Transfer Pricing and Controlled Foreign Subsidiaries

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Transfer Pricing and Controlled Foreign Subsidiaries

 Mazen Artistic Aluminum Ltd. v. The Queen, 2014 TCC 194

At issue were amounts paid by the Canadian resident corporation to its wholly owned subsidiary, located in a low-tax jurisdiction, for services provided to the Canadian resident corporation.  Specifically, whether the terms and conditions as between the related parties were ones that differ from what would have been agreed to by parties at arm’s-length.


The Canadian resident corporation, on advice from professionals, set up a structure whereby it incorporated a wholly owned subsidiary in a low-tax jurisdiction, paid amounts to this subsidiary in pursuit of active business profits internationally (Marketing, promotions, management, and administrative), and paid these amounts back to itself tax free (deducting dividend under s 113).

The MNR reassessed these payments as not meeting proper transfer-pricing guidelines as a violation of the arm’s-length principle, under s 247(2).


The Court noted that the foreign company could do nothing on its own – it was an empty shell devoid of personnel and tangible or intangible property/assets.  It reviewed the potential service provided and value added by the foreign corporation, and found there to be little evidence of anything.

The court the summarized the arm’s length principle:

[170]   The arm’s length principle assumes that independent enterprises “… will compare the transaction to other options realistically available to them, and they will only enter into the transaction if they see no alternative that is clearly more attractive”.

The Court concluded, on the evidence, that there was no benefit other than a tax benefit to be found in the arrangement (para 172), neither of which would be available for arm’s-length parties.

The Court then considered the appropriateness of the quantum of fees paid.  The ITA does not provide much guidance in subsection 247(2) as to how to determine the arm’s length price, and courts have held that recourse to the OECD Guidelines is appropriate: Canada v. GlaxoSmithKline, 2012 SCC 52; The Queen v. General Electric Capital of Canada, 2010 FCA 344; and Alberta Printed Circuits Ltd. v. The Queen, 2011 TCC 232  , as is reference to the CRA’s IC 87-R2.

Transfer pricing analysis is highly fact driven.  The first step is identifying the transaction under review.  Once this is done, the next step is determining the appropriate method to use so as to arrive at an arm’s length transfer price appropriate for the facts.  The Court noted that although the 2010 OECD Guidelines don’t provide a preference of methods, the 1995 OECD Guidelines listed the various methods in decreasing order of reliability, being:

1. Traditional Transaction Methods:

  • Comparable Uncontrolled Price method (“CUP Method”) Respondent [108] and [160] – value of Mr. Csumrik and Longview
  • Resale Price method
  • Cost Plus method

2. Transactional Profit Methods:

  • Profit Split method
  • Transactional Net Margin method (“TNMM”)

The Court preferred the CRA’s expert method using CUP over the Appellants method using TNMM, on the facts.   Specifically, the court used the internal CUP being the price negotiated between the third party advisor and the Canadian Parent as the appropriate comparator.

- Sas Ansari, JD LLM PhD (exp)

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Medical Impairment and Directors’ Liability for HST/GST

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Medical Impairment and Directors’ Liability for HST/GST

Attia v The Queen, 2014 TCC 46

At issue was the availability of the Due Diligence defense against personal liability of a corporate director under Excise Tax Act subsection 323(3), and the effect of medical depression of the director on the defense.


The Appellant stared the business, which was his sole source of income, and had always met his tax liabilities.  As a result of his father dying and the franchisor informing him of the loss of his franchise, he suffered medical depression and was medicated by a physician (who testified) and saw a psychotherapist (who also testified).  Neither of these parties’ credibility was in doubt.  The taxpayer hired a manager to take care of the financial affairs while he was incapable, because of his depression, from doing so.


The legal framework for the due diligence defense is found in Canada v Buckingham, 2011 FCA 142, and Balthazard v Canada, 2011 FCA 331.  They impose an obligation of prudent and diligent conduct so as to improve the quality of decisions made by corporate boards and discourage the use of nominees as directors (para 11).

In this case the Appellant was not a nominee director or one who was unaware of his responsibilities – the history of compliance proved this. Also, the court noted that the Appellant had appointed a competent manager to replace him until he was capable again, because he was aware of his responsibilities.

