New Transfer Pricing Case: Burlington Resources Finance Company v. The Queen, 2015 TCC 71

By Robert Robillard - 1 April 2015

This blogpost originally appeared on rbrt.ca.

A new quarrel about guarantee fees as they pertain to transfer pricing purposes is brewing in Canada.

As indicated in Burlington Resources Finance Company v. The Queen, 2015 TCC 71:

“[1]  The Appellants, Burlington Resources Finance Company (“Burlington”) and Conoco Funding Company (“Conoco”) have brought motions, pursuant to Rules 4, 7, 95 and 110 of the Tax Court of Canada Rules (General Procedure) for the following:

1. directing the Respondent’s nominee to re-attend at the Respondent’s own expense and answer certain questions (the Disputed Questions), and any proper question arising from the answer, from the discovery examinations held on June 2, 3, 4 and 5 and November 13 and 14, 2014 (in the case of Burlington) and on June 5 and 6 and November 12 and 13, 2014 (in the case of Conoco) which the Respondent has refused to answer or has not fully answered;

2.  costs of the within Motion; and

3. such other relief as the Appellant may submit and this Honourable Court may allow.

[2]  The Appellants contend that the Disputed Questions are relevant to the matters in issue but that the Respondent has not answered, or has not fully answered, those questions.

[3]  These motions for each Appellant were heard consecutively on December 9 and 10, 2014.

[4]   The Respondent opposed the motions on the basis that all proper questions have been answered and that improper questions have been correctly refused.”

The Facts

As indicated by the Court:

“[5] Briefly, the facts in the appeal of Burlington are as follows:

  1.    Burlington is a Nova Scotia unlimited liability company and a wholly-owned subsidiary of Burlington Resources Inc. (“BRI”), a resident U.S. corporation.
  2.    Burlington’s business is principally involved in obtaining financing to fund the operations of affiliated Canadian companies and, specifically, to borrow funds from public markets and to “on-loan” those proceeds to its affiliated Canadian entities, which were conducting businesses related to crude oil and natural gas assets.
  3.    Burlington, BRI and the affiliated corporations engaged in a series of transactions including the issuance of inter-company promissory notes, subscription and security agreements which, according to Burlington, were to ensure its payments due under the notes.
  4.    In 2001 and 2002, the Appellant borrowed approximately U.S. $3 billion and issued notes to arm’s length parties.
  5.    BRI unconditionally guaranteed the payment of the notes and Burlington “on-loaned” the proceeds to Canadian sister companies.
  6.    Burlington and BRI agreed that Burlington would pay guarantee fees to its non-resident parent corporation based on an annual guarantee fee of 50 basis points of the principal amount of the outstanding notes. According to the Appellant, the fees were incurred in exchange for BRI’s guarantees and were based upon advice received from investment banks.
  7.    During the 2002 to 2005 taxation years, Burlington paid approximately U.S. $83 million as guarantee fees to BRI and also incurred financing costs in the course of the issuance of its notes.
  8.    In calculating its income, in each of the 2002 to 2005 taxation years, Burlington deducted the guarantee fees that were paid annually to its parent company, BRI, pursuant to section 9 of the Income Tax Act (the “Act”), together with certain financing costs, deducted for each of the taxation years.
  9.    The Minister of Finance (the “Minister”) reassessed the Appellant, in respect to those taxation years, denying those deductions and imposing transfer pricing penalties pursuant to subsection 247(3) of the Act because Burlington failed to make reasonable efforts to determine the arm’s length transfer price in respect to the guarantees.
  10.   The Minister relied on paragraphs 247(2)(a) and (c) of the Act in reducing the amount of the guarantee fees to nil in each taxation year and claiming that the terms and conditions of this fee arrangement between Burlington and its parent company were not terms and conditions which would have existed between arm’s length parties. The Minister also relied on paragraphs 247(2)(b) and (d) in its pleadings to argue that the series of transactions giving rise to the fees would not have been entered into between arm’s length parties and cannot be considered to have been entered into primarily for  bona fide purposes other than to obtain a tax benefit.
  11.   The Minister relied on paragraph 18(1)(a) of the Act to deny the financing costs, claiming that they were not incurred in order to earn income in respect of the Appellant’s business.
[6] The facts in the appeal of Conoco [Conoco Funding Company] are similar to those of Burlington. Briefly, those facts include:

