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In a recent case in the Tax Court of Canada, the Minister of
National Revenue failed to support a reassessment of AgraCity Ltd.
(the “Taxpayer“) under the transfer
pricing rules of the Income Tax Act (Canada)(the
“ITA“).
The Taxpayer was part of a corporate group in Saskatchewan, the
Farmers of North America (“FNA“), that
was established to act as agent to purchase a glyphosate-based
herbicide, “ClearOut” (being a generic version of
Bayer-Monsanto’s RoundUp), for sale to farmers in Canada.
Originally, FNA used an American subsidiary to act as the
wholesaler, but then caused the activities to be transferred to a
Barbados subsidiary of the Taxpayer, “NewAgco Barbados”,
apparently in order to reduce the high taxes payable in the U.S.A.
New Agco Barbados would acquire its inventory of ClearOut from an
arm’s length supplier, and determined its selling price on the
basis of its costs plus a markup for profit.
NewAgco Barbados and the Taxpayer entered into a service
agreement under which the Taxpayer provided logistical and related
support for the sales and deliveries to the Canadian buyers.
Meanwhile, the FNA group promoted the sales of ClearOut to the
target market of Canadian farmers.
The Canada Revenue Agency (the “CRA“)
reassessed the Taxpayer on several bases and allocated all of the
profits of NewAgco Barbados to the Taxpayer in respect of the sales
of ClearOut to FNA’s Canadian farmers.
First, the CRA asserted that the transactions were a
sham. The CRA alleged that NewAgco Barbados held no assets
and performed no economic activities; it performed no value-add
functions and assumed no risk; in fact it was the Taxpayer that
undertook all of the functions and assumed all of the risks. In
addition, the service agreement did not reflect the true agreement
between the parties. These parties acted in concert to give the
false appearance that NewAgco Barbados was carrying on the business
of selling ClearOut. The parties knew that the profits reported by
NewAgco Barbados from selling ClearOut were actually the profits of
the Taxpayer,
Second, the CRA asserted that under the transfer pricing rules
of section 247 of the ITA, the transactions were primarily entered
into to obtain tax benefits under the ITA; the parties’
transactions would not have been entered into between arm’s
length parties; and the terms and conditions of the transactions
were not the same as those that would have applied between
arm’s length parties.
The Court found against the CRA on the issue of sham, as the
evidence fell short of establishing that:
- the parties to the transactions sought to present that the
legal rights and obligations of the parties were different from
what they knew or understood, and - any of the parties sought to deceive anyone.
In particular, the evidence showed that FNA set up an American
subsidiary to act as the wholesaler of ClearOut because there had
to be a non-Canadian wholesaler, and establishing a company in a
high-tax jurisdiction like the U.S.A. could not have been to
improperly avoid Canadian tax. Furthermore, moving the same
activities to a Barbados subsidiary is consistent with reducing
foreign not Canadian taxes.
Moreover, the evidence showed that NewAgco Barbados had assets
and resources, and had assumed real risks in terms of product
liability, price risk, currency risk, etc.
The Court also rejected the CRA’s attempt at transfer
pricing re-characterization under section, and in so doing set out
the guiding principles as follows:
“One of the express requirements for re-characterization is
that non-arm’s length parties must be participants in a
transaction or series of transactions that would not have been
entered into between arm’s length persons. That is, the issue
of concern to the fisc is not simply the price or other terms
agreed to by the parties, it is that the very transactions agreed
to and completed by the parties “would not have been entered
into between parties dealing at arm’s length”.
The CRA was unable to adduce any evidence to support its
assumption that no arm’s length parties would have entered into
these transactions. In fact, the expert transfer pricing witness
for the CRA acknowledged that with proper inter-corporate pricing,
the Service Agreement between the Taxpayer and NewAgco Barbados was
an agreement that arm’s length parties could have entered
into.
In connection with the CRA’s final position that the prices
charged under the Service Agreement were subject to adjustment
under section 247 as to what arm’s length parties would have
charged in similar circumstances, the Court found that the
CRA’s expert failed to consider foreign exchange, product
liability, or other risks borne by NewAgco Barbados. The
Taxpayer’s evidence was the best available using the cost plus
method, with the result that the payments were within the range of
payments under comparable service agreements.
Accordingly, the Taxpayer was completely successful in
demolishing all the assumptions made by the CRA.
Given the succession of losses realized recently by the CRA in
transfer pricing cases and other international tax cases, 2 we
should not be surprised if the Federal Government brings in
toughening rules in the next Budget. Such an action may seriously
weaken Canada’s competitive international tax regime, resulting
in making it more difficult for Canadian multinationals to remain
headquartered in Canada.
Footnotes
1 2020 DTC 1066 (TCC).
2 The Queen v. Cameco Corporation, 2020 DTC 5059
(F.C.A.); Loblaw Financial Holdings Inc. v. The Queen, 2020 DTC
5040 (F.C.A.), and Bank of Montréal v. The Queen, 2020 FCA
82 (F.C.A.).
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