The existence of depression is a factor to consider.  Although generally a director may delegate duties only with appropriate oversight (see  Kaur v. The Queen, 2013 TCC 227; Chell v. The Queen, 2013 TCC 29; Stafford v. The Queen, 2009 TCC 247.), this is not to be interpreted too narrowly. In Verret v. The Queen,2008 TCC 240, it was said that the directors health problems must be considered.

To determine whether the defense is made out, one must ask “what more a reasonable prudent person placed in comparable circumstances could have done to try to prevent the corporation’s failure to remit”:  Cloutier v MNR, [1993] T.C.J. No 103 (QL.  The court held that;

[15] … In this case, I believe that the appellant has shown a sufficient degree of diligence in delegating his duties to a competent manager, whose competence and honesty he had no reason to doubt, and I believe that a reasonable person placed in comparable circumstances would have don’t nothing more.

The purpose of 323(1) is not to penalize ill persons for failure to supervise, but rather to penalize directors “who were careless and who neglect their role as agents of the Crown” (para 20).

- Sas Ansari, JD LLM PhD (exp)

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Surrender Payment for Stock Options – Character of Receipt

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Surrender Payment for Stock Options – Character of Receipt

Rogers Estate v The Queen, 2014 TCC 348

The Estate of the deceased received a surrender payment for surrendering options granted under an employee stock option plan.  The issue was the characterization of the surrender payment for income tax purposes.

The taxpayer reported the amount as a capital gain.  The MNR included the full amount in income as either (1) income from employment under section 5 or 6(1)(a); (ii) a shareholder benefit under subsection15(1); or (iii) profit from an adventure in the nature of trade under subsection 9(1).


The Court held that:

  • A court is not bound by an abandonment of an issue by the parties where the issue is one of law or mixed fact and law;
  • A court is not bound by an agreed statement of facts, as it must make findings of fact on all of the evidence;
  • Section 7 is a complete code on dealing with employee benefits under or because of a stock option plan, excluding the application of sections 5 and 6;
  • An employee stock option plan cannot result in a shareholder benefit under 15(1);
  • The holding and disposing of an employee stock option plan can be an adventure of concern in the nature of trade, only if the conditions for an adventure of concern in the nature of trade are met;
  • Capital gains result from the disposition of ANY property (not just capital property) that are not excluded property; and
  • In this case the surrender payment was a capital gain, as it did not fall within section 7,  or subsections 15(1), or 9(1).


The Deceased was the CEO and President of the issuing corporation, and they did not deal with each other at arm’s length.  He was issued options under the corporations employee stock option plan.  The options had later attached to them a share appreciation right that, if exercised, would result in a cash payment equal to the difference between the day’s average trading price and the exercise price of the option. The share appreciation right could be refused by the corporation, forcing the option holder to exercise the option.


The Crown abandoned its argument on the “profit from an adventure in the nature of trade” argument but the Judge, after asking for submissions as to whether he was bound by the abandonment, decided to proceed and consider the abandoned argument on the facts presented at trial.

The Taxpayer argued that the Court could not consider the section 9 argument because it was abandoned by the Crown, was incompatible with the agreed statement of facts, and was an usurpation of the MNR’s assessment power (para 11).

The Crown argued that a Court may reject a party’s abandonment of argument, relying on the decision in Labourer’s International Union of North America, Local 527, Members’ Training Trust Fund v. Canada, 92 DTC 2365, where it was said:

Parties to an action may agree on certain facts and this agreement may form the basis for a judicial admission by which the presiding judge will be bound. Parties cannot, however, make a judicial admission on a point of law, because “the Court may not be bound by error in an admission by the parties as to the law…” The court is not bound by concessions on points of law. . . .

The Court noted that there was no stated assumption of fact that the surrender payment was received qua employee.  The court highlighted the importance of not conflating the granting of the option (one event) with the payment of the surrender amount on surrender (second event), as these are distinct and capable of distinct characterization (para 14).

