements with Tenex and Urenco, this does not detract from
the fact that the purpose of the Series was to save Canadian tax.
[742]
My finding that the principal purpose of the
Tenex Series and the Urenco Series was to save tax must not to be taken as a
condemnation of the Appellant’s behaviour. For the reasons described above, any
tax savings realized by the Appellant resulted from the application of the
foreign affiliate regime in the ITA. In taking advantage of the foreign
affiliate regime, the Appellant was simply utilizing a tax planning tool
provided by Parliament. The foreign affiliate regime has clearly defined
boundaries, as evidenced by the fact that CESA/CEL’s income from selling
uranium to the Appellant was subject to current taxation in Canada.
[743]
Unlike the Series, the primary purpose of each
of the Transactions does not simply follow the purpose of the reorganization. The
Appellant implemented the reorganization to increase the after-tax profit of
the Cameco Group by placing the profit from an active business carried on
outside Canada in a jurisdiction that imposed lower taxes than Canada. CESA/CEL
and the Appellant entered into the Transactions for the bona fide purpose of
earning a profit. To the extent a profit was earned by CESA/CEL, it was subject
to a lower rate of tax because of the reorganization. However, the tax savings
resulting from the reorganization do not alter the bona fide profit-earning
purpose of the Transactions.
(3) Paragraphs 247(2)(a) and (c)
a) Introduction
[744]
In the balance of these reasons, I will refer to
the rules in paragraphs 247(2)(a) and (c) as the “traditional
transfer pricing rules”.
[745]
In Marzen, the Federal Court of Appeal
summarized the general approach dictated by paragraphs 247(2)(a) and (c) as
follows:
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.
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.
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 had
been dealing at arm’s length. The Court also affirmed that a transfer pricing
analysis is inherently fact driven.
[746]
As stated by the Supreme Court of Canada in GlaxoSmithKline,
the application of the traditional transfer pricing rules is an inherently
fact-driven exercise. The questions of fact raised by the traditional transfer
pricing rules are typically resolved with the assistance of expert opinion.
[747]
In these appeals I have a cornucopia of expert opinion
to parse and consider. The evidence of each expert relies in part on hearsay. In
considering the expert evidence, I have been careful not to rely on any hearsay
in the expert evidence as independent proof of that hearsay.
[748]
An expert may rely on hearsay as a basis for
expert opinion provided the expert did not obtain the hearsay from a suspect
source.
An expert’s reliance on non-suspect hearsay goes to the weight given to his or
her expert evidence.
If an expert relies on unproven facts of the type reasonably relied upon by
experts in the same field, such reliance does not in and of itself diminish the
weight to be given to the evidence of the expert.
[749]
The first step under the traditional transfer
pricing rules is to determine whether the terms or conditions made or imposed,
in respect of the transaction or series, between any of the participants in the
transaction or series of transactions differ from those that would have been
made between persons dealing at arm’s length. If the answer is yes, then the
second step is to determine the terms and conditions that would have been made
between persons dealing at arm’s length in the same circumstances.
[750]
It is apparent that the traditional transfer
pricing rules are circular because the terms and conditions described by
paragraph 247(2)(c) dictate whether the condition in paragraph 247(2)(a) is
satisfied. Accordingly, in practice, the two-step approach described by the
traditional transfer pricing rules is one step since to answer the question
posed by paragraph 247(2)(a) it is necessary to consider the terms and
conditions that would have been made between persons dealing at arm’s length in
the same circumstances.
[751]
As stated in GE Capital, the task under
the traditional transfer pricing rules is to ascertain the price that would
have been paid in the same circumstances if the parties had been dealing at
arm’s length. The traditional transfer pricing rules must not be used to recast
the arrangements actually made among the participants in the transaction or
series, except to the limited extent necessary to properly price the
transaction or series by reference to objective benchmarks.
[752]
This approach is highlighted by the decisions of
the Tax Court of Canada and the Federal Court of Appeal in GE Capital,
in which one important question raised was whether the implicit support
resulting from the parent-subsidiary relationship should be ignored in
determining an appropriate price for the explicit guarantee provided by the
taxpayer’s U.S. parent. Hogan J. concluded that the implicit support
should not be ignored and Noлl J.A. (as he then was) agreed:
[52] It is important to
note that the respondent does not contend that the method adopted by the Tax
Court Judge has the effect of re-casting the transaction in an impermissible
way. The method identifies the transaction as it took place between the
respondent and GECUS and seeks to ascertain the benefit to the respondent by
comparing, based on recognized rating criteria, the credit rating associated
with the implicit support with that associated with the explicit support. The
only question is whether implicit support is a factor that can be considered
when applying subsection 69(2) and paragraphs 247(2)(a) and (c),
given that it arises by reason of the non arm’s length relationship.
[53] The Tax Court Judge
answered this question in the affirmative. I can detect no error in this
regard.
[753]
With respect to the Series, the question to be
addressed is whether arm’s length persons in the same circumstances would have attributed
value to the business opportunities. With respect to the Transactions, the
question to be addressed is whether the pricing of the Transactions reflected
arm’s length pricing, having regard to all the circumstances and to objective
benchmarks.
b) The Application of Paragraphs 247(2)(a) and (c) to the Series and
the Transactions
i.
General Comments Regarding the Expert Evidence
[754]
I find that Doctor Horst undertook a
transfer pricing analysis under the traditional transfer pricing rules that
accords with the approach endorsed in GlaxoSmithKline, GE Capital
and Marzen. Doctor Horst considered the various methodologies
endorsed in the 1995 Guidelines and determined that the CUP method provided the
most reliable results in the circumstances.
[755]
Doctor Horst identified the comparable
uncontrolled transactions utilized in his analysis and explained the
adjustments he made to eliminate the effect of the differences between the
Transactions and the comparable uncontrolled transactions.
[756]
Although this is by no means determinative, I
note that even the proposed amendments following the completion of the OECD/G20 Base Erosion and Profit Shifting Project
recognize the general appropriateness of using the CUP methodology to price
commodities:
Subject to the guidance in paragraph 2.2 for
selecting the most appropriate transfer pricing method in the circumstances of
a particular case, the CUP method would generally be an appropriate transfer
pricing method for establishing the arm’s length price for the transfer of
commodities between associated enterprises. . . .
[757]
In his testimony in chief, Doctor Sarin
makes the following general observation regarding the Respondent’s approach to
the transfer pricing issues in these appeals:
The CRA is falling in a classic economic
trap. It is looking at not the transaction as it was designed at the point in
time that it was arranged. It is looking at what was the outcome of the
transaction.
And the outcome of the transaction was that
a large Canadian taxpayer with mines and thousands of employees lost money. And
it is also the outcome of the transaction whereby, as a relatively small shop
-- one, two, three-people shop -- in Europe landed up making large amounts of
money. And the CRA views that as a problem, and there is a problem, and the problem
really is that they’re looking at the outcome of the transaction in hindsight.
The right way to think of it is looking at the transaction at the time it
actually was entered into.[823]
[758]
I find that Doctor Barbera and Doctor Wright
did not undertake the transfer pricing analysis required by the traditional
transfer pricing rules and that their expert evidence is to a significant
degree based on hindsight and on assumptions regarding the subjective views of
the Appellant and Tenex at the time the relevant transactions occurred rather
than on objective benchmarks as required by the traditional transfer pricing
rules.
[759]
Doctor Barbera describes his approach to
the Series and the Transactions as replacing the prices actually paid under the
intercompany contracts with “the prices that would have
been charged between unrelated parties conducting the same transactions under
the same or similar circumstances.”
However, the result of his analysis is not to reprice the Series or the
Transactions with reference to objective benchmarks but to replace the legal
substance of the Series and the Transactions with notional relationships in
which the Appellant had essentially all the price risk associated with the
purchase and sale of the uranium legally and factually purchased and sold by
CESA/CEL.
[760]
Doctor Barbera opines that the activities of
CESA/CEL can be divided into two separate buy-sell operations but that each
such operation is essentially equivalent to that of a routine distributor. Doctor
Barbera, ironically, observes that “[s]uch distributors
typically buy and sell products with stable prices over time.” In my
view, these conflicting statements highlight Doctor Barbera’s failure to
address the legal substance of the Series and the Transactions and his attempt
to fit the Series and the Transactions into a paradigm that ignores the
economic reality of the actual legal arrangements.
[761]
Doctor Barbera proceeds from the view that
the Appellant’s price forecasts and production cost forecasts are relevant to
the price the Appellant would accept for its uranium and to the price the
Appellant would accept for the HEU Feed Agreement. For example, Doctor Barbera
opines that in light of the Appellant’s own price forecasts and cost
expectations it would want to retain the “upside”
of the HEU Feed Agreement and would not allow CESA/CEL to achieve more than a
routine distributor’s return from the HEU Agreement.
[762]
In my view, the subjective views of the
Appellant are not relevant to the transfer price of the Series or the
Transactions, which involve dealings in a commodity with a market-determined
value. The Appellant had no control over the market price of uranium and the
Appellant’s price and production cost forecasts had no bearing on the market
price of uranium. Nor do these factors have any bearing on what terms and
conditions arm’s length persons would agree to in the same circumstances. A
person’s subjective view of a market is not an objective benchmark and reliance
on such views introduces intolerable uncertainty into the transfer pricing
rules.
