McKesson Canada Corporation v. The Queen
(Signed December 13, 2013, Posted on the Court’s Web Site December 27, 2013) is a decision of the Tax Court of Canada that is the fourth of a series of recent cases that are fundamentally changing our understanding of the operation of transfer pricing rules in Canada. In addition there are some recent procedural decisions suggesting that more large transfer pricing cases are in the pipeline.
The McKesson decision is complex and extremely long (397 paragraphs) and was under reserve for almost two years. The length of the decision is directly related to the size of the price adjustment (approximately $26.6 million), the complexity of the facts and the volume of evidence before the court:
 McKesson Canada is the principal Canadian operating company in the McKesson group of companies owned by the U.S. multinational McKesson Corporation (“McKesson U.S.”). McKesson U.S. is a United States public company and is the 15th ranking largest public company in the Fortune 20 list of companies. Its annual revenues are an excess of US$100 billion. It is the largest U.S. health care company. It has over 32,000 employees worldwide. It has been said that McKesson U.S. is the biggest company no one has ever heard of.
 Worldwide, and in Canada, the core business of the McKesson group of companies (“McKesson Group”) is the wholesale distribution of over-the-counter and prescription pharmaceutical medicine products. This accounts for about 97% of its revenues. Its other related business is that of hospital software technology.
 The McKesson Group’s wholesale pharmaceutical business has an impressive market share. The McKesson Group delivers one-third of all medicare to the public in the US. In the years in question, McKesson Canada had about one-third of the Canadian market. It distributes the products of a large range of pharmaceutical companies, and sells to drug store chains large and small, to large grocery store and department store chains that have pharmacies and/or sell over-the-counter medicinal products, to independent pharmacies, to hospitals, and to long-term care institutions.
 In the year the receivables facility was put in place, 2002, McKesson Canada had sales of $3 billion, profits of $40 million, 2,400 employees and the largest share of the Canadian market. Its Canadian customers included a number of Canada’s largest retailer grocers and drug store chains. It had credit facilities available to it in the hundreds of millions of dollar range with major financial institutions. Its public ultimate parent, McKesson U.S., had a solid investment grade credit rating and the interest rates on the available lines reflected that. The McKesson Group had a very considerable cash surplus built up in its Irish affiliate.
 At that time, and in the years leading up to it, McKesson Canada had its own successful and sizeable credit department which managed its credit and collection policies and practices. Credit and collections results were trending favourably. McKesson Canada’s receivables were managed with considerable success, having a roughly 30 day payment average, and a 0.043% bad debt experience with its customers overall. That is, 99.96% of its receivables proved to be good and collected when managed by McKesson Canada’s credit department applying McKesson Canada’s credit and receivables collection policies. This was very important to McKesson Canada’s success given that the wholesale drug business was low-margin – in the range of 2% – on high volumes.
 There was no evidence that there was any pending imminent or future change expected, anticipated or planned for in the make-up, nature or quality of McKesson Canada’s receivables or customers, although there was always the future risk of unforeseen adverse change.
 At that time, McKesson Canada had no identified business need for a cash infusion or borrowing, nor did McKesson Group need McKesson Canada to raise funds for another member of the group. There was a so-called double-dip Nova Scotia Unlimited Liability Company or ULC financing which was coming to maturity and would need to be recapitalized in some fashion; this was for a fraction of the amount of the new receivables facility. McKesson Canada did not approach its traditional lenders or conventional financial institutions (nor anyone else) before entering into its own non-arm’s length receivables facility and related transactions. The McKesson Group had previously put in place a tax-effective international corporate structure and inter-group transactions that allowed it to amass very large amounts of cash in Ireland. The non-Canadian members of the McKesson Group were able to use this money to finance all of the purchases of McKesson Canada’s receivables under the facility.
 The non-Canadian McKesson Group company that purchased the receivables had the right to put non-performing receivables back to McKesson Canada for a price equal to 75% of the face amount, later readjusted to the amount actually collected on it by McKesson Canada. The purchaser did not otherwise have recourse to McKesson Canada for unpaid purchased receivables.
 The non-Canadian McKesson Group entity that purchased the receivables borrowed all the money needed from another non-Canadian McKesson Group entity. The borrower’s obligations to the lender under the loan was fully guaranteed by yet another non-Canadian McKesson Group entity, which also indemnified the borrower for any shortfall between what the borrower received from McKesson Canada’s receivables and what it needed to pay on the loan.