Additionally, the court noted that  it is not bound by the Agreed Statement of Facts, but has a duty to make factual findings on the basis of the documentary evidence and the discover read-ins. (para 15).  Lipson v Canada,  2009 SCC 1, does not apply to prevent a court from considering an issue that is plead where the matter is a mixed question of fact and law, as the court is not bound by any party’s interpretation of a point of law (para 19).

Adventure in the nature of trade

A question of mixed fact and law that considers factors – see Friesen v. Canada, [1995] 3 S.C.R. 103 – including:

  • the nature of the property
  • the length of the period of ownership
  • the frequency or number of other similar transactions by the taxpayer
  • the circumstances responsible for the sale of the property
  • the taxpayer’s motive in acquiring the asset

The FCA in Baird v. Canada, 2010 FCA 35, dealt with the issue in respect of disposition of shares of a public company, and held that losses on the exercise of employee stock options were on capital account.  An “adventure of concern in the nature of trade” is “an isolated transaction (which lacks the frequency or system of a trade) in which the taxpayer buys property with the intention of selling it at a profit and then sells it (normally at a profit, but sometimes at a loss).”  (para 56). The intention to sell the shares at a profit is not determinative: Irrigation Industries Ltd. v. Minister of National Revenue, [1962] S.C.R. 346 .

The facts of this case, in light of the above factors, lead the court to conclude that the dealing in the shares were not an adventure or concern in the nature of trade.

Employees’ Taxable Benefit

The court next considered whether the carve-out in paragraph 7(3)(a) applied to prevent a surrender payment from being a taxable benefit under section 6, even-though the non-arm’s length relationship makes the taxpayer not taxable under section 7.

Sections 7 deals with taxation of benefits derived by employees from exercise or dispositions of stock options, and it is meant to, inter alia, defer recognition of the income until the amount is received in its entirety and is quantifiable (para 28).  It is a complete scheme for taxation of employee stock options, and operates in the particular circumstances in stead of section 6 – See MNR v Chrysler Canada Ltd et al, 92 DTC 6346, where it is said that a specific provision trumps  general one.  Specifically, paragraph 7(1)(b) sets out the rules when an employee disposes of right to shares and takes cash, but applies only to employee’s who are dealing at arm’s length.

The appellant argued that since the payment is not caught by 7(1)(b), it is not  benefit to the taxpayer, and relied on the FCA decision in Canada v. Quinco Financial Inc, 2014 FCA 108, where it was held that where a provision is “precisely worded, clear and unambiguous” it must be given effect even if resulting in a windfall.  In support the appellant argued that amendments adding 7(1)(b.1) in 2010 now close this loophole, which confirms that no other provision in section 7 applies to the surrender payments (para 40).

The Crown argued that a benefit not caught  by section 7 must be included in income under section 6, relying on Dundas v MNR, 90 DTC 1529, where it was stated that an employee benefit not caught by section 7 is taxable under section 6.

The court noted that just because the payment was not captured by 7(1)(b), did not mean that 7(3)(a) was not applicable. Paragraph 7(3)(a) is applicable to taxation of benefits arising under or because of stock option agreements, and is clear and unambiguous.  It specifically states that unless section 7 captures the benefit of a non-arm’s length person, it is not  benefit taxable qua employee.

The amount was also not considered to be “other remuneration” under subsection 5(1). The Court sated that “salary” and “wages” connote periodic and fixed payments for work done or services rendered, and other remuneration must (following the specific enumerations) fall within this meaning- surrender payments do not.  In Hale v. The Queen, 90 DTC 6481 (FCTD), affirmed 92 DTC 6473 (FCA), and  Hurd v. The Queen,  [1982] 1 FC 554, it was stated that “other remuneration” are sums of money received in return for services and not a benefit of employment (para 47).

Shareholder Benefit

In Del Grande v. The Queen, 93 DTC 133, where amounts received on exercise of options were not shareholder benefits within the meaning of 15(1)(c), but rather a benefit by virtue of being an officer or employee.  The Court held that the surrender payments were not shareholder benefits under 15(1).

Capital Gains

The Court held that the surrender payment was for a disposition of property, that was not excluded property (subsection 39(1)), and resulted in a capital gain. The Court noted that a capital gain is NOT limited to gains on disposition of capital property, but gains on the disposition of ANY non-excluded property.