[763]
Doctor Barbera opines that the HEU Feed
Agreement was not a comparable because Tenex was likely motivated by different
considerations than a typical uranium producer. Doctor Barbera’s assumptions
regarding the forces driving Tenex are pure speculation and, unless there is
clear evidence of an inequality of bargaining power, such considerations are
not relevant to the validity of the HEU Feed Agreement as an arm’s length
comparable.
[764]
In addition to the foregoing concerns, I am
unable to reconcile the calculations in the expert reports of Doctor Barbera with the adjustments set out
in schedules to the Respondent’s pleadings. I have therefore concluded that
Doctor Barbera’s opinions are in substance addressing the Respondent’s
position under paragraphs 247(2)(b) and (d) and not the factual issues raised
by paragraphs 247(2)(a) and (c).
[765]
Doctor Wright performed an analysis of
various hypothetical scenarios involving the performance of various functions,
but did not provide any transfer prices as such. Again, the hypothetical
scenarios appear to be in support of the Respondent’s position under paragraphs
247(2)(b) and (d).
[766]
The 1995 Guidelines state the following
regarding a functional analysis:
The functions that taxpayers and tax
administrations might need to identify and compare include, e.g., design,
manufacturing, assembling, research and development, servicing, purchasing,
distribution, marketing, advertising, transportation, financing, and
management. . . . While one party may provide a large number of functions
relative to that of the other party to the transaction, it is the economic
significance of those functions in terms of their frequency, nature, and value
to the respective parties to the transactions that is important.
[767]
My main concern with the functional analysis of
Doctor Wright is that she fails to recognize the economic significance of
the core functions performed by CESA/CEL and Cameco US, i.e., purchasing,
marketing and selling a commodity the value of which is market-driven. While
transportation, financing and management may have played a role, I do not
accept that these functions were economically significant in relation to the
core functions. With respect to financing, Doctor Chambers opined:
Arms-length counterparties would have
incorporated CEL’s relationship with and support by its parent in assessing
whether or not to enter into substantial contracts with CEL. That parental
support, along with CEL’s stand-alone position, would have made CEL a credible
counterparty, able to fulfill its obligations under purchase and sales
contracts, financing and other business dealings from 2002 onwards.
[768]
In short, the implicit support provided to
CESA/CEL by the Appellant would be factored into any financial assessment of
CESA/CEL just as such parental support was factored into the determination of
an arm’s length guarantee fee in General Electric.
ii.
The Series
[769]
With these general comments in mind, I will
address the Tenex Series and the Urenco Series first. The Respondent submits
that, with respect to the HEU Feed Agreement and the Urenco Agreement, the
Appellant knew it had negotiated valuable business opportunities, and that it
placed these opportunities in CESA/CEL by allowing CESA/CEL to enter into the
HEU Feed Agreement and the Urenco Agreement.
[770]
With respect to the Tenex Series, Doctor Barbera
relies on the Appellant’s price forecasts, cost estimates and price of
acquiring UF6 from Tenex to justify the conclusion that the
Appellant would not allow CESA/CEL to earn anything more than a routine
distributor’s return from entering into the HEU Feed Agreement. On the basis of
the arm’s length agreements between Nukem and Kazatomprom and between Nukem and
Sepva-Navoi, Doctor Horst estimates the gross margin for a routine
distribution function to be between 8% and 11.9%.
[771]
In the Horst Rebuttal of Barbera,
Doctor Horst reviews Doctor Barbera’s analysis of CESA/CEL’s
execution of the HEU Feed Agreement and opines:
But whether the appropriate gross margin for
CEL and CCO was 8% or 11.9%, Tenex’s offer to sell UF6 under an EBP
method that allowed an 8% discount from the Escalated TradeTech Base Price
provided no unearned windfall for CEL and CCI taken together. If there is no
unearned windfall for CEL and CCI, there is no economic basis for the Barbera
Report’s conclusion that CCO was entitled to a share of that gross margin. . .
.
[772]
In rebutting Doctor Barbera’s analysis,
Doctor Horst assumes that the maximum value of the HEU Feed Agreement at
the time it was executed by CESA/CEL was equal to the discount on market price
provided for in the default pricing mechanism. Of course, the discounted price
also had to exceed the floor price initially set at US$29 per kgU. In my view,
Doctor Horst’s assumption regarding the value of the HEU Feed Agreement is
conservative and more than justifies the conclusion that no adjustment is
required under the traditional transfer pricing rules because of the Tenex
Series.
[773]
In the case of an arm’s length bilateral
agreement to purchase and sell a commodity with a market-determined value,
absent evidence to the contrary, it is reasonable to assume that at the
inception of the agreement the consideration agreed to be given by one of the
parties to the agreement is equal to the consideration agreed to be given by
the other party to the agreement. Otherwise, one party would be transferring
value to the other party for no consideration, which is inconsistent with the
behaviour of persons dealing at arm’s length.
[774]
Doctors Shapiro and Sarin explain this point
in their rebuttal of Doctor Barbera’s analysis of the HEU Feed Agreement:
In establishing the ex-ante value of
the contracts between CEL and Tenex, it is critical to understand that these
were arm’s length contracts. The Tenex agreement was intensely negotiated over
a period of years by four parties dealing at arm’s length, with each party
clearly looking to its own interests. The resulting arm’s length transactions
reflected market conditions at the time.
Tenex was acting in its own interest, and
would not grant Cameco access to their HEU material at prices that were
expected to yield risk-free gross margins of 35 percent. As noted by Dr.
Barbera (paragraph 220), no profit-maximizing company would give away
potentially significant value. Instead, the price at which Tenex agreed to
sell HEU would be commensurate with expected market prices and the risks being
borne by the Cameco Group.
Similarly, CCO would not have sought
partners in Cogema and Nukem if the Tenex transaction was expected to yield
risk-free gross margins of 35 percent. Instead, the coparticipation reflects
the desire to spread the risks of participation, as demonstrated in our
affirmative report.
While the Tenex transaction turned out to be
highly profitable, this is because the price of uranium unexpectedly rose
sharply. At the time the deal was reached, this was not known, and to conclude
that parties negotiating at arm’s length left so much money on the table is
contrary to economic logic.
[Emphasis added.]
[775]
The evidence shows that the driving force behind
the Appellant’s negotiation with Tenex was the desire to control the sale of
the HEU feed to avoid it being dumped on the market thereby depressing the
market price of uranium. The Appellant also did not want Nukem alone to secure
an agreement with Tenex for fear that Nukem would sell the HEU feed on the spot
market with the same effect.
[776]
The evidence does not support the Respondent’s
position that the Appellant viewed the HEU Feed Agreement as giving rise to an
economic windfall for the Appellant. Rather, the evidence supports the
conclusion that, as of the date on which the HEU Feed Agreement was executed by
CESA/CEL and Tenex, the agreement had no intrinsic economic value because the
obligations on each side were balanced.
[777]
The Appellant started negotiating an agreement
with Tenex in early 1993. In 1996, the Appellant agreed with Cogema to jointly
negotiate an agreement for the HEU feed with Tenex and shortly thereafter Nukem
joined this joint effort. The Appellant did not require compensation from
Cogema or Nukem for this new arrangement even though the Appellant had been
negotiating an agreement with Tenex since early 1993. Conversely, Cogema and
Nukem did not require compensation from the Appellant for its taking on a
percentage of any agreement reached with Tenex. The lack of consideration
flowing in either direction reflects the rational expectation of all three
arm’s length parties that any agreement reached with Tenex would have no
intrinsic economic value at the time it was made.
[778]
On April 13, 1999, shortly after the
HEU Feed Agreement was executed, Mr. Goheen reported to the Executive
Committee of the Appellant that the expected gross profit from the HEU Feed
Agreement was 4% through 2002 and 6% thereafter. Mr. Assie explained that
the projected gross profit assumed that 92% of the spot price for restricted UF6
reported by TradeTech and Ux for the previous month would exceed the US$29 per
kgU floor price so that CESA/CEL could exercise the FOENs and realize an 8%
gross profit less its expenses. In fact, the discounted market price for UF6
did not exceed the floor price until 2002, which suggests that, at least
initially, Mr. Assie’s prediction regarding profitability was optimistic.
[779]
With respect to the spot price benchmarks used
in the HEU Feed Agreement, Doctors Shapiro and Sarin observe that in the
first quarter of 1999 the TradeTech spot price indices for uranium sourced from
Russia and other areas within the former Soviet Union were 10% to 20% lower
than for uranium from other geographic sources. Since the benchmark for “restricted” uranium (i.e., uranium that can be sold
into restricted countries such as the United States) used in the HEU Feed
Agreement did not reflect this 10% to 20% discount, one might reasonably
conclude that the benchmark used in the HEU Feed Agreement overstated the
market value of the HEU feed even after application of the 8% discount.
[780]
The Respondent submits that Tenex did not have
the resources to sell the HEU feed itself and that this leads to the conclusion
that Tenex agreed to terms and conditions that resulted in a valuable business
opportunity for the Appellant, which it passed on to CESA/CEL.
