Transfer Pricing Update – Imputing Transactions & the Appropriateness of Guarantee Fees Tax Executives Institute (Calgary) – May 30, 2017 Julie D’Avignon 707917 MAY 30, 2017 STIKEMAN ELLIOTT LLP Today’s Topics Appeals from Transfer Pricing Reassessments: 1. Suncor Energy Inc. (As Successor to Petro-Canada) v R 2. Burlington Resources Finance Company v R 3. Conoco Funding Company v R 1 STIKEMAN ELLIOTT LLP STIKEMAN ELLIOTT LLP 1 Suncor Energy Inc. (As Successor To Petro-Canada) v R Notice of Appeal dated November 21, 2014; Reply dated April 13, 2015; and Answer dated July 10, 2015 2 STIKEMAN ELLIOTT LLP Suncor Energy Inc. (As Successor To Petro-Canada) v R Facts Corporate Structure (Simplified) • Appeal by Suncor from a notice of 3rd Petro-Canada reassessment of its predecessor, Parties Hedges on Brent Petro-Canada for the 2007 tax year crude oil • The Minister’s transfer pricing 3908968 Canada adjustment based on s. 247(2)(a) Inc. and (c) of the Income Tax Act Canada (Canada) (“ ITA ”) increased Petro- Canada’s income by $2 billion UK • In 2004 PCUK, a UK-based Holdings UK subsidiary of Petro-Canada, acquired certain assets in the North Sea 3rd PCUK Parties Sale of oil from • Around that time, Petro-Canada North Sea asset entered into forward contracts for the sale of 28,000 bbl/d of Brent North Sea Oil crude oil at $~25/bbl for the period Assets July 1, 2007 – December 31, 2010 3 STIKEMAN ELLIOTT LLP STIKEMAN ELLIOTT LLP 2 Suncor Energy Inc. (As Successor To Petro-Canada) v R Facts (Cont’d) • The North Sea oil assets started Price of Brent Crude Oil $US/bbl producing in 2007. Expected 140 production of 60,000 bbl/d Board authorizes 120 close out of • The first cash settlements on the hedges forward contracts became due in 100 First cash July 2007. Initial cash settlement settlement payments of USD $287 million due 80 • $US/bbl The price of crude had risen 60 Petro-Canada dramatically since 2004, Petro- enters hedges Canada entered into swaps to close 40 out the forward contracts with a settlement payment of USD $1.7 billion 20 0 • Petro-Canada deducted these settlement payments in calculating Jul-2002 Jul-2007 Jan-2000 Jan-2005 Jun-2000 Jun-2005 Oct-2003 Apr-2001 Apr-2006 Sep-2001 Feb-2002 Sep-2006 Feb-2007 Dec-2002 Dec-2007 Aug-2004 Nov-2000 Nov-2005 Mar-2004 its income May-2003 May-2008 Source: US Energy Information Administration 4 STIKEMAN ELLIOTT LLP Suncor Energy Inc. (As Successor To Petro-Canada) v R Minister’s Grounds for Reassessment • The Minister imputed a $2 billion reimbursement from PCUK to Petro-Canada for the hedging losses • The Minister made certain findings of fact: – The hedges were part of a strategy to allow Petro-Canada to increase its bid for the North Sea oil assets – Petro-Canada was the only company authorized to undertake forward contracts and the only company that could supply the credit to undertake such contracts • The Minister’s view was that, for the purposes of applying s. 247(2), the “series of transactions” encompassed: – The acquisition of the North Sea oil assets – Entering into the forward contracts – Closing out the forward contracts 5 STIKEMAN ELLIOTT LLP STIKEMAN ELLIOTT LLP 3 Suncor Energy Inc. (As Successor To Petro-Canada) v R Minister’s Grounds for Reassessment (cont’d) • Petro-Canada and PCUK were participants in an imputed transaction, whereby Petro- Canada entered into the hedges for the benefit of its non-resident subsidiary • Minister considered Petro-Canada and PCUK to have priced such imputed transactions at $0 as no reimbursement of Petro-Canada by PCUK • If the parties had been dealing at arm’s length, Petro-Canada would have allocated hedging gains to PCUK and PCUK would have reimbursed Petro-Canada for hedging losses • Minister applied a penalty for Petro-Canada’s failure to adequately prepare contemporaneous documentation 6 STIKEMAN ELLIOTT LLP Suncor Energy Inc. (As Successor To Petro-Canada) v R Notice of Appeal • Issues: – Whether the Minister erred by applying s. 247(2)(a) and (c) to impute a reimbursement by PCUK to Petro-Canada? – Whether, even if s. 247(2)(a) and (c) apply, the Minister erred in assessing Petro-Canada on the basis that the transfer price between Petro-Canada and PCUK was inconsistent with the arm’s length standard? – Whether the Minister erred by applying s. 247(3) and (4) to impose a penalty for the alleged failure to adequately prepare contemporaneous documentation? 