 As described below, the non-resident affiliate also paid McKesson Canada to continue to have McKesson Canada’s credit and collections department manage the receivables applying McKesson Canada’s credit and receivables collection policies and practices. Under the agreements these policies and practices could not be changed without consent. Similarly, McKesson Canada could only continue to grant other discounts or rebates in the ordinary cause of its business and in accordance with its usual practices when the facility was entered into.
 Most of the proceeds of the initial $460,000,000 receivables sale were returned by McKesson Canada to its non-resident shareholder affiliate, a portion was loaned for a period to another Canadian corporation to permit its tax losses to be used, and about 1% of the proceeds were used by McKesson Canada for its general corporate purposes.
 The CRA has challenged these related party transactions for McKesson Canada’s 2003 taxation year on the basis that the amounts paid to the non-Canadian McKesson entity pursuant to the receivables purchase transactions differ from those that would have been paid between arm’s length persons transacting on arm’s length terms and conditions. The discount upon the purchase of the receivables in accordance with the revolving facility was a 2.206% discount from the face amount. While this discount rate and the overall transactions between the parties are considered in greater detail below, this discount rate for receivables that on average were expected to be paid within about 30 days can be restated as an annual financing cost payable by McKesson Canada for its rights under the facility in the range of 27% per annum.
 A direct result of these discounts was that McKesson Canada ceased to be profitable for its 2003 taxation year and reported a tax loss in the year in issue in this appeal. McKesson Canada’s profits in later years were similarly significantly reduced.
 The taxation year of McKesson Canada under appeal ending March 29, 2003 was a short taxation year of approximately three and a half months, having started upon its amalgamation as part of a Canadian restructuring of the McKesson Group’s Canadian interests. Its taxation and financial year ends on the last Saturday in March of each year. Its financial year is divided into a 13 four week Accounting Periods. CRA’s 2003 transfer pricing adjustment was approximately $26,610,000, reflecting a 1.013% discount for the purchased receivables. No transfer pricing penalty was assessed.
 The receivables facility was a five-year revolving facility. As detailed below, the purchaser had several rights to terminate the agreement in the event of any anticipated deterioration in the quality of receivables generated in McKesson Canada’s business.
 As discussed further below, the predominant purpose of McKesson Canada entering into the transactions was the reduction of its Canadian tax on its profits. None of the raising or freeing up of capital, reducing credit risk from its customers, nor improving its balance sheet was McKesson Canada’s predominant purpose; they were results of the transactions.
 This trial was a very lengthy and hard fought 32 day trial heard over a period of five months from October 2011 to February 2012. Formidable groups of lawyers represented each of the Appellant and the Crown. The Court heard from two material witnesses and five expert witnesses. Reams and reams of documentation were entered into evidence, including further expert reports whose authors did not testify. After oral argument both parties made further written submissions and further responding submissions. Following the Supreme Court of Canada’s decision in Canada v. GlaxoSmithKline Inc., 2012 SCC 52,  3 S.C.R. 3 in October 2012, both parties made further written submissions.
The court found as a fact that the predominant purpose of the financing transaction was to reduce McKeeson’s Canadian and worldwide tax payable – which was acceptable so long as the payments did not exceed “what an arm’s length person would agree to pay for the rights and benefits obtained”:
 I find as a fact that the predominant purpose and intention of McKesson Canada participating in the RSA and related transactions with the other McKesson Group members was not to access capital or to lay off credit risk. Those were results of the transactions but did not motivate them. The purpose was to reduce McKesson Canada’s Canadian tax liability (and therefore McKesson Group’s worldwide tax liability) by paying the maximum discount under the RSA that McKesson Group believed it could reasonably justify. For the McKesson Group this appears to have been much more of a tax avoidance plan than a structured finance product. No reason was ever given for wanting to transfer risk to Luxembourg.
 There is certainly nothing wrong with taxpayers doing tax-oriented transactions, tax planning, and making decisions based entirely upon tax consequences (subject only to GAAR which is not relevant to this appeal). The Supreme Court of Canada reminds us regularly that the Duke of Westminster is alive and well and living in Canada. However, the primary reasons and predominant purposes of non-arm’s length transactions, whatever they may be in any given case, form a relevant part of the factual context being considered. For example, if neither side has a business purpose or need to do a particular non-arm’s length transaction, it will probably not be particularly persuasive to try to argue that particular terms, conditions, provisions, or approach reflect the particular business need of either party.