[781]
However, in a confidential memorandum dated
January 4, 1999, Mr. Grandey explained that the western
consortium was in fact focused on various options that would allow the
Appellant, Cogema and Nukem to purchase the HEU feed at market prices
notwithstanding the Russian state requirement that the price of the HEU feed be
no lower than a minimum of US$29 per kgU. There is no discussion in the
memorandum of a windfall to the western consortium and the clear focus of
Mr. Grandey, the lead negotiator for the western consortium, is the
reduction of the financial risk associated with an agreement with Tenex for the
HEU feed that included a “high” floor price. The
approach ultimately settled on by the western consortium and Tenex was to use
options (FOENs) so that the Appellant, Cogema and Nukem would not be required
to purchase the HEU feed at above market prices.
[782]
The market price of uranium declined in the
second half of 1999 and in 2000 so there was no economic reason for the western
consortium to exercise the options in the HEU Feed Agreement. Nevertheless, in
2000, the western consortium committed to purchasing the quota amount of
UF6 to show good faith to Tenex and the U.S. government. On June 7, 2000
CESA’s management committee discussed the anticipated losses from exercising
the options:
The income statement for the year 2000 as
reforecasted provides for a loss of approximately $2.5 million. This is, in
essence, due to the fact that the remaining sales in the year 2000 are composed
largely of HEU feed material. This is being purchased from Tenex at a minimum
price as provided for in the HEU Agreement which is, as a result of the recent
negative uranium market development, exceeding the present spot market price.
The latter is, however, the basis for the contemplated sale of the HEU feed to
Cameco Corporation later this year thereby resulting in a loss. It is expected,
as G. Glattes explained, that this recent price trend will turn around with the
predicted upswing of the uranium market. The continuation of purchases by CSA
under the HEU Agreement is, as G. Glattes went on, important from a broader
corporate perspective in light of the medium and long-term benefits which are
connected with the HEU Agreement for the company and the stability of the
uranium market.
The Management Committee expressed its
concern regarding the extent of losses to be expected and will continue to
closely monitor the further developments.
[783]
Tenex was not happy with the volumes of HEU feed
being purchased by the western consortium and, following further negotiations,
the HEU Feed Agreement was amended on November 8, 2001 to reduce the
floor price from US$29 per kgU to US$26.30 per kgU in exchange for the exercise
by the western consortium of options for delivery of HEU feed in 2002 through
2013.
[784]
The Respondent submits that the Appellant
negotiated the HEU Feed Agreement and the amendments to that agreement and
passed the value of the negotiations on to CESA/CEL.
Doctors Shapiro and Sarin opine that the cost of negotiation was a
sunk cost that was not relevant to whether the HEU Feed Agreement had intrinsic
economic value at the time the parties executed the agreement. I agree with
Doctors Shapiro and Sarin that negotiation in and of itself does not
determine the value of an agreement reached as a result of the negotiation. The
proper focus is on the terms and conditions that result from the negotiation,
not on the negotiation itself.
[785]
According to Doctors Shapiro and Sarin, the
only factors that a rational economic actor would consider in determining the
value of an agreement at its inception are the future benefits and costs of the
agreement. Since the principal benefit of the HEU Feed Agreement–controlling
the supply of the HEU feed–benefited everyone in the market at the time, it did
not matter who executed the agreement to achieve that benefit.
[786]
The evidence recited above leads to the
conclusion that the economic benefit of participating in the HEU Feed Agreement
was negligible at the time the parties executed the agreement in March 1999.
While there is no doubt that CESA/CEL was afforded an opportunity, whether that
opportunity had a positive or negative value depended on uncertain future
events. A reasonable view of the circumstances, however, is that the HEU Feed
Agreement would have had a negative value to CESA/CEL in March 1999 but
for the optionality of the agreement, which was negotiated to address that
concern. The optionality in the HEU Feed Agreement was eliminated in 2001 with
the execution of the fourth amendment.
[787]
There is no doubt that after 2002 the HEU Feed
Agreement became very valuable to CESA/CEL. However, that value resulted from a
significant rise in the market price of uranium after 2002, which, at the time they
executed the HEU Feed Agreement and the fourth amendment, the parties did not
know would occur.
[788] On the basis of the foregoing, I conclude that there is no evidence
warranting an adjustment with regard to the Appellant because of the Tenex
Series.
[789]
The analysis of the Urenco Series is similar but
not identical to the analysis of the Tenex Series.
[790]
Mr. Assie testified that the possibility of an
agreement with Urenco was first identified in the spring or early summer of
1999. The Urenco Agreement was executed by CESA/CEL on September 9, 1999.
Mr. Assie stated that the objective of the Urenco Agreement was twofold. The
first objective was to avoid Urenco dumping UF6 onto the market and
depressing the market price of uranium. The second objective was to provide a
trading opportunity for CESA/CEL. Mr. Assie and Mr. Britt took the
lead in negotiating the Urenco Agreement on behalf of CESA/CEL.
[791]
Mr. Glattes testified that Mr. Britt
led the negotiation but that he himself had a close relationship with senior
personnel at Urenco and that every step of the negotiation with Urenco was
discussed at the sales meetings. As I have stated before, Mr. Glattes has
a wealth of experience in the uranium industry and clearly garnered the respect
of others in the Cameco Group. I accept Mr. Glattes’ testimony that he had
input into the negotiations even if he did not lead the negotiations or recall
attending specific meetings with Urenco.
[792]
Mr. Assie testified that he and
Mr. Britt worked closely with Mr. Glattes, that they kept Mr. Glattes
fully informed regarding the negotiations with Urenco and that Mr. Glattes
dealt with the European regulatory issues that had to be resolved for CESA/CEL
to purchase UF6 from Urenco. The regulatory issues associated with
the purchase and sale of uranium are no doubt of significant importance.
[793]
The Urenco Agreement fixed the price of the UF6
at a base escalated price starting at US$25.05 plus 50% of the amount by which
the spot price exceeded US$30.10 (this spot price being based on specified spot
price indices). No UF6 was delivered under the original Urenco
Agreement.
[794]
The Urenco Agreement included a clause that
allowed CESA/CEL to renegotiate the agreement if the price of uranium remained
below a stipulated threshold for six months. If the renegotiation failed then
CESA/CEL could cancel the agreement. The price of uranium did remain below the
threshold and the agreement was renegotiated, resulting in Amendment No. 1
dated August 8, 2000.
[795]
Amendment No. 1 reduced the price for
UF6 delivered in 2000 to US$22.50 per kgU and amended the base escalated
price for 2001 onward to US$22.50 plus 50% of the amount by which the spot
price exceeded US$27.55 (this spot price being based on specified spot price
indices).
[796]
Amendment No. 1 also had a
renegotiation clause and once again the price of uranium remained below the
threshold price, resulting in renegotiation and in Amendment No. 2
dated April 11, 2001. Amendment No. 2 further reduced the
price for the UF6.
[797]
The UF6 to be delivered by Urenco
under the Urenco Agreement was acquired by Urenco under an agreement with Tenex
whereby Urenco delivered its uranium tails to Tenex and Tenex delivered UF6
to Urenco.
Urenco had no guarantee that Tenex would deliver UF6 in exchange for
its tails so Urenco’s supply of UF6 was uncertain. The UF6
delivered by Urenco was considered to be of Russian origin.
[798]
Doctor Barbera opined that the Appellant would
not have allowed an arm’s length party to enter into the Urenco Agreement
and applied the same analysis he applied to the HEU Feed Agreement.
In doing so, Doctor Barbera assumed that Cameco US would sell the UF6
purchased from Urenco at the spot prices forecast by the Appellant.Doctor Barbera’s analysis
does not distinguish between an agreement, such as the HEU Feed Agreement,
negotiated prior to the existence of the subsidiary that signs the agreement
and an agreement negotiated on behalf of the subsidiary that signs the
agreement.
[799]
In this case, Cameco Group identified a possible
business opportunity to purchase UF6 from Urenco and that
opportunity was pursued by Mr. Britt and Mr. Assie on behalf of
CESA/CEL. Since the negotiation with Urenco was on behalf of CESA/CEL, the
actual business opportunity represented by the Urenco Agreement was CESA/CEL’s
from the start. Even if it was the Appellant’s decision to have CESA/CEL pursue
the opportunity, that decision alone does not warrant a transfer pricing
adjustment.
[800]
The fact that Mr. Britt and Mr. Assie
led the negotiation for the Urenco Agreement does not mean that CESA/CEL received
a windfall when it executed the Urenco Agreement or the amendments to that
agreement. If there is a transfer pricing issue because of Mr. Britt’s and
Mr. Assie’s involvement in the negotiations, that issue is whether Cameco
US should have been compensated for the time of its employees. However, since
Cameco US also benefited from an agreement with Urenco because of its 2%
commission on sales of Urenco UF6, it is unlikely such a transfer
pricing issue exists.