-Sas Ansari, JD LLM PhD (exp)

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Amount on Account of Income or Capital? – Henco Industries

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Amount on Account of Income or Capital?

Henco Industries Ltd v The Queen, 2014 TCC 192

At issue was whether a payment of over $15M by the Ontario Government to Henco was fully taxable as Income or non-taxable as a Capital receipt that was not an eligible capital amount.  The character of a few smaller payments were also at issue.

[A very lengthy decision that addressed a number of questions in depth, including: capital vs income; ECE vs other capital expenditure; being in business vs earning income from a business].


Henco was in the business of land development and owned three parcels of land in Caledonia, ON.  After having done significant work and entering into contract in pursuit of developing these properties, First Nations groups began blockades and occupations of the first property to be developed.  Injunctions were issued by the Ontario Courts but the Police did not make any arrests or enforce the injunctions.

The Ontario Government made a $650K payment to Henco, without requiring anything particular to be done or seeking anything in return from Henco. The Ontario Government and Henco, after negotiations, entered into several agreements with respect to the various assets of Henco.


The MNR argued that the $650K payment fell squarely within ITA 12(1)(x) and thus included in income as an amount that is a refund, reimbursement, contribution or allowance, or as assistance from government.  Henco, relying on R v Cranswick, [1982] 1 F.C. 813 (F.C.A.)., argued that the amount is a windfall.  The court stated that in order for an amount to fall within paragraph 12(1)(x):

  • it must be received by the taxpayer in the year “in the course of earning income from a business or property”
  • must be from a government
  • must reasonably be considered to be received as assistance in respect of an outlay or expense; and
  • must NOT be for the acquisition of the taxpayer’s business or property.

The Court pointed out that a taxpayer may be in business, but not be in the course of earning income from a business (as 12(1)(x) requires) and the focus is on the time period when the payment was received (para 121).   In this case, when the payment was received, Henco was still in business but not in the course of earning income from that business as it could not access the property, and therefore was cripples and sterilized, rather it was trying to preserve the business (para 125).  Additionally, given that there is no evidence of what the payment was received for or used for, and no requirement for accounting for the payment, it cannot be said that the amount was received “as assistance in respect of an outlay or expense” (para 126).

This amount was a windfall and not taxable.

The Court then turned to the question of Capital vs Income on the amounts paid for one property, and referred to the decision in Canada Safeway Ltd v R, 2008 FCA 24, where the relevant factors were laid out:

  • the boundary between income and capital gains is not easy to draw;
  • regard will have to be had to the circumstances and inferences will have to be drawn;
  • A primary or secondary intention to sell the property must have been present at the time of purchase so as to constitute an adventure in the nature of trade;
  • The intention for resale must be an operating and important consideration in the purchase of the property;

The evidence here did not favour one intention over the other (income over capital), and the taxpayer did not demolish the MNR’s assumptions – the court was bound to find that the amount in relation to this one property was on income account.

The second issue, the income or capital nature of the $15M payment was addressed last.  The MNR relied on the agreement that stated that the amount was for the sale of land.  The Appellant argued that the agreement did not reflect the true nature of the deal between them, and the payment was for the vaporization of Henco’s business.

Here, the agreement refereed not to consideration but compensation, and the quantum is determined by reference to a purchased asset (the court held that this was merely a mechanism to determine compensation for something difficult to value) (para 151).  The agreement refers to various assets, including intangibles,  and to a release of liability (which refers to the full $15M amount as consideration for the release) (paras 154-55).  Additionally there were other aspects that point to something more: requirement to cease business, set aside an injunction, and no valuations of assets were done.  The court went through a long list of factors (paras 159-60) that showed that the agreement did not reflect the true nature of the deal, and that the payment was not made for the land.

The court, though not required to, asked whether section 23 would apply (ceasing to carry on business), and stated that prior to the payment, by Ontario’s actions, the taxpayer did not have a business and was not in business.  The land was neither an investment not inventory as it was useless and worthless (para 167).