 The maximum amount deductible in Canada by McKesson Canada is limited to what an arm’s length person would agree to pay for the rights and benefits obtained. The Appellant says it did not exceed that limit. The Respondent says they exceeded it by more than 100%. This is the only question that the Court is called to decide.
Based on the evidence however the court concluded that the appellant had exceeded what an arm’s length person would have paid under the circumstances:
 The Court has concluded that its best estimate of the range of Discount Rate to which arm’s length parties to a notional arm’s length RSA would agree is between 0.959% and 1.17%.
 The taxpayer has not been able to establish with sufficient credible and reliable evidence, that the RSA Discount Rate of 2.206% was computed based upon arm’s length terms and conditions.
 The evidence does not show that the Discount Rate used by the Minister of National Revenue (the “Minister”) in the reassessment of 1.013% was below a Discount Rate computed on arm’s length terms and conditions for a notional arm’s length RSA. The Court can not conclude on all of the evidence that the reassessment was incorrect as it was within the arm’s length range determined by the Court.
 In any event it is not necessary to fix a particular point within the determined range as the arm’s length transfer price as, importantly, the taxpayer’s evidence does not rise to the level of making out a prima facie case that “demolishes” the key assumptions of fact made by the Minister that support the reassessments.
 Assumption (v) in paragraph 28 of the Amended Reply is that the Discount Rate that would have been agreed to had the Appellant and MIH been dealing at arm’s length would have been established of a rate no greater than 1.0127%. The taxpayer has not been able to discharge the burden and onus upon it of showing that the amount of the reassessment is incorrect. The shortcomings of the TDSI Report, the Reifsnyder Report, and the supporting testimony regarding both, were obvious and apparent and did not require contrary evidence from the Respondent to make them evident. For this reason, the taxpayer’s appeal with respect to the transfer pricing adjustment is dismissed.
 This is an appropriate result. It would not be appropriate for this Court to order the Minister in a case such as this to reconsider and to reassess at the high point of the range of arm’s length Discount Rates (1.17%). That would reward overreaching taxpayers who would then count on the court process to ensure they enjoyed the highest permissible transfer price. This would encourage the poor use of public resources and expenditures. In contrast, in transfer pricing disputes which, as here, often involve very large amounts, the taxpayer’s costs can be less than the value of even a slight variance in the underlying price of the inputted asset or service. Taxpayers would be economically encouraged to use the Court to ensure they get their maximum transfer price by choosing one that is likely to exceed it.
 Further, the Discount Rate range with respect to the year in issue is less than 0.959% to 1.17%. Estimating that the midpoint of the 2003 range is the appropriate arm’s length Discount Rate, and after making the further needed DSO adjustments to components of the Loss Discount and the Discount Spread described in paragraph 288 above, it appears that in any event the arm’s length Discount Rate for the 2003 year in issue as determined by the Court is less than the rate used by the Minister in the reassessment.
[Emphasis added. Footnote omitted.]
The appellant’s alternative argument was that the 2003 Part XIII assessment was barred by the Canada-Luxembourg Tax Treaty:
 It is the Appellant’s position that Article 9(3) of the Treaty applies and the assessment was barred by Article 9(3) as it was issued outside of the five-year period.
 It is the Respondent’s position that, while CRA’s Part XIII assessment for McKesson Canada’s vicarious liability for an amount equal to the amount that should have been withheld and remitted to CRA by it when it paid MIH is the same as the amount of Canadian tax that would have been payable by MIH on its deemed dividend income, the standalone obligation of McKesson Canada under subsection 215(6) of the Act as a Canadian payor who fails to remit is distinct for Article 9 purposes from a change in the income of MIH for tax purposes resulting from the benefit conferred and the resulting deemed dividend.