[801]
As with the HEU Feed Agreement, the
mere possibility that CESA/CEL could earn a profit by purchasing Urenco’s UF6
and selling it in the market is not evidence that the Urenco Agreement had
value that accrued to CESA/CEL at the time the agreement was executed. Nor do
the Appellant’s price forecasts determine the value of the agreement. The
Urenco Agreement was negotiated by persons dealing at arm’s length, which means
that each party took on contractual obligations and that at the time the
agreement was executed the respective values of these obligations cancelled
each other out. There is no evidence to support a different view regarding the value
of the Urenco Agreement.
[802]
The Urenco Agreement (as amended) may have
become valuable to CESA/CEL but, as with the HEU Feed Agreement, that occurred
because the market price of uranium increased significantly after 2002. Since
CESA/CEL took on the price risk when it entered into the Urenco Agreement,
CESA/CEL was entitled to the upside.
[803]
On the basis of the foregoing, I conclude that
there is no evidence warranting an adjustment with regard to the Appellant
because of the Urenco Series.
iii.
The Transactions
[804]
Doctor Barbera describes his cost plus
analysis as the most reliable means of determining the arm’s length price for
sales of uranium by the Appellant to CESA/CEL under the BPCs. The final version
of Doctor Barbera’s cost plus analysis is found in the
Barbera Addendum and the Barbera Update. Doctor Barbera opined
that his cost plus analysis required an aggregate upward adjustment to the
Appellant’s income of $238 million, which includes an upward adjustment of $22 million
for loan transactions. The adjustments are set out in Table 3 of the Barbera
Update as follows:
[805]
The 1995 Guidelines state that, in order
for the cost plus method to apply, it is necessary that either “1.) none of the
differences (if any) between the transactions being compared or between the
enterprises undertaking those transactions materially affect the cost plus mark
up in the open market; or, 2.) reasonably accurate adjustments can be
made to eliminate the material effects of such differences.”
[806]
The cost plus method implicitly assumes a
product or service with a non-volatile price. The 1995 Guidelines state that
the cost plus method “is most useful where semi-finished
goods are sold between related parties, where related parties have concluded
joint facility agreements or long-term buy-and-supply arrangements, or where
the controlled transaction is the provision of services.” The cost plus method is
valid in that context because it compares the margin earned in comparable arm’s
length transactions with the margin earned in the non-arm’s length
transactions. The objective of the cost plus analysis is to reliably identify
the magnitude of the price differences, not differences in cost.
[807]
If the cost plus method is applied to a
commodity with a potentially volatile price then the issue becomes one of how
to identify and remove the price volatility component of the arm’s length
margin. If the price volatility component cannot be removed from the arm’s
length comparable then the requirement that there be no difference that
materially affects the cost plus mark up in the open market is not satisfied.
[808]
Doctor Barbera relies on a selection of
sixteen arm’s length contracts for his benchmark. Three of the contracts are
base escalated price contracts and thirteen are market-based price contracts. Of
those thirteen, five use a capped market price formula.
[809]
Doctor Barbera uses the Appellant’s actual
results on sales of uranium to third parties under these contracts in 2003,
2005 and 2006 to determine the margin that an arm’s length person would earn on
sales of uranium under the BPCs. Doctor Barbera opines that the comparison is
valid because the Appellant entered into or renegotiated the third-party
contracts during the same 1999 to 2001 time period as that during which the
BPCs were concluded.
[810]
Doctor Horst opines that it is not possible to
reliably use contracts with market-based price mechanisms as arm’s length
comparables because the future price under such contracts depends on the future
price of uranium, which is uncertain at the time the contracts are made. Accordingly, if market-based
contracts are used to determine the arm’s length margin in a future year, the
analysis is in essence using hindsight to determine the margin because the
future price is the result of the choice made at the inception of the contract.
[811]
To understand this point, it is helpful to first
recite an opinion of Doctors Shapiro and Sarin:
Without the benefit of hindsight, no
contracting option is unequivocally better than another, and none is prima
facie irrational. Whether a supplier or consumer ends up better off under a
base-escalated contract, a pure market-price contract, or a market-price contract
with a ceiling, depends on the future price of uranium. Only in hindsight can
one know whether a particular type of contract was the right one for a buyer or
seller to enter into, and on an ex-ante basis, any choice could be
reasonable depending on counterparty preferences and other market
circumstances.
[812]
The actual price of uranium in a future year
under a market-price-based contract reflects the result of the originally
neutral choice made when the arm’s length persons agreed to the price mechanism
in the contract. In the case of a commodity with a potentially volatile price,
the future result will almost invariably favour one pricing choice over another,
different pricing choice even if the initial choices each reflected arm’s
length terms and conditions.
Accordingly, to measure the price under a non-arm’s length contract against the
result under a market-based contract is in effect to use hindsight— i.e., the
result of the original choice–since the result could not be known at the time
the contract was executed. This skews the calculation of the margin by the “result” component of the choice of price mechanism, contrary
to the 1995 Guidelines.
[813]
Doctor Horst illustrates the lack of
comparability in the sixteen contracts used by Doctor Barbera and the resulting
concern with the use of hindsight by stripping down Doctor Barbera’s cost plus
analysis to reveal that the analysis is in substance a CUP analysis.
[814]
Doctor Horst opines that the three base
escalated contracts included legacy premiums that inflated the prices in those
contracts.
Accordingly, the three base escalated contracts are not suitable for a CUP
analysis.
[815]
Doctor Horst opines that there is no way to
make reliable comparisons of the actual prices paid under intercompany capped
market price contracts and the actual prices paid under third-party capped
market price contracts. Doctor Horst provides the following explanation:
. . . Suppose that a uranium supplier
received requests for quotations from two unrelated buyers (Buyer A and Buyer
B), both of whom requested a CMP formula. Suppose that the seller gave both
buyers a choice between (1) paying 100% of the spot price at the time of
delivery, but subject to a ceiling price of $12.00 per pound, and (2) paying
95% of the spot price at the time of delivery, but subject to a ceiling price
of $14.00 per pound. Buyer A was concerned that uranium spot prices would
appreciate strongly during the term of the agreement and elected the first
option. Buyer B was less concerned than Buyer A about appreciation of spot
prices and elected the second option.
Which buyer will pay a lower price at the
later date when a delivery is made under their respective agreements? Using
algebra, it is easy to determine that:
Because future spot prices are very
uncertain, there is no reliable way of determining at the time the agreement is
negotiated whether Buyer A or Buyer B will in fact pay the lower price in some
future year. So even though both CMP formulas were negotiated at arm’s length
at exactly the same time, they yield different prices when actual deliveries
are made in later years.
To explain why I conclude that transfer
pricing adjustments should not be made based on actual prices paid under CMP
agreements, suppose that (1) Buyer A was a related party, whereas Buyer B was
an unrelated party, and (2) the actual spot price at the time of delivery was
$14.00 per pound. In that case, Buyer A, the related party, would pay a
transfer price of $12.00 per pound, and Buyer B, the third party, would pay a
price of $14.00 per pound. Assuming the CMP formula that applies to Buyer A
would have been agreed to at arm’s length at the time that CMP formula was
negotiated, it would not be appropriate in my view to make a transfer pricing
adjustment based on the differential between the actual prices ($12.00 per
pound and $14.00 per pound) at the later time of delivery. Whether the CMP
formula in an intercompany agreement is consistent with the arm’s length
principle must be based on an analysis of the parties’ expectations at the time
the long-term agreement was made, not the actual prices that prevailed in later
years. Only if buyers and sellers could predict future spot prices and, thus,
future contract prices with complete certainty could the actual prices paid
under a third-party MKT agreement be used to evaluate the actual transfer
prices under a related-party MKT agreement. Since buyers and sellers are not
prescient, transfer pricing analyses of MKT agreements based on the prices
actually paid are, in effect, applying the “wisdom of hindsight.”
[816]
With respect to the remaining eight market price
agreements, Doctor Horst opines:
I know of no reliable way for comparing
contract prices when two contracts use fundamentally different uranium price
indices (e.g., spot prices versus the average export price calculated by
NRCAN), so I did not include in my CUP or Resale Price Method analyses in my
June 2016 Expert Report those third-party agreements that applied uranium price
indices that were fundamentally different from the spot prices used in CCO’s
MKT agreements with CEL. Only with hindsight would the parties know whether or
not two MKT agreements that relied on different uranium price indices would or
would not yield the same prices for deliveries made several years after the
agreements were negotiated. Because Dr. Barbera’s Revised Cost Plus Method does
not consider, much less adjust for, the effect of differences between uranium
price indices, I conclude that his transfer pricing comparisons for MKT
agreements are in effect relying on the wisdom of hindsight.
[817]
Finally, Doctor Horst opines that Doctor Barbera
failed to make required adjustments to address the differences in composition
of the sixteen contracts used as arm’s length comparables.
[818]
Doctor Barbera also performed an RPM analysis
and an analysis he called a valuation analysis. Doctor Barbera’s valuation
methodology is not specifically included in the 1995 Guidelines.
[819]
Doctor Barbera’s RPM analysis appears to assume
that the contracts between CESA/CEL and Cameco US are in effect back-to-back
with the purchases from the Appellant under the BPCs and thus place CESA/CEL in
the same position vis-à-vis
risk as a routine distributor.
