Cameco, together with its subsidiaries, is a large uranium producer and supplier of the services that convert one form of uranium into another form. Cameco had uranium mines in Saskatchewan and uranium refining and processing (conversion) facilities in Ontario. Cameco also had subsidiaries in the United States that owned uranium mines in the United States.
In 1993, the United States and Russian governments executed an agreement that provided the means by which Russia could sell uranium formerly used in its nuclear arsenal. The net result of this agreement was that a certain quantity of uranium would be offered for sale in the market. Cameco initially attempted to secure this source of uranium on its own but later took the lead in negotiating an agreement for the purchase of this uranium by a consortium of companies. When the final agreement was signed in 1999, Cameco designated its Luxembourg subsidiary, Cameco Europe S.A. (CESA), to be the signatory to this agreement.
The agreement related to the purchase of the Russian uranium was executed in 1999 among CESA, Compagnie Générale des Matières Nucléaires (COGEMA) (a French state-owned uranium producer), Nukem, Inc. (a privately owned United States trader in uranium), Nukem Nuklear GMBH and AO “Techsnabexport” (Tenex) (a Russian state-owned company).
This agreement, which is also referred to as the HEU Feed Agreement, initially provided for the granting of options to purchase the uranium that Tenex would make available for sale. In the years following 1999, there were a number of amendments to this agreement. In particular, the fourth amendment in 2001, in part, obligated the western consortium (CESA, COGEMA and Nukem) to purchase a certain amount of uranium (paragraph 82 of the reasons).
On September 9, 1999, CESA entered into an agreement with Urenco Limited (Urenco) (a uranium enricher) and three of its subsidiaries to purchase uranium that Urenco would be receiving from Tenex.
Also in 1999, Cameco formed a subsidiary in Switzerland. This company, in 2001, changed its name to Cameco Europe AG (SA, Ltd) (CEL). In 2002, CESA transferred its business (which was described in the transfer agreement as “trading with raw materials, particularly uranium in various forms”) to CEL under the Asset Purchase and Transfer of Liabilities Agreement dated as of October 1, 2002, but executed on October 30, 2002. Therefore, CESA transferred to CEL the rights that CESA had to purchase uranium from Tenex and Urenco.
CEL also purchased Cameco’s expected uranium production and its uranium inventory.
It would appear that this arrangement did not include any uranium that was sold by Cameco to any customers in Canada (paragraph 40 of the Crown’s memorandum). At certain times, Cameco also purchased uranium from CEL.
The profits in issue in this appeal arose as a result of the sale of uranium by CEL that it purchased from three different sources: Tenex, Urenco, and Cameco.
When the arrangements with Tenex and Urenco were put in place in 1999, the price of uranium was low. In subsequent years, the price of uranium increased substantially. As a result, the profits realized by CEL from buying and selling uranium were substantial.
The Canadian Revenue Agency found that the transactions between Cameco Corp and the Swiss subsidiary constituted a sham arrangement resulting in improper profit shifting.
According to the Canadian Revenue Agency, Cameco would not have entered into any of the transactions that it did with CESA and CEL with any arm’s length person, cf. paragraph 247(2) of the Act. All of the profit earned by CEL should therefore be reallocated to Cameco Corp.
Hence, a tax assessment was issued for FY 2003, 2005, and 2006 where $43,468,281, $196,887,068, and $243,075,364 was added to the taxable income of Cameco Canada.
Cameco disagreed with the Agency and brought the case to the Canadian Tax Court.
In 2018 the Tax Court ruled in favor of Cameco and dismissed the assessment.
This decision was then appealed by the tax authorities to the Federal Court of Appeal.
The Federal Court of Appeal dismissed the appeal and also ruled in favor of Cameco.
“In this appeal, the Crown does not challenge any of the factual findings made by the Tax Court Judge. Rather, the Crown adopts a broader view of paragraphs 247(2)(b) and (d) of the Act and submits that Cameco would not have entered into any of the transactions that it did with CESA and CEL with any arm’s length person. As a result, according to the Crown, all of the profit earned by CEL should be reallocated to Cameco. The Crown, in its memorandum, also indicated that it was raising an alternative argument related to the interpretation of paragraph 247(2)(a) of the Act.