 The Respondent also argues that the description of income in Article 9 of the Treaty does not extend to deemed dividend income. It argues that a deemed dividend that accrues precisely because of the non-arms’ length relationship can not be considered to be income described in Article 9(1). The Crown argues that neither a benefit nor a deemed dividend could have accrued to MIH if the non-arm’s length conditions were removed from the RSA that is, if the Discount Rate had been the appropriate arm’s length discount rate. This would be the case only if the RSA Discount Rate were computed on arm’s length terms and the resulting higher purchase price was paid by MIH for the transferred receivables, or if less than all of the receivables portfolio had been transferred to reflect the RSA’s understatement of value. In either case, there would be no benefit conferred under the adjusted transactions with the result that there would be no deemed dividend and there could only be dividend income from McKesson Canada arising to MIH if McKesson Canada paid a dividend or conferred a benefit outside the RSA once adjusted to reflect arm’s length terms. The Crown argues that a real dividend could have accrued to MIH if the non-arm’s length conditions were removed from the RSA but only if McKesson Canada had separately declared a dividend for that particular given amount.
The court rejected this alternative argument:
 In this appeal there was no evidence that MIH paid any Luxembourg income tax on the income generated by it under the RSA from McKesson Canada’s receivables. The only evidence was Mr. Brennan’s handwritten note that some undescribed tax could be expected to be payable to Luxembourg as a result of the purchase and collection of McKesson Canada’s receivables under the RSA. This was not described as an income tax. There was also no evidence that any adjustment to MIH’s Luxembourg tax was needed to relieve any double tax, or whether such relief was either requested by MIH or granted by Luxembourg.
 Paragraph 3 of Article 9 is the paragraph which imposes a five-year limitation period for making certain described transfer pricing adjustments. For purposes of McKesson Canada’s appeal of its Part XIII assessment for the amount it should have withheld from MIH and remitted to CRA in respect of MIH’s Part XIII Canadian tax liability on the benefit (or deemed dividend) of the overstated Discount Rate and resulting underpayment by MIH to McKesson Canada under the RSA for the transferred receivables, paragraph 3 provides that Canada shall not change the income of MIH in the circumstances referred to in paragraph 1 after a specific five-year period. That period is five years from the end of the year in which the income of MIH sought to be adjusted by Canada would have accrued to MIH but for the conditions referred to in Article 9(1).
 Clearly Article 9(3) provides a maximum five-year limit (except in cases of wilful default or fraud) for either state to make an Article 9(1) transfer pricing adjustment. It also clearly provides the same time limit on the other state having to make the corresponding adjustment on its counterparty under Article 9(2).
 It is clear that Article 9(3) can apply to an assessment by either country of either the Canadian or Luxembourg party since it refers to the circumstances referred to in Article 9(1) which can so apply.
 McKesson Canada argues that Article 9(3) also prevents Canada from assessing it under subsection 215(6) after March, 2008. In order for this argument to prevail, the following requirements of Article 9(3) (and by cross reference, Article 9(1)) must be met:
(i) the subsection 215(6) assessment of McKesson Canada must be a change in the income of MIH.
(ii) that adjustment of MIH’s income must be in the circumstances referred to in Article 9(1), namely:
(a) MIH controls McKesson Canada or both MIH and McKesson Canada are indirectly managed or controlled by McKesson U.S.;
(b) The conditions of the financial or commercial relations between MIH and McKesson Canada differ from the conditions which would have been made between independent parties;
(c) The income adjustment is income which would have accrued to MIH, not McKesson Canada, but for those differing conditions in their financial and commercial relations; and
(d) Canada sought to add the income adjustment to MIH’s income and taxed it accordingly.
(iii) a period of five years must have passed since the end of the year in which the income of MIH sought to be changed would, but for the conditions which differ from what independent parties would agree to, have accrued to MIH.
 In my view this argument can not prevail because Canada’s subsection 215(6) assessment of McKesson Canada does not satisfy all of these requirements.
The court articulated three bases why these requirements were not met:
 Firstly, I question whether a subsection 215(6) vicarious assessment of a Canadian payor for failure to remit and withhold tax is a change by Canada of MIH’s income (requirement (i) above), or constitutes Canada seeking to add a transfer pricing adjustment amount to MIH’s income and tax that increased amount (requirement (ii)(d) above).
 I am more inclined to see it as an enforcement and collection provision than a tax charging provision. Subsection 215(6) permits CRA to assess the Canadian payor an amount determined by reference to the amount it should have remitted to CRA but did not, which withholding amount is in turn determined by reference to the amount of Canadian tax that would have been payable by the non-resident payee. In the circumstances, however, I do not have to decide this point to dispose of this appeal.
 It does, however, appear clear that an assessment of McKesson Canada for its failure to withhold and remit does not constitute Canada adding the transfer pricing income adjustment to MIH’s income and then taxing it accordingly (requirement (ii)(d) above). Adding it to MIH’s income and taxing it accordingly requires that Canada sought to tax MIH.