While it is true that the contracts between CESA/CEL and Cameco US are
back-to-back, thereby ensuring that Cameco US does not bear price risk, other
than the carve-out agreements under the Urenco Agreement there is no evidence
to suggest that CESA/CEL’s purchases of uranium were back-to-back with its
sales to Cameco US.
[820]
Doctors Shapiro and Sarin opine that
Doctor Barbera’s RPM analysis is flawed:
[B]ecause it 1) ignores the price risk borne
by CEL (essentially re-characterizing CEL as a risk-free distributor), 2)
ignores the fact that CEL’s long-term purchase contracts were entered into
years before, and under vastly different market conditions than, many of its
sales contracts, and 3) uses incomplete data.
[821]
Doctor Horst opines that Doctor Barbera’s
RPM analysis materially overstates the transfer price because it fails to make
an appropriate adjustment for changes in market conditions between the time the
BPCs were entered into in 1999 through 2001 and the time the long-term
agreements between CESA/CEL and Cameco US used for comparison were made. Doctor Horst uses the TradeTech
long-term price indicator to make an adjustment yielding the following results:
[822]
Doctor Barbera’s valuation analysis relies
on the Appellant’s price forecasts in 1999 and 2000 to determine an arm’s
length price under the BPCs. As already stated, subjective speculation as to
the future price of uranium is not a valid objective benchmark on which to base
a transfer pricing analysis.
[823]
Doctors Shapiro and Sarin opine:
. . . Dr. Barbera completely ignores the
uncertainty surrounding price forecasts and fundamentally misrepresents the
risk inherent in CCO’s expected returns. Correcting for his error shows that no
adjustment is warranted.
[824]
Doctor Horst states his concern with
Doctor Barbera’s valuation analysis as follows:
In my view, the Barbera Valuation Method
does not yield reliable results for two reasons. First, as I explained above in
my critique of the Barbera Tenex Analysis, the prices that wholesale buyers
like CEL, Cogema and Nukem were actually willing to pay in EBP agreements with
a third-party (Tenex) were substantially lower than the prices that those
buyers, according to the Barbera Report analysis of Cameco’s spot price
forecasts, should have been willing to pay. The Barbera Valuation Analysis
concludes that CEL, if it had been dealing at arm’s length with CCO, would have
been willing to purchase very substantial volumes under an EBP formula with an
initial base price of $12.43 per pound (in 2000 U.S. dollars), which represents
a 34% premium over the TradeTech Long-Term Indicator for U3O8
($9.25 per pound) as of November 30, 2000.
[825]
The Respondent relies on Doctor Wright’s
analysis to support the position that the profit earned by CESA/CEL from the HEU Feed Agreement
and from the BPCs should be attributed to the Appellant because the Appellant
performed all the critical functions that earned the profit. The principal
functions identified are the services provided by the Appellant under the
Services Agreement and market
forecasting and research “services” ostensibly obtained by CESA/CEL through
Mr. Glattes’ and Mr. Murphy’s participation in the sales meetings.
[826]
With respect to the market forecasting and
research services, I am unclear as to how these “services”
constituted more than the sharing of available information within a multinational
group. The information is not proprietary but is information gathered as a result
of the operations of the Cameco Group. No doubt the information flowed from all
quarters in the Cameco Group to all quarters in the Cameco Group through the
vehicle of the sales meetings. I do not accept that members of a multinational
group cannot share such information without triggering a transfer pricing
issue. Nevertheless, to demonstrate that the provision of such information is
not material to the transfer pricing issues, I will address the sharing of that
information as if it were provision of a service by the Appellant to CESA/CEL.
[827]
The evidence establishes that CESA/CEL and
Cameco US worked in a coordinated fashion to purchase, market and sell uranium.
CESA/CEL purchased uranium from the Appellant and third parties and held that
uranium in its inventory. Cameco US marketed and sold uranium to third parties.
CESA/CEL and Cameco US operated on the understanding that, if Cameco US sold
uranium, CESA/CEL would sell the uranium required to meet that obligation to
Cameco US at the sale price agreed to by Cameco US less 2%. The employees of
CESA/CEL, Cameco US and the Appellant discussed the purchasing, marketing and
sales activities of CESA/CEL and Cameco US at the sales meetings and everyone
was kept apprised of developments through the circulation of activity reports.
[828]
With the limited exception of carve-out
agreements under the Urenco Agreement, the purchases of uranium by CESA/CEL
were not contingent upon, matched to or connected with specific sales by Cameco
US and therefore CESA/CEL took the price risk of acquiring and holding the
uranium it purchased.
Doctors Shapiro and Sarin describe CESA/CEL’s price risk exposure as follows:
In this section we demonstrate that CEL bore
significant price risk. Price risk stems from volatility and fluctuations in the
prices of a company’s products and services. As with all commodities, uranium
prices are subject to volatility stemming from numerous factors, including but
not limited to demand for nuclear power, political and economic conditions in
uranium-producing and consuming countries, reprocessing of used reactor fuel,
re-enrichment of depleted uranium tails, sales of excess civilian and military
inventories, and production levels and costs.
This volatility exposed CEL to price risk in
two senses. First, CEL was often committed to purchasing more uranium than it
had commitments in place to sell. As a result, if the price of uranium were to
fall, CEL would bear the loss in value of its unsold uranium. Second, CEL often
had a relatively high percentage of its purchase contracts at fixed or
base-escalated prices while having a large share of its sales contracts at
market-linked prices. In these situations, if the spot price of uranium were to
fall, CEL could suffer losses on uranium it had contracts to sell.
[829]
The evidence establishes that the services
provided by the Appellant to CESA/CEL in support of its purchase and sale
activities were routine commercially available services. Ms. Klingbiel
testified regarding the market forecasting and research services provided by TradeTech
to the uranium industry, and those services paralleled the market forecasting
and research “services” provided by the
Appellant to CESA/CEL. Ms. Klingbiel estimated that TradeTech would charge
no more than US$500,000 per year for the provision of market forecasting and
research services.
[830]
The general administration and contract
administration services provided by the Appellant to CESA/CEL are manifestly
administrative in nature. For example, Mr. Wilyman described contract
administration as follows:
Once the contract was in place, the contract
administration group was charged with administering those agreements and would
have interactions with the third-party utilities. If there was anything that
came up that was at all contentious, for example, a notice being missed, then
typically you would advise the sales group and discuss the path forward to
resolving that.
[831]
The Respondent points to decisions such as where
to draw down inventory as being more than administrative. I disagree. A
decision to draw down CESA/CEL’s inventory at one converter rather than another
in order to save shipping costs is perfunctory. The value of the inventory
results from the sale of the inventory, not from the decision as to which pile
to use to deliver the inventory to the customer.
[832]
Doctors Shapiro and Sarin conducted a transfer
pricing analysis of all the services that were ostensibly provided by the
Appellant to CESA/CEL and concluded that the aggregate mark-up for the general
administrative and contract administration services would be in the range of
$26,000 to $36,000 per year and that, according to information from Ms.
Klingbiel, the value of the market forecasting and research “services” was no
greater than US$500,000 per year.
Doctors Shapiro and Sarin also opined that the Appellant did not incur risk in
providing any of these services.
I accept these opinions.
[833]
In addition to the foregoing, the evidence
establishes that CESA/CEL contracted with the Appellant for the services provided
under the Services Agreement. As stated earlier, the law in Canada has long
been that there is no distinction between a corporation
carrying on an activity by using its own employees and a corporation
carrying on an activity by using independent contractors. This general view further
reinforces the conclusion that the general and contract administration services
provided by the Appellant to CESA/CEL under the Services Agreement cannot be
viewed as functions performed by the Appellant for its own account, that the
proper focus of a transfer pricing analysis of such services under the
traditional transfer pricing rules is the arm’s length value of those services
and that the existence of these services does not justify shifting the price
risk inherent in the core purchase and sale function of CESA/CEL, which the
services support, from CESA/CEL to the Appellant.
[834]
The Respondent does not challenge the amount
paid by CESA/CEL for the Appellant’s services (actual or implicit) but instead
asserts in effect that the value of these services is equal to the profit
earned by CESA/CEL from its purchase and sale of uranium. I reject that assertion
as being wrong in fact–the value of the services was in the range stated in the
Shapiro-Sarin Report–and in law‑paragraph 247(2)(c) does not permit the
price risk associated with the purchase and sale of uranium to be shifted to
the Appellant simply because the Appellant provided support services to
CESA/CEL under a contract for services or otherwise.
[835]
I also reject the Respondent’s submission that
the services (functions) performed by the Appellant cannot be separated from
the price risk associated with CESA/CEL’s purchase and sale of uranium. It is
manifestly self-evident that price risk is inherent in uranium as a fungible
commodity with a market-driven price and that a purchaser of uranium takes on
this price risk. The price risk does not attach to the information or judgment
used to determine when to purchase or sell uranium and how much to pay or
accept for each purchase or sale. In that regard, I accept the following
opinion of Doctors Shapiro and Sarin:
. . . because risk depends on the volatility
of an asset’s future cash flows, the recipient of those cash flows (the owner
of the asset), must bear the risk of the asset. This feature of an asset is
reflected in the fact that the price of an asset is based on the risk of that
asset, with riskier assets selling at a discount to less risky assets. In other
words, potential owners of an asset will discount the price of an asset to
reflect the risk they must bear if they buy the asset. The key point is that it
is the owners of the asset who bear the asset’s risk, not the managers of that
risk.