  1.    Conoco is also a Nova Scotia unlimited liability company and a wholly-owned subsidiary of Conoco Inc., a resident U.S. corporation.
  2.    Similarly to Burlington, this Appellant’s primary business involved obtaining financing from public markets in order to fund the operations of its affiliated Canadian corporations. It did so by having the parent company, Conoco Inc., guarantee the borrowing debt on the notes and it then proceeded to “on-loan” the funds to the affiliated entities.
  3.    Like Burlington, this Appellant and its parent company engaged in a series of transactions, including promissory notes, forward share subscription agreements and limited security agreements, in respect to the guarantees, in order to ensure its payments under the debt offerings.
  4.    In 2001, Conoco borrowed approximately $3.5 billion and issued notes to arm’s length parties for the purpose of financing the acquisition of Gulf Canada Resources Limited by related Canadian parties.
  5.    The Appellant’s parent company, Conoco Inc., unconditionally guaranteed the payment of the notes and Conoco “on-loaned” the proceeds to Canadian sister companies.
  6.    Like Burlington, the Appellant paid annual guarantee fees to the guarantor parent company in the amount of 50 basis points of the principal amount of the outstanding debt. Conoco claimed that the fees were incurred in exchange for the parent corporation’s guarantees.
  7.    During the 2002 to 2005 taxation years, Conoco paid approximately U.S. $109 million as guarantee fees to its parent corporation, Conoco Inc.
  8.    In calculating its income in each of the 2002 to 2005 taxation years, Conoco, like Burlington, deducted the guarantee fees paid annually to its parent company.
  9.       The Minister reassessed Conoco and denied the deductions thereby reducing the guarantee fees to nil in each taxation year and also imposing transfer pricing penalties pursuant to subsection 247(3) of the Act.
  10.   The Minister relied on paragraphs 247(2)(a) and (c) of the Act in reducing the amount of the guarantee fees to nil by claiming that the terms and conditions of the fee arrangement were not the terms and conditions which would have been entered into between arm’s length parties. The Minister also relied on paragraphs 247(2)(b) and (d) to argue that the series of transactions or arrangements giving rise to the fees would not reasonably be entered into between arm’s length parties and, consequently, were entered into, not for bona fide purposes, but for obtaining a tax benefit.”

The Issues

As summarized by the Court:

“[7] The primary issues in respect to both appeals are the following:

(a) Whether the Minister properly reduced the guarantee fees to nil in each taxation year in determining that the Appellants could not deduct the guarantee fees in the calculation of their respective income in those taxation years; and

(b) Whether the Minister properly applied sections 247(3) and (4) of the Act in assessing the Appellants with the transfer pricing penalties.

[8] In respect to the guarantee fees in both appeals, the Respondent lists five separate sub issues:

(a) whether the Guarantee Fees were incurred by the Appellant for the purpose of earning or producing income from its business;

(b) whether the terms or conditions, including the Guarantee Fees, made or imposed in respect of the guarantees differed from those that would have been made between persons dealing at arm’s length;

(c) whether the terms or conditions, including the Guarantee Fees, made or imposed in respect of the Arrangements differed from those that would have been made between persons dealing at arm’s length;

(d) whether the guarantees would have been entered into between persons dealing at arm’s length and can reasonably be considered not to have been entered into primarily for bona fide purposes other than to obtain a tax benefit;

(e) whether the arrangements would have been entered into between persons dealing at arm’s length and can reasonably be considered not to have been entered into primarily for bona fide purposes other than to obtain a tax benefit;

(Reply to the Notice of Appeal in Conoco, para 9)”

In the rest of this transfer pricing case, Justice Campbell analyzes the relevance of the content of the appelant’s queries to force the Canada Revenue Agency to motivate its position in both transfer pricing cases.