However, subparagraph 247(2)(b)(i) of the Act does not refer to whether the particular taxpayer would not have entered into the particular transaction with the non-resident if that taxpayer had been dealing with the non-resident at arm’s length or what other options may have been available to that particular taxpayer. Rather, this subparagraph raises the issue of whether the transaction or series of transactions would have been entered into between persons dealing with each other at arm’s length (an objective test based on hypothetical persons) — not whether the particular taxpayer would have entered into the transaction or series of transactions in issue with an arm’s length party (a subjective test). A test based on what a hypothetical person (or persons) would have done is not foreign to the law as the standard of care in a negligence case is a “hypothetical ‘reasonable person’” (Queen v. Cognos Inc.,  1 S.C.R. 87, at page 121, 1993 CanLII 146).
The Crown’s position with respect to this hypothetical transaction is also contradicted by its position in this case. Essentially, in this case, Cameco became aware of an opportunity to purchase Russian sourced uranium from Tenex and Urenco and chose to complete those arrangements through a foreign subsidiary rather than purchasing this uranium itself and selling it to third-party customers in other countries. This was a foreign-based business opportunity to purchase uranium outside Canada and sell it to customers outside Canada which Cameco could either have done itself or through a foreign subsidiary.
Since Cameco initially chose CESA (who subsequently transferred the rights to CEL) and since the tax rates were lower in Switzerland than in Canada, the Crown, in this case, is arguing that the condition in subparagraph 247(2)(b)(ii) of the Act was satisfied. The same argument with respect to subparagraph 247(2)(b)(ii) of the Act would presumably be made if Cameco had chosen any other jurisdiction for the incorporation of its subsidiary, if the applicable corporate tax rate in that country was less than the corporate tax rate in Canada.
In my view, Parliament did not intend that subparagraph 247(2)(b)(i) of the Act would apply as proposed by the Crown. This is supported by the text of paragraph 247(2)(d) of the Act as well as the context and purpose of the provision.
In addressing paragraph 247(2)(d) of the Act, the Crown states in paragraph 52 of its memorandum:
Pursuant to s. 247(2)(d), the court must ask what Cameco Canada would have done if it had been dealing at arm’s length from the Swiss Subsidiary. At arm’s length, Cameco Canada would not use two intermediaries, when one of them adds nothing of value. Pursuant to s. 247(2)(d), Cameco Canada can be assessed on the basis that at arm’s length, it would have purchased uranium from third parties and sold uranium directly to Cameco US without the Swiss Subsidiary as part of the economic chain.
There are two problems with this proposed alternative arrangement. The first problem is that paragraph 247(2)(d) of the Act does not ask what one of the participants would have done. Rather, it asks what transaction or series of transactions would have been entered into between persons dealing at arm’s length and what would have been the terms and conditions of that transaction or series. This is not, as the Crown suggests, simply asking what only one of the two participants would have done. Rather, it requires the Court to substitute for the transaction or series of transactions entered into between the participants, the transaction or series of transactions that would have been entered into between persons dealing at arm’s length.
The second concern with this proposed alternative arrangement is that it seems to suggest that Cameco would not have used two intermediaries, when one of them adds nothing of value. This begs the question of whether Cameco would have added anything of value in relation to any uranium that would have been purchased under the Tenex agreements or Urenco agreements and then resold, as is, to Cameco US. This uranium was sourced outside Canada and sold to customers outside Canada. It is far from clear what would have been gained if Cameco had purchased the uranium and then sold it to Cameco US who would then have sold it to third parties, as suggested by the Crown. It would have been much simpler if Cameco US replaced CEL, purchased this uranium from Tenex and Urenco and sold it to third parties. In that scenario, however, the profits that had been realized by CEL from buying and selling this uranium would instead have been realized by Cameco US (not Cameco).
In my view, the text of this provision does not support the interpretation as proposed by the Crown. Rather, the words should be interpreted as written. The condition in subparagraph 247(2)(b)(i) of the Act is only satisfied if the transaction or series of transactions is one that would not have been entered into by arm’s length persons.