To emphasize this point, we note that there
is an entire branch of financial economics called asset pricing that attempts
to relate the value of an asset to the riskiness of that asset. In other words,
it is a basic precept in finance that the value of an asset is based on the
risk of that asset, which again points out that risk is an inherent
characteristic of an asset and not of the owner or manager of that asset, or
the control exerted over that asset.
[836]
I also reject the contention–implicit in the
Respondent’s position–that the Appellant unilaterally made all decisions
regarding the purchase and sale of CESA/CEL’s uranium. Mr. Glattes and
Mr. Murphy each had more than sufficient expertise and experience in the
uranium industry to make judgment calls regarding the purchase and sale of
uranium and to contribute to discussions at the sales meetings regarding the
purchase and sale of uranium. The evidence establishes that Mr. Glattes
and Mr. Murphy each participated in and contributed to the twice-weekly
sales meetings when the Cameco Group made key decisions regarding these
matters.
[837]
The fact that decisions may have been
collaborative rather than adversarial does not support the shift of substantive
contractual price risk from CESA/CEL to the Appellant. Carol Hansell opined
that MNEs act in a highly integrated and interdependent manner driven in part
by the financial reporting and disclosure requirements imposed by securities
laws on the parent corporation and that a commercially normal relationship
between a parent corporation and a subsidiary corporation within a large,
complex MNE during the Relevant Period would have involved common goals,
coordinated efforts, commercial interdependence and governance integration.
[838]
Of course, contractual terms may not always
reflect the economic substance of an arrangement, which may in turn warrant a
transfer pricing adjustment. In this case, CESA/CEL entered into a number of
contracts for the purchase of uranium. In doing so, CESA/CEL took on the price
risk associated with its ownership of the uranium acquired under those
contracts. CESA/CEL mitigated its price risk by marketing and selling its
uranium to arm’s length third parties through Cameco US, which performed this
function in exchange for a 2% return on gross sales. The return to Cameco US
for its marketing efforts has not been challenged in these appeals and there is
no evidence to suggest that the return to Cameco US was not an arm’s length
return (i.e., Cameco US was adequately compensated for its marketing efforts).
[839]
The profit ultimately earned by CESA/CEL
resulted from the price risk assumed by CESA/CEL under the various contracts
that it made with the Appellant and third parties, from the meeting by CESA/CEL
of the regulatory requirements that permitted its purchase and sale of uranium
and from the marketing efforts of Cameco US in selling the uranium purchased by
CESA/CEL. When the activities (functions) of CESA/CEL and Cameco US are viewed
together, it is apparent that the economic result is entirely consistent with
the functions performed by CESA/CEL and Cameco US. The fact that decisions
regarding the purchase and sale of uranium by CESA/CEL were made on a
collaborative basis during the sales calls does not alter that conclusion.
[840]
In addition to providing services under the
Services Agreement, the Appellant guaranteed CESA/CEL’s performance under the
contracts with Tenex and Urenco and indirectly provided financing to CESA/CEL.
However, the Respondent has not attributed a specific value to these particular
services and Doctor Barbera did not address the value of these services, other
than on the global profit-shifting basis already noted. Accordingly, there is
no evidence on which to base an adjustment for these services even if one were
warranted.
[841]
As stated at the outset, Doctor Horst undertook
a rigorous transfer pricing analysis that sought to determine if the prices
agreed to under the BPCs and the relevant CC Contracts were arm’s length prices. Doctor
Horst used three iterations of a CUP analysis as his main approach and then
performed an RPM analysis to check the reasonableness of his conclusions under
the CUP analyses.
[842]
Doctor Horst described the third iteration
of his CUP analysis as the most accurate but also the most complicated because
it involved adjustments to account for variations in future spot market prices
as well as differences in the forecasted base escalated prices.
[843]
In the Horst Report, Doctor Horst
summarizes the overall results of his CUP analyses as follows:
. . . As shown in Table 1, under any of my
three CUP applications, no discount factor for any intercompany agreement falls
below the comparable arm’s length range. In fact, all three applications of the
CUP method result in discount factors for each intercompany agreement that are
either above or in the upper half of the comparable arm’s length range. This
means that, according to the CUP method, the transfer prices paid under the
twelve long-term agreements between CEL and CCO were in some cases greater
than, and never less than, prices paid in comparable transactions that occurred
at arm’s length (after adjusting for the inherent differences between those
transactions).
[844]
Doctor Horst undertakes a separate CUP analysis
of the relevant CC Contracts. On the basis of this analysis, he concludes that
the Appellant’s income for 2003 should be adjusted upward by $671,547.
[845]
Doctor Horst recommends aggregate transfer
pricing adjustments that would increase the Appellant’s income for 2003 by
$665,000 and decrease the Appellant’s income for 2005 and 2006 by $5,173,000
and $3,959,000 respectively.
[846]
Doctor Horst relies on Mr. Hayslett’s
assessment of the terms and conditions of the BPCs to determine whether he must
adjust his transfer pricing analysis to account for off-market terms. After the
release of the Horst Report, Doctor Horst made an adjustment to his RPM
analysis to account for Mr. Hayslett’s conclusion that the BPCs provided
CESA/CEL with favourable delivery schedule flexibility. Doctor Horst concluded that
this factor had no material impact on his third CUP analysis.
[847]
I accept Mr. Hayslett’s opinions regarding
the terms and conditions of the BPCs and I conclude that Doctor Horst’s
reliance on these opinions in conducting his analysis of the pricing under the
BPCs was reasonable and appropriate in the circumstances.
[848]
I do not propose to review in detail Doctor Horst’s
transfer pricing analysis. I have summarized his analysis earlier in these
reasons and I have considered carefully the merits of his analysis. In my view,
the third CUP methodology used by Doctor Horst to
analyze the prices charged under the BPCs and the CUP methodology used by
Doctor Horst to analyze the prices charged under the relevant CC Contracts
provide the most reliable and objectively reasonable assessment of those
prices.
[849]
I reject the Respondent’s submissions that the
comparables chosen by Doctor Horst are not in fact comparable. In my view,
the position of the Respondent’s experts on this point is based on speculation
as to the motivations of Tenex and other arm’s length third parties which
purportedly support the conclusion that the economic circumstances in which the
comparables arose are different.
[850]
The 1995 Guidelines describe the focus of “economic circumstances” as follows:
Arm’s length prices may vary across
different markets even for transactions involving the same property or
services; therefore, to achieve comparability requires that the markets in
which the independent and associated enterprises operate are comparable, and
that differences do not have a material effect on price or that appropriate
adjustments can be made.
[851]
There is no evidence to suggest that the price
for uranium varied from region to region or that the Transactions involved a
different market from that for the comparable arm’s length transactions chosen
by Doctor Horst. The Cameco Group sold uranium in a global market. The
prices commanded in the different regions of the world varied only to the
extent that the uranium was restricted uranium or unrestricted uranium, which was
a function of the geographic source of the uranium. The price indices published
by TradeTech and Ux show the global price differentiation between restricted
and unrestricted uranium.
[852]
Notably, in Jean Coutu, the seven-member
majority of the Supreme Court of Canada stated:
. . . Equally, if taxpayers agree to and
execute an agreement that produce [sic] unintended tax consequences,
they must still be taxed on the basis of that agreement and not on the basis of
what they “could have done” to achieve their intended tax consequences, had
they been better informed. Tax consequences do not flow from contracting
parties’ motivations or tax objectives.
[Emphasis added.]
[853]
Similarly, I see no reason to incorporate the
purported motivations of the contracting parties into the objective benchmark-driven
analysis required by the traditional transfer pricing rules. I also see no
evidence to suggest that there was an inequality of bargaining power between
the western consortium and Tenex or between CESA/CEL and Urenco, or between any
of the other parties to the agreements used by Doctor Horst as arm’s length
comparables.
[854]
I also reject the Respondent’s submission that
the results of the transfer price under the BPCs (i.e., losses to the
Appellant) support the conclusion that the price was not an arm’s length price.
While I agree that losses may be an indicator that a transfer price is suspect,
losses are not in and of themselves evidence of a transfer price resulting from
non-arm’s length terms and conditions. This is particularly true when the
property sold is a commodity with a market-driven price that is independent of
the cost of its production. The idea that no arm’s length party would accept
significant and prolonged losses assumes that the losses are known or
predictable with certainty at the time the terms and conditions come into
existence. I have not been convinced that the Appellant knew or could have predicted
with any degree of certainty that it would incur losses because of the BPCs.
[855]
Finally, I reject the Respondent’s submission
that the timing of the Long-term Contracts is somehow suspect and indicative of
the fact that the Appellant knew prices would rise. The Appellant’s and
CESA/CEL’s strategic decision to enter into the BPCs when they did may have
been based on the subjective views of those parties as to the price of uranium,
but that fact has no bearing on whether the terms and conditions agreed to in
the Long-term Contracts are arm’s length terms and conditions. The serendipity
of such a choice is not a basis for a transfer pricing adjustment.
