A Canadian court reversed C $483 million (about $370.4 million) in adjustments to Cameco Corp.’s taxable income, holding that the company’s cross-border uranium sales were bona fide and properly priced using the comparable uncontrolled price method.
In its September 26 decision in Cameco Corp. v. HM The Queen, 2018 TCC 195, the Tax Court of Canada rejected the government’s argument that the sales were either part of a sham transaction or subject to adjustment under Canada’s transfer pricing rules. The nearly 300-page opinion by Justice John Owen provides a substantive ruling after years of procedural battles between the parties, including the 2015 appeal of a tax court procedural ruling to the Federal Court of Appeal and a dispute over a 2017 proposed order compelling Cameco to make 25 employees available to the Canada Revenue Agency for interview.
Cameco, one of the world’s largest uranium producers, reorganized its corporate structure in 1999 to ensure that its expanding operations outside of Canada were arranged in a tax-efficient manner. Initially, the new structure used offshore subsidiaries — Cameco Europe S.A. (CESA), a Luxembourg subsidiary with a Swiss branch; and Cameco Europe AG (S.A., Ltd.) (CEL), a Swiss subsidiary — to acquire commercial-grade uranium from Russia. The same approach was later expanded to include uranium produced in Canada through intercompany sales of uranium from the Canadian parent to an offshore subsidiary. The sales price was determined using the CUP method based on Cameco’s sales contracts with unrelated parties.
Because the uranium, most of which was sold to U.S. customers through Cameco’s U.S. subsidiary, never physically passed through the subsidiary’s jurisdiction and no meaningful functions were transferred outside Canada, the CRA argued that the restructuring and subsequent intercompany sales had no economic purpose other than tax avoidance and therefore constituted a sham transaction. The court rejected that argument, noting that “the motivation for these arrangements may have been tax-related, but a tax motivation does not transform the arrangements . . . into a sham.”
“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,” Owen said.
The decision also rejects the CRA’s argument based on paragraph 247(2)(b) of Canada’s Income Tax Act, which allows the CRA to adjust the price charged in related-party transactions or series of transactions when they would not have occurred at arm's length and can reasonably be considered not to have been undertaken for bona fide reasons other than a tax benefit. Although the provision — which the opinion explains by reference to the OECD’s commercial rationality test for recharacterization — appears to empower the CRA to recharacterize transactions that satisfy those conditions, the opinion says the CRA’s authority is limited to using alternatively structured arm's-length transactions as comparables.
“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,” the opinion says.
The court also rejected the CRA’s alternative argument that even if the transactions are not a sham or subject to recharacterization, they should have been priced by calculating a routine return for the offshore subsidiaries using the transactional net margin method (TNMM) to reflect their limited functions compared to the Canadian parent. Applying the TNMM, which tests entity profitability rather than transactional pricing, was inappropriate, the court said, because it effectively relied on hindsight and replaced the legal substance of the transactions by reallocating price risk away from the actual purchaser.
Reactions
Cameco celebrated its victory in a September 27 announcement that says the court “ruled unequivocally” in favor of the company against the CRA’s reassessments.
“We are very pleased with the Tax Court’s clear and decisive ruling in our favor,” CEO Tim Gitzel said in the statement. “We followed the rules, yet this dispute has caused significant uncertainty for our investors during a period of prolonged weakness in markets for our products. Now we hope CRA accepts the decision and applies it to other tax years in dispute so we can focus on managing our business for the benefit of all our stakeholders.”
If the CRA’s approach to the years addressed by the decision is consistently applied from 2003 to 2017, Cameco would owe additional cash taxes and transfer pricing penalties of about C $2 billion plus interest and installment penalties, Gitzel said in a September 27 conference call discussing the decision.
“While this decision only applies to the years 2003, 2005, and 2006, where the cash taxes owing were modest, and is subject to appeal, we believe the thorough and meticulous analysis of the facts in the judgment will make it difficult to overturn and furthermore, will be relevant in determining the outcome for subsequent years,” he added.
In a statement emailed to Tax Notes, a CRA representative said, “The government of Canada is committed to ensuring a tax system that is fair for all Canadians. The [CRA] will carefully review the decision and will respond in due course.” The statement says the CRA cannot comment on the specifics of the case, but notes that it has until October 26 to appeal the decision.