In the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations dated July 1995 (1995 Guidelines), it is noted that, except in exceptional circumstances, transfer pricing arrangements should be examined based on the transactions undertaken by the parties. The 1995 Guidelines also indicate the circumstances in which the transactions undertaken by a particular taxpayer could be disregarded:
1.36 A tax administration’s examination of a controlled transaction ordinarily should be based on the transaction actually undertaken by the associated enterprises as it has been structured by them, using the methods applied by the taxpayer insofar as these are consistent with the methods described in Chapters II and III. In other than exceptional cases, the tax administration should not disregard the actual transactions or substitute other transactions for them.
Restructuring of legitimate business transactions would be a wholly arbitrary exercise the inequity of which could be compounded by double taxation created where the other tax administration does not share the same views as to how the transaction should be structured.
1.37 However, there are two particular circumstances in which it may, exceptionally, be both appropriate and legitimate for a tax administration to consider disregarding the structure adopted by a taxpayer in entering into a controlled transaction. The first circumstance arises where the economic substance of a transaction differs from its form. In such a case the tax administration may disregard the parties’ characterisation of the transaction and re-characterise it in accordance with its substance…. The second circumstance arises where, while the form and substance of the transaction are the same, the arrangements made in relation to the transaction, viewed in their totality, differ from those which would have been adopted by independent enterprises behaving in a commercially rational manner and the actual structure practically impedes the tax administration from determining an appropriate transfer price. An example of this circumstance would be a sale under a long-term contract, for a lump sum payment, of unlimited entitlement to the intellectual property rights arising as a result of future research for the term of the contract (as previously indicated in paragraph 1.10). While in this case it may be proper to respect the transaction as a transfer of commercial property, it would nevertheless be appropriate for a tax administration to conform the terms of that transfer in their entirety (and not simply by reference to pricing) to those that might reasonably have been expected had the transfer of property been the subject of a transaction involving independent enterprises. Thus, in the case described above it might be appropriate for the tax administration, for example, to adjust the conditions of the agreement in a commercially rational manner as a continuing research agreement.
In the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations dated July 2010 (2010 Guidelines), the above paragraphs appear as paragraphs
1.64 and 1.65. In paragraph 9.187 of these Guidelines, further guidance is provided with respect to these paragraphs:
9.187 That guidance indicates that the tax administration would seek to substitute for the non-recognised transaction an alternative characterisation or structure that comports as closely as possible with the facts of the case, i.e. one
that is consistent with the functional changes to the taxpayer’s business resulting from the restructuring, comports as closely as possible with the economic substance of the case, and reflects the results that would have derived had the transaction been structured in accordance with the commercial reality of
independent parties…. Similarly, where one element of a restructuring involves the actual relocation of substantive business functions, any recharacterisation of the restructuring cannot ignore the fact that those functions were actually relocated….
There are two circumstances identified in paragraph 1.37 of the 1995 Guidelines that would allow a tax administration to disregard a structure put in place by a taxpayer. As noted, “[t]he first circumstance arises where the economic substance of a transaction differs from its form”. There is no allegation in this appeal that the transactions undertaken did not reflect the substance of the transactions. This was essentially the sham argument that was raised before the Tax Court and which the Tax Court Judge rejected. As noted above, the Crown has not appealed this finding.
The second circumstance identified in the 1995 Guidelines “arises where, while the form and substance of the transaction are the same, the arrangements made in relation to the transaction, viewed in their totality, differ from those which would have been adopted by independent enterprises behaving in a commercially rational manner and the actual structure practically impedes the tax administration from determining an appropriate transfer price”.
In this case, there is no indication that the structure, as implemented, impeded the determination of an appropriate transfer price. There is nothing to indicate or suggest that the structure impeded either the Canada Revenue Agency’s or the Tax Court Judge’s ability to determine the appropriate transfer price. The Tax Court Judge was able to determine the value of the Tenex and Urenco agreements when they were entered into and whether the prices at which the uranium was sold by Cameco to CEL “were well within an arm’s length range of prices” (paragraph 856 of his reasons).
The additional guidance provided by the 2010 Guidelines also suggests that in any application of paragraphs 247(2)(b) and (d) of the Act, the restructuring undertaken by Cameco would still have to be respected. If, as submitted by the Crown, paragraphs 247(2)(b) and (d) of the Act could apply to reallocate all of the profit of CEL to Cameco, this, in effect, would mean that the restructuring, whereby the purchases and sales of uranium were completed by CEL, would not be respected. Essentially, Cameco would be treated as if it — and not CEL — had purchased the uranium from Tenex and Urenco that CEL had acquired.