[856]
In conclusion, I accept the results of
Doctor Horst’s third CUP analysis as reflecting a reasonable assessment of
the terms and conditions that arm’s length parties would have reached in the
same circumstances. The result of Doctor Horst’s transfer pricing analysis
is that the prices charged by the Appellant to CESA/CEL for uranium delivered
in the Taxation Years were well within an arm’s length range of prices and that
consequently no transfer pricing adjustment was warranted for the Taxation
Years.
(4) The Resource Allowance
[857]
The final issue in these appeals is whether the
Appellant is required to include losses on the sale of uranium purchased from
CESA/CEL in computing its entitlement to the resource allowance provided under
former paragraph 20(1)(v.1) of the ITA and Part XII of the ITR.
[858]
For taxation years ending before 2007, the ITA generally
permitted taxpayers to claim a resource allowance in respect of income
generated from certain natural resource production and processing activities.
Specifically, former paragraph 20(1)(v.1) provided that, in computing a
taxpayer’s income for a taxation year from a business or property, there may be
deducted such amount as is allowed by regulation in respect of, among other
things, mineral resources in Canada. At the same time, paragraph 18(1)(m)
denied the deduction of royalties, taxes and other amounts paid to a Canadian
federal or provincial government, agent or entity in relation to the
acquisition, development or ownership of a Canadian resource property, or the
production in Canada of, among other things, metals, minerals or coal from a
mineral resource located in Canada (to any stage that is not beyond the prime
metal stage or its equivalent).
[859]
The regulations referred to in paragraph 20(1)(v.1) are found in
Part XII of the ITR. The resource allowance is computed using a multi-step process
as follows: first, compute “gross
resource profits” under subsection 1204(1) of the ITR; second,
compute “resource profits”
under subsection 1204(1.1) of the ITR; third, compute “adjusted resource profits” under subsection 1210(2) of
the ITR; and finally, compute the resource allowance by multiplying the
taxpayer’s adjusted resource profits by 25% under subsection 1210(1) of the ITR.
[860]
For years after 2002 and before 2007, paragraph 20(1)(v.1)
allowed a deduction equal to a percentage of the resource allowance calculated
under subsection 1210(1) of the ITR.
The resource allowance deduction was eliminated for years after 2006.
[861]
The phrase “gross
resource profits” is defined in subsection 1204(1) of the ITR.
The sources of income relevant to these appeals are as follows:
1204 (1) For the purposes of this Part, “gross resource
profits” of a taxpayer for a taxation year means the amount, if any, by which
the total of
. . .
(b) the amount, if any, of the
aggregate of his incomes for the year from
. . .
(ii) the production
and processing in Canada of
(A) ore, other than iron ore or tar sands ore, from mineral resources in
Canada operated by him to any stage that is not beyond the prime metal stage or
its equivalent,
. . .
(iii) the
processing in Canada of
(A) ore,
other than iron ore or tar sands ore, from mineral resources in Canada not
operated by him to any stage that is not beyond the prime metal stage or its
equivalent . . .
[862]
Subsection 1204(1) goes on to provide that the taxpayer’s incomes
and losses from these sources are to be computed in accordance with the ITA on
the assumption that the taxpayer had no incomes or losses except from those
sources and was allowed no deductions except:
(d) amounts deductible under section 66 of the Act (other than
amounts in respect of foreign exploration and development expenses) or
subsection 17(2) or (6) or section 29 of the Income Tax Application Rules,
for the year;
(e) the amounts deductible or deducted, as the case may be,
under section 66.1, 66.2 (other than an amount that is in respect of a property
described in clause 66(15)(c)(ii)(A) of the Act), 66.4, 66.5 or 66.7 (other
than subsection (2) thereof) of the Act for the year; and
(f) any other deductions for the year that can reasonably be
regarded as applicable to the sources of income described in paragraph (b) or
(b.1), other than a deduction under paragraph 20(1)(ss) or (tt) of the Act or
section 1201 or subsection 1202(2), 1203(1), 1207(1) or 1212(1).
[863]
Subsection 1204(3) of the ITR provides that a taxpayer’s income
or loss from a source described in paragraph 1204(1)(b) does not include any income
or loss from certain specified activities, i.e., transporting, transmitting or
processing activities, and (with exceptions) the provision of services.
[864]
Subsection 1206(2) of the ITR states that “production” from a Canadian
resource property has the meaning assigned by subsection 66(15) of the ITR. Subsection
66(15) states, as regards ore, that “production”
from a Canadian resource property means ore produced from such a property
processed to any stage that is not beyond the prime metal stage or its
equivalent.
[865]
The technical notes accompanying the introduction of the
definition in 1987
state that it is relevant for the purposes of the successor corporation rules,
which explicitly refer to “production
from a Canadian resource property”.
The incorporation of the definition in Part XII of the ITR reflects the fact
that the various depletion allowance rules that existed in Part XII had their
own set of successor rules.
[866]
The word “production”
does not appear to be used in its defined sense in paragraph 1204(1)(b) of the
ITR or in the definition of “resource
activity” in paragraph 1206(1) (other than paragraph (e) of that
definition) since the word production in those provisions refers to the act of
production rather than the product of production (i.e., to the production of
ore, not to ore produced from a Canadian resource property processed
to any stage that is not beyond the prime metal stage or its equivalent).
The word is however used in its defined sense in subsection 1204(1)(b.1) of the
ITR. Regardless, the definition has no bearing on the issue in these appeals.
[867]
Subsection 1204(1.1) of the ITR provides that a taxpayer’s “resource profits” for a
taxation year are the amount, if any, by which the taxpayer’s “gross resource profits”
exceeds the total of the following: (a) all amounts deducted in computing the
taxpayer’s income under Part I of the ITA for the year, other than the amounts
described in subparagraphs 1204(1.1)(a)(i) through (v); (b) where a non-arm’s
length party charges an amount for the use of property or the provision of
services, the amount by which the amount an arm’s length party would have
charged the taxpayer for the use of property or for the services exceeds the
amount actually charged; and (c) any amount included in income by virtue of the
debt forgiveness rule in subsection 80(13) of the ITA.
[868]
Subparagraphs 1204(1.1)(a)(i) through (v) of the ITR describe the
amounts excluded from the general deduction rule in paragraph 1204(1.1)(a). Subparagraphs
1204(1.1)(a)(iv) and (v) state:
(iv) an amount deducted in computing the taxpayer’s income
for the year from a business, or other source, that does not include any
resource activity of the taxpayer, and
(v) an amount deducted in computing the taxpayer’s income for
the year, to the extent that the amount
(A) relates to an activity
(I) that is not a resource
activity of the taxpayer, and
(II) that is
1. the production, processing,
manufacturing, distribution, marketing, transportation or sale of any property,
2. carried out for the purpose of
earning income from property, or
3. the rendering of a service by
the taxpayer to another person for the purpose of earning income of the
taxpayer, and
(B) does not relate to a resource
activity of the taxpayer.
[869]
Subparagraph 1204(1.1)(a)(v) applies if both of
two conditions are satisfied. First, the amount
deducted relates to an activity that is not a resource activity of the taxpayer
but is an activity described in sub‑subclauses 1204(1.1)(a)(v)(A)(II)1
to 3. Second, the amount deducted does not relate to a resource activity of the
taxpayer.
[870]
The phrase “resource
activity” is defined in subsection 1206(1). The relevant portions of the
definition state:
“resource activity” of a taxpayer means
. . .
(b) the
production and processing in Canada by the taxpayer or the processing in Canada
by the taxpayer of
(i) ore (other
than iron ore or tar sands ore) from a mineral resource in Canada to any stage
that is not beyond the prime metal stage or its equivalent,
. . .
and, for the
purposes of this definition,
. . .
(g) the
production or the processing, or the production and processing, of a substance
by a taxpayer includes activities performed by the taxpayer that are ancillary
to, or in support of, the production or the processing,
or the production and processing, of that substance by the taxpayer,
. . .
[871]
Paragraph (b) of the definition of “resource activity” describes the activities that
comprise the sources of income referred to in subparagraphs 1204(1)(b)(ii)
and (iii),
and paragraph (g) of the definition includes within the scope of those
activities the activities performed by the taxpayer that are ancillary to, or
in support of, those activities. The words “ancillary”
and “support” each connote an activity that is
subordinate to the main activity. For example, the Oxford English Dictionary
(2nd ed.) defines “ancillary” in part as
follows:
Designating activities and services that
provide essential support to the functioning of a central service or industry.
[872]
The description of the activities (the “specific activities”) in subparagraph (b)(i) of the
definition of “resource activity” is precise and
detailed. A natural reading of the text of paragraph (g) of the definition of “resource activity” in this context suggests that the
additional activities must be ancillary to or in support of the specific
activities, that is, ancillary to or in support of the production or the
processing, or the production and processing, of ore by the taxpayer. It is not sufficient that
the activities be ancillary to or in support of a business that includes the
specific activities as well as other activities–the additional activities must
be ancillary to or in support of the specific activities.