The payment was therefore not for land but for extinction of the right to sue Ontario – it could only be on Eligible Capital Amount.  However, because of the election to have the mirroring rules in 14(5) apply, the payment is not on account of ECP, but a non-taxable nothing.   Referring to the decision in T Eaton Co v R, 99 D.T.C. 5178 (FCA)., where it was said that payment for damage to income producing assets is on income account while payment for destruction of the income producing asset is on capital account, the payment was held to be on capital account. See also Pe Ben Industries Co. v R., [1988] 2 C.T.C. 120 (F.C.T.D.).; BP Canada Energy Resources Co. v. R., 2002 DTC 2110; and River Hills Ranch Ltd. v R., 2013 TCC 248.

In Toronto Refiners & Smelters Ltd. v R, 2002 FCA 476, four factors were set out to determine if an amount is an ECE:

  • Was the amount received as a result of a disposition?
  • Was the amount received in respect of the business carried on by the recipient of the payment?
  • What consideration did the recipient give for the payment?
  • If the recipient had made the payment for the same consideration that it had given to the payor (the mirror-imaging test), would that have been an eligible capital expenditure of the recipient?

Here, there was a disposition in respect of a business carried on, and the consideration was for goodwill (what is left over after amounts have been allocated to identifiable assets) (para 194-97).  Thus the amount was for ECE, but was non-taxable because of the mirror-imaging rule in 14(5).

- Sas Ansari, JD LLM PhD (exp)

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Associated Corporations – De Facto Control

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Associated Corporations – De Facto Control

McGillivray Restaurant Ltd v The Queen, 2014 TCC 357

The issue before the Court was whether the Appellant corporation was Associated with other corporations due to being “Controlled, directly or indirectly in any manner whatever, by the same person or group of persons” (256(1)(b) of the ITA), and therefore had to share the small business limit.


The Appellant corporation operated a Keg Restaurant, and its shares were owned 76% by a Wife and 24% by a Husband.  The Husband owned two other restaurants in town, was the Appellant’s landlord, and also provided the appellants management and financing services.  Finally, the Husband was also the Appellants sole director, president,  and general manager.


The ITA provides in paragraph 256(1)(b) that two corporations are associated, if at anytime in the year, “both of the corporations were controlled, directly or indirectly in any manner whatever, by the same person or group of persons”.  The court referred to the decision in Silicon Graphics Limited v The Queen, 2002 FCA 260, where the FCA dealt with the concept of de facto control.

In order to determine whether there is de facto control, courts will examine (a) external agreements (Duha Printers Ltd (Western) Ltd v Her Majesty the Queen), [1998] 1 SCR 795), (b) shareholder resolutions (Société Foncière d’Investissement Inc v Canada, [1995] TCJ No 1568, para 10 (TCC)), (c) ability of a party to change or influence the composition of the board, whether through a shareholders’ agreement or otherwise (International Mercantile Factors Ltd v The Queen (1990), 90 DTC 6390 at 6399 (FCTD), aff’d (1994), 94 DTC 6365 (FCA)).    These factors point towards a person’s clear right and ability to affect significantly the boars of directors or the powers of the board of directors, or to be able to exercise real influence over the shareholder’s who would be able to effect the preceding.

The FCA in Transport ML Couture Inc v Her Majesty the Queen, 2004 FCA 23, stated that there are many factors that may be relevant to determining whether a corporation is subject to the de facto control of a person or group, including family relationships.  The evidence, however, must show that the decision-making power of the corporation in question in fact lies elsewhere than those who have de jure control.  Some of the factors include (a) economic controlling influence, (b) control of day-to-day operations, (c) control over major corporate decisions, (d) business influence of such magnitude so as to be able to exert will, and (f) power to sign cheques of corporation (Mimetix Pharmaceuticals Inc. v. Her Majesty the Queen, 2001 TCJ No. 749, affirmed 2003 FCA 106).

 The Court concluded that it was hard to imagine how the Husband could have any more control over the affairs and fortunes of the Appellant corporation, and held that the Husband exercised de facto control.

- Sas Ansari, JD LLM PhD (exp)

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Income Tax (Federal & Provincial) – HST/GST – International Tax