 Secondly, these requirements are more clearly not met because the only transfer pricing adjustment in Article 9(1) is income which, but for the related party conditions, would have accrued to MIH under the RSA transactions (requirement (ii)(c) above). While the amount of MIH’s taxable benefit and deemed dividend may be the same as this transfer pricing adjustment, it is not an amount of income that, had the RSA had an arm’s length discount rate, would have accrued to MIH. On the contrary, the transfer pricing adjustment is income that but for the non-arm’s length terms and conditions would have accrued to McKesson Canada.
 Thirdly, this same fatal problem arises equally clearly yet again in respect of the Article 9(3) requirement (described in (iii) above) that a five-year limitation period can only begin to run from the end of the year in which the income of MIH sought to be changed would, but for the non-arm’s length Discount Rate used in the RSA, have accrued to MIH. Again, had an arm’s length Discount Rate been used in the RSA in McKesson Canada’s year ending March 31st, 2003, the additional income would have accrued to McKesson Canada not MIH, as MIH would have paid McKesson Canada more for its receivables. Clearly, the “but for” wording of the Treaty requires the arm’s length conditions be substituted for the non-arm’s length conditions and, if this is done, the Article 9(1) and 9(3) adjusted income amounts can only be read as amounts that would have accrued to McKesson Canada, not MIH. This is a third independent reason why Article 9(3) can not relieve McKesson Canada from its liability under the Part XIII assessment for its failure to withhold and remit upon transferring its receivables to its non-resident parent for less than their value after agreeing to an excessive Discount Rate in the RSA.
Accordingly the court rejected the appellant’s limitation period argument:
 In conclusion, the five year limitation period in Article 9(3) of the Treaty does not apply to the assessment of McKesson Canada’s vicarious liability for the amount of Part XIII tax payable by MIH which results from McKesson Canada’s failure to withhold and remit such amount. As shown above that is the result of the clear wording of Article 9(3), consistent with the overall context of Article 9, and consistent with the purposes of Treaty. Paragraph 227(10)(d) of the Act otherwise permits a subsection 215(6) assessment to be made at any time. For these reasons, the taxpayer’s appeal of its Part XIII assessment is also dismissed.
Comment: Most transfer pricing cases turn on the facts and, apart from the limitation period issue, this case was no exception. The court was unusually critical about the aggressive approach of the The Reifsnyder Expert Report proffered by the appellant:
 Overall I can say that never have I seen so much time and effort by an Appellant to put forward such an untenable position so strongly and seriously. This had all the appearances of alchemy in reverse. One could only assume that the Appellant knew full well the weaknesses of the TDSI Report and this was the best method it could use to support the Discount Rate used by the McKesson Group in the RSA.
While this is a lengthy case and will take some time to assess adequately it would appear that what most troubled the court was a certain lack of balance in the case presented by the appellant.
 2013 TCC 404.
 Canada v. General Electric Capital Canada Inc.,
2010 FCA 344:
[CanLii does not indicate that any application for leave was taken to the Supreme Court of Canada.]
Canada v. GlaxoSmithKline Inc.,
2012 SCC 52:
[This case was remanded to the Tax Court of Canada for reconsideration and the Tax Court’s case information file was still active as of December 20, 2013.]
Alberta Printed Circuits Ltd. v. The Queen, 2011
[There has been no reported appeal of this decision to the Federal Court of Appeal and since the decision was rendered more than 2 ½ years ago it would seem unlikely that any appeal is pending.]
 E.g., Burlington Resources Finance Company v. The Queen,
2013 TCC 231; Cameco Corporation v. The Queen, 2011 TCC 356.
 The Tax Court judge in fact offered a form of apology for the length of the decision at footnote 82:
At this point and by way of postscript, I should acknowledge the length of these reasons and offer a form of apology to those reading it who are not the parties or their counsel, nor appellate judges or their clerks. I can do no better than quote from a 2013 address by Lord Neuberger of Abbotsbury, President of the UK Supreme Court (entitled ironically Justice in an Age of Austerity): “We seem to feel the need to deal with every aspect of every point that is argued, and that makes the judgment often difficult and unrewarding to follow. Reading some judgments one rather loses the will to live – and that is particularly disconcerting when it’s your own judgment that you are reading.”