A reassessment under subparagraphs 247(2)(a) and (c) does not permit a recharacterization of the transactions entered into by non-arm’s length parties, nor can another different transaction entirely be substituted therefor. This would only be permitted under subparagraphs 247(2)(b) and (d) which have not been pleaded and the Crown is not relying upon. A transfer pricing recharacterization is only permitted under those provisions if arm’s length parties would not have entered into the transaction chosen by the non-arm’s length parties even with different terms and conditions and amounts, and if the only bona fide primary purpose of the transaction was to obtain a tax benefit.
However, it is clear from the provisions of section 247 that under subparagraphs (a) and (c) the Court is not limited to making adjustments with respect to the quantum of an amount in a term or condition that incorporates an amount. I do not accept the taxpayer’s submission that I am so limited. Paragraph 247(2)(a) is triggered when terms or conditions differ from those terms and conditions that arm’s length parties would agree to. There is no such limiting restriction on the phrase terms and conditions. Paragraph 247(2)(c) then mandates an adjustment to the quantum or nature of an amount used by the taxpayer for purposes of the Act to reflect the quantum or nature of that amount that would have been used had the “terms and conditions” conformed to what arm’s length parties would have agreed to.
Perhaps there is a point at which the extent of changes to the agreed non-arm’s length terms and conditions needed to reflect arm’s length terms and conditions in a transaction can constitute an effective recharacterization of the transaction only permitted to be affected under paragraph 247(2)(d) and only in the circumstances described in paragraph 247(2)(b) which provisions are not engaged in this appeal. Perhaps there also may be some terms and conditions in a transaction that are so fundamental that any particular change thereto could constitute in effect a recharacterization of the transaction. The Court does not need to venture anywhere close to that line in disposing of this appeal. That can be left for another day. In this case the Court is able to limit itself to a consideration of terms and conditions which it finds to not be on arm’s length terms and that directly relate to pricing.
Paragraphs 247(2)(b) and (d) of the Act apply only where a taxpayer and non-arm’s length non-resident have entered into a transaction or a series of transactions that would not have been entered into between any two (or more) persons dealing at arm’s length, under any terms or conditions. In such a situation, the transaction or series of transactions that would have been entered into between arm’s length persons is substituted for the transaction or series of transactions in question, with the appropriate terms and conditions. In particular, paragraphs 247(2)(b) and (d) of the Act cannot be used to simply reallocate all of the profits earned by CEL to Cameco, its Canadian parent corporation, in the circumstances of this case. Of course, in another situation where these paragraphs would apply, the substituted transactions may well result in adjustments to the income (and the profit) of a Canadian taxpayer.
The Crown, during the hearing of the appeal, was particularly focused on the amount of profit realized by CEL in 2003, 2005 and 2006. However, this argument is based on hindsight and is indirectly an attack on the factual findings made by the Tax Court Judge.
The arrangements with CEL, as acknowledged by the Crown, in relation to the purchase of uranium from Tenex, were put in place in 1999 when CESA signed the agreement with Tenex and others. CESA later transferred its rights under this agreement to CEL. The Tax Court Judge reviewed these arrangements and, as noted above, found, “the economic benefit of participating in the HEU Feed Agreement was negligible at the time the parties executed the agreement in March 1999”. The Tax Court Judge also noted that, but for the optionality of the agreement, the value of the HEU Feed Agreement would have been negative in 1999. When the optionality was removed in 2001, the logical conclusion would be that the agreement then had a negative value.
By now alleging that Cameco would not have entered into the arrangement whereby ultimately CEL would be the purchaser of the uranium from Tenex, the Crown is, in effect, challenging these factual findings related to the value of the right to purchase uranium from Tenex. If the economic benefit of participating in the agreement was negligible or negative, why would any person not have transferred any right that it might have had to enter into this agreement to an arm’s length party? It is far from clear why a person would not transfer a right that has no value or a negative value to an arm’s length party. That other arm’s length persons would have accepted such a right is evidenced by the fact that COGEMA and Nukem entered into the same agreement with Tenex.”