7 STIKEMAN ELLIOTT LLP STIKEMAN ELLIOTT LLP 4 Suncor Energy Inc. (As Successor To Petro-Canada) v R Notice of Appeal (Cont’d) • Reasons: – S. 247(2)(a) and (c) does not apply: • Petro-Canada participated in two transactions: (1) entering into the forward contracts on its own behalf; and (2) settling those contracts • PCUK participated in two transactions: (1) the North Sea assets acquisition; and (2) earning revenue from the production and sale of crude oil from those assets with other arm’s length parties • Each of the transactions were made with arm’s length parties • The Minister’s application of s. 247(2)(a) and (c) results in an arbitrary application of the provision requiring taxpayers to self-report on imputed transactions that do not actually occur – Even if s. 247(2)(a) and (c) apply, the transfer price imputed by the Minister between Petro-Canada and PCUK was inconsistent with the arm’s length standard: • The adjustment makes PCUK liable for the obligations of Petro-Canada, which is inconsistent with the legal obligations of the parties 8 STIKEMAN ELLIOTT LLP Suncor Energy Inc. (As Successor To Petro-Canada) v R Notice of Appeal (Cont’d) • Reasons: • An arm’s length party would not make a $2 billion voluntary payment without a legal obligation • The $2 billion reimbursement would not have been agreed to by arm’s length parties. • Arm’s length price would be nil as PCUK had no entitlements or obligations under the forward contracts – There was no failure to adequately prepare contemporaneous documentation: • There was no transaction within the meaning of s. 247 to be documented and therefore no failure to document a transaction according to s. 247(3) and (4) • Asserting that a taxpayer should document notional transactions which the Minister may impute is inconsistent with the textual, contextual and purposive interpretation of s. 247(3) and (4) • Subsections (3) and (4) require reasonable efforts. Petro-Canada exercised reasonable diligence in the circumstances in documenting the transactions that actually occurred • Petro-Canada provided contemporaneous documentation with respect to each of the transactions in the series of transactions 9 STIKEMAN ELLIOTT LLP STIKEMAN ELLIOTT LLP 5 Suncor Energy Inc. (As Successor To Petro-Canada) v R Minister’s Reply • Issues: – Whether s. 247(2)(a) and (c) apply to adjust Petro-Canada’s income? – Whether Petro-Canada is liable to a penalty pursuant to s. 247(3)? • Reasons: – The Minister correctly applied s. 247(2)(a) and (c) to adjust Petro-Canada’s income: • Petro-Canada engaged in the forward contracts to hedge the price risk of its indirect subsidiary, PCUK, to guarantee a certain level of return for the North Sea asset acquisition • When PCUK acquired the North Sea assets, it also acquired the crude oil price risk. An arm’s length party would have reimbursed Petro-Canada for hedging losses – Petro-Canada is liable to a penalty pursuant to s. 247(3): • Petro-Canada did not make reasonable efforts to determine arm’s length transfer price with PCUK • Petro-Canada did not make or obtain adequate documentation 10 STIKEMAN ELLIOTT LLP Suncor Energy Inc. (As Successor To Petro-Canada) v R Comments • According to a Suncor press release dated December 5, 2016, Suncor successfully resolved the dispute with the CRA, resulting in no additional taxes, interest or penalties • The CRA position takes a broad view of the transfer pricing provisions of the ITA: – CRA imputed a transaction in absence of any legal obligation, legal entitlement or contractual relationship – Purports to expand the onerous requirements of the transfer pricing to notional transactions 11 STIKEMAN ELLIOTT LLP STIKEMAN ELLIOTT LLP 6 Burlington Resources Finance Company v R Notice of Appeal dated June 26, 2012; and Reply dated October 9, 2012 12 STIKEMAN ELLIOTT LLP Burlington Resources Finance Company v R Facts • Appeal by BRFC from a notice of reassessment for the 2002 - 2005 Corporate Structure taxation years (Simplified) Burlington • BRFC was a Nova Scotia unlimited Resources Inc. 0.5% guarantee liability company (“ ULC ”) that Guarantee of BRFC’s debt (“BRI”) fee to parent borrowed funds with its parent’s US guarantee and on-loaned those funds to related entities Canada Burlington • In exchange for the guarantee, Burlington 3rd Resources Finance BRFC paid its parent a 0.5% fee and Resources Parties Company (“BRFC”) deducted that fee in calculating its Loans On-loaned Group income funds to related entities at a spread • BRI sought advice from investment banks in determining an appropriate guarantee fee and agreed to the 0.5% fee with BRFC based on that advice 13 STIKEMAN ELLIOTT LLP STIKEMAN ELLIOTT LLP 7 Burlington Resources Finance Company v R Minister’s Grounds for Reassessment • The Minister reduced the guarantee fees to nil and imposed transfer pricing penalties pursuant to s. 247(3) • The Minister made certain findings of fact: – BRFC was established with minimal capital, no employees, no operations, no collateral and no cash flow – BRFC could not borrow funds without its parent’s guarantee – No bona fide purpose for this structure and the guarantee, other than to obtain a tax deduction for BRFC – An arm’s length party would require a fee at such an excessive rate that BRFC would not be able to on-loan its funds at a competitive rate – The terms and conditions of the transaction differed from those that would have been made between person’s dealing at arm’s length – Arm’s length parties would not have required that there be any fee in respect of BRI’s guarantees.