[873]
Although the descriptions of the sources of
income in clauses 1204(1)(b)(ii)(A) and (iii)(A) of the ITR also refer to
the activities described in subparagraph (b)(i) of the definition of resource
activity, it is apparent that those provisions are referring to sources of
income that involve the specific activities and not to the specific activities
themselves. This is simply because the specific activities do not in and of
themselves result in income.
[874]
In The Queen v. 3850625 Canada Inc.,
2011 FCA 117 (“3850625
Canada”), the Federal Court of Appeal explained this point as
follows:
. . . The reasoning is that in order to
qualify for inclusion in the computation of “taxable production profits”, the
income (or the deductions) must be related to production in the narrow sense of
extraction from the ground as a source of income. This does not restrict the
qualifying activity to extraction per se. As was made clear on appeal,
extraction per se is not a source of income; only the “business of
production” can give rise to income (see the decision of the Appeal Division at
p. 6127). In my respectful view, the Gulf test is consistent with the
one set out in Echo Bay Mines and which the Tax Court Judge applied in
this case, i.e. whether the refund interest was sufficiently connected
to the production and processing activities to constitute income from that
source. . . .
[875]
In Echo Bay Mines Ltd. v. Canada, [1992]
3 F.C. 707 (FCTD), the Court stated:
If one turns to Regulation 1204(1), I note
that a fuller excerpt of the words used in defining “resource profits” than
that offered by the defendant more fully represents the provision. Thus, these
profits are defined, in part in paragraph (b), as “the amount . . .
of the aggregate of . . . incomes . . . from the production in Canada of . . .
metals or minerals” [to the primary metal stage]. The use of the words
“aggregate” and “incomes”, and the implicit inclusion of “income . . . derived
from transporting, transmitting or pro cessing” [to the primary metal stage] in
the case of metals or minerals under Regulation 1204(1)(b) which arises
from Regulation 1204(3), both signify that income from “production” may be
generated by various activities provided those are found to be included in
production activities. Production activities yield no income without sales. Activities
reasonably interconnected with marketing the product, undertaken to assure its
sale at a satisfactory price, to yield income, and hopefully a profit, are, in
my view, activities that form an integral part of production which is to yield
income, and resource profits, within Regulation 1204(1).
[Emphasis added.]
[876]
The decision in 3850625
Canada was addressing the computation of gross resource profits and the
decision in Echo Bay was addressing the computation of resource profits
prior to the amendments in 1996 that introduced subsection 1204(1.1) of
the ITR.
The clear rationale of these decisions is that the sources of income/loss
described in paragraph 1204(1)(b) are comprised of the activities described in
that paragraph (the “core activities”) and the
activities that are integral to or sufficiently connected with the earning of
income from the core activities (collectively, the “source
activities”).
[877]
In Echo Bay, the Court held that the
hedging activities of the taxpayer were integral to the earning of income from
the production of ore from the taxpayer’s silver mine. In 3850625 Canada,
the Tax Court of Canada found that the activity consisting in the payment of
income tax on income from the production and sale of coal was sufficiently
connected with the taxpayer’s core activities to warrant the inclusion of
interest on a tax refund in income from the sources of income described in paragraph
1204(1)(b). The Federal Court of Appeal found no palpable and overriding error in
this finding of fact.
[878]
The Respondent does not suggest that the
Appellant should include in its computation of gross resources profits for its
2005 and 2006 taxation years the losses from selling uranium purchased from
CESA/CEL. I agree that the purchases and sales of this uranium are not integral
to or connected with the specific activities of the Appellant. The purchases
and sales do not fall anywhere along the continuum of activities integral to or
connected with the earning of income from the specific activities.
[879]
The Respondent submits, however, that the losses
ought to be deducted under paragraph 1204(1.1)(a) in computing the Appellant’s
resource profit. The Respondent summarizes the basis for this position in the
following terms:
The Losses relate to CCO’s resource activity
and the full amount of the Losses ought to be deducted in computing CCO’s
resource profits. CCO’s only business which is carried on in Canada consists of
producing, processing, and selling uranium. CCO has no business other than this
resource activity. CCO was always a miner and producer of uranium both pre- and
post-restructuring. CCO purchased uranium to advance its over-contracting
strategy. It was envisioned that CCO would keep whatever production was needed
to meet its legacy and Canadian contracts and the rest would be sold to CE.
Cameco admitted to reviewing production forecasts in estimating how much CCO
could sell to CE. Those forecasts showed that, in 1999, CCO anticipated that by
2005, it would only have 22.7 million pounds of Canadian production available
to sell to CE, including 9 million pounds from Rabbit Lake and Cigar Lake. The
nine bulk sales . . . agreements gave CE the right to purchase just under 24
million pounds from CCO if all the flexes were exercised upward. CCO purchased
the uranium in order to meet these existing long-term supply contracts; CCO had
a policy to not sell on the spot market, and no evidence was adduced that the
purchased uranium were [sic] for spot sales. Accordingly, the Losses are
an indirect expense of CCO in producing uranium and deductible in computing the
corporation’s resource profits.
Further, CCO was not engaged in activities
other than a resource activity, ergo there is no non-resource activity to which
to allocate the Losses. The exception in subparagraph 1204(1.1)(a)(v)
contemplates that there be a reasonable allocation to a taxpayer’s resource activities
on the one hand and to a taxpayer’s defined activities that do not relate to a
resource activity on the other hand. The double-barreled nature of the test
(i.e., the amount that is required, both to relate to a non-resource activity,
and not relate to a resource activity) ensures that taxpayers cannot avoid an
allocation of a deduction to a resource activity by arguing that there is more
than one purpose associated with a particular deducted amount.
[880]
There is no question that the losses from the
purchase and sale activity relate to an activity described in subclause
1204(1.1)(a)(v)(A)(II): the sale of any property.
[881]
The first question raised by the Respondent’s
position is whether the purchase by the Appellant of uranium from CESA/CEL and
the sale of that uranium (the “ps activity”) is
ancillary to or in support of the specific activities. If
it is then the ps activity constitutes a resource activity and the losses from
this activity fail to meet the condition in subclause 1204(1.1)(a)(v)(A)(I)
because they relate to a resource activity of the Appellant.
[882]
If the answer to the first question is no, then
the second question is whether the losses resulting from the ps activity are
related to a resource activity of the taxpayer. If they are then the condition
in clause 1204(1.1)(a)(v)(B) is not satisfied. If they are not then the losses
satisfy both conditions in subparagraph 1204(1.1)(a)(v) and are excluded
from the rule in paragraph 1204(1.1)(a).
[883]
The ps activity is not ancillary to or in support
of the specific activities. In particular, the ps activity does not support,
assist in or contribute to the Appellant’s performance of the specific
activities. The fact that the ps activities may allow the Appellant to satisfy
contractual obligations to sell uranium does not connect the ps activity with
the specific activities. The ps activity exists apart from the specific
activities. Accordingly, the ps activity is not a resource activity.
[884]
The question that remains is whether the loss
from the ps activity is related to a resource activity of the Appellant. The
Respondent submits that the phrase “related to”
is to be given a broad interpretation.
[885]
In my view, the phrase “related
to” read in context simply requires a connection between the loss from
the ps activity and a resource activity of the Appellant. This is no different
than the approach taken in 3850625 Canada, where the Federal Court of
Appeal observed that “[t]he Tax Court Judge went on to
consider whether there was a sufficient connection between the refund and the
production and processing activities.” In this case, the question
is whether there is a sufficient connection between the losses from the ps
activity and a resource activity of the Appellant to conclude that the losses
are related to a resource activity of the Appellant.
[886]
I am not able to discern a connection between
the losses from the ps activity and a resource activity of the Appellant. The
losses result from the ps activity and the ps activity itself has no connection
with the resource activity of the Appellant. While it is true that the ps
activity was an aspect of the Appellant’s business and that that business
involved significant resource activity, the losses from the ps activity were
separate from and unconnected with that resource activity. Contrary to the
implication of the Respondent’s position, the test is not whether the losses
were related to a business of the Appellant that includes of resource activity;
the test is whether the losses were related to the resource activity of the
Appellant.
[887]
In my view, this result is consistent with the
purpose of the resource allowance which the federal government introduced in
1976 to provide a deduction in computing income in recognition of the fact that
provinces impose taxes or royalties in respect of provincial resources. The ps activity and the loss
from that activity have no connection with the production and/or processing of
ore from a mineral resource in Canada, and losses from the ps activity should
not reduce the relief provided by the resource allowance in respect of the
resource-related tax imposed by Saskatchewan.
Conclusion
[888]
The Appellant’s appeals of the Reassessments are
allowed and the Reassessments are referred back to the Minister for
reconsideration and reassessment on the basis that:
1. none of the
transactions, arrangements or events in issue in the appeals was a sham;
2. the Minister’s
transfer pricing adjustments for each of the Taxation Years shall be reversed;
3. the amount of
$98,012,595 shall be added back in computing the resource profit of the
Appellant for its 2005 taxation year; and
4. the amount of
$183,935,259 shall be added back in computing the resource profit of the
Appellant for its 2006 taxation year.
[889]
The parties have 60 days from the date of this
judgment to provide submissions regarding costs. Such submissions are not to
exceed 15 pages for each party.
Signed
at Ottawa, Canada, this 26th day of September 2018.
“J.R. Owen”
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