Paragraphs 11-17 thoroughly discuss the principles of discovery in Canada as they apply to a transfer pricing audit and, as applicable, thereafter to an appeal process or any tax court case:

“[11]  Caselaw is clear and abundant. The core of discovery principles is that its scope should be wide, with relevancy construed liberally, without, however, allowing it to enter the realm of a fishing expedition. These basic principles are essential because the purpose of discovery is to enable parties to know the case they have to meet at trial, to know the facts upon which the opposing party relies, to narrow or eliminate issues, to obtain admissions that will facilitate the proof of matters in issue and, finally, to avoid surprise at trial (General Electric Capital Canada Inc. v The Queen, 2008 TCC 668 (CanLII), 2009 DTC 1186, at para 14). This is all with a view to making the hearing of an appeal streamlined and to ensure that the parties are focussed on the appropriate issues.

[12] In the decision of Baxter et al v The Queen, 2004 TCC 636 (CanLII), 2004 DTC 3497, at paragraph 13, Chief Justice Bowman, as he was then, summarized the principles concerning relevancy of questions in discoveries as follows:

(a) relevancy on discovery must be broadly and liberally construed and wide latitude should be given;

(b) a motions judge should not second guess the discretion of counsel by examining minutely each question or asking counsel for the party being examined to justify each question or explain its relevancy;

(c) the motions judge should not seek to impose his or her views of relevancy on the judge who hears the case by excluding questions that he or she may consider irrelevant but which, in the context of the evidence as a whole, the trial judge may consider relevant;

(d) patently irrelevant or abusive questions or questions designed to embarrass or harass the witness or delay the case should not be permitted.

[13] A summary of the general principles gleaned from the caselaw was provided by Justice V. Miller at paragraph 60 of Kossow v The Queen, 2008 TCC 422 (CanLII), 2008 DTC 4408, as follows:

  1.       The principles for relevancy were stated by Chief Justice Bowman and are reproduced at paragraph 50.
  2.       The threshold test for relevancy on discovery is very low but it does not allow for a “fishing expedition”: Lubrizol Corp. v. Imperial Oil Ltd., 1996 CanLII 4095 (FCA), [1997] 2 FC 3, at para. 19.
  3.       It is proper to ask for the facts underlying an allegation as that is limited to fact-gathering. However, it is not proper to ask a witness the evidence that he has to support an allegation: Sandia Mountain Holdings Inc. v. The Queen, [2005] 2 CTC 2297, at para. 19(iii).
  4.       It is not proper to ask a question which would require counsel to segregate documents and then identify those documents which relate to a particular issue. Such a question seeks the work product of counsel: SmithKline Beecham Animal Health Inc. v. The Queen, [2001] 2 CTC 2086, at para. 11.
  5.       A party is not entitled to an expression of the opinion of counsel for the opposing party regarding the use to be made of documents: SmithKline Beecham Animal Health Inc. v. The Queen, Ibid.
  6.       A party is entitled to have full disclosure of all documents relied on by the Minister in making his assessment: Amp of Canada v. Canada, [1987] F.C.J. No. 149.
  7.       Informant privilege prevents the disclosure of information which might identify an informer who has assisted in the enforcement of the law by furnishing assessing information on a confidential basis. The rule applies to civil proceedings as well as criminal proceedings: Webster v. The Queen, 2003 DTC 211, at para. 14.
  8.       Under the Rules a party is not required to provide to the opposing party a list of witnesses. As a result a party is not required to provide a summary of the evidence of its witnesses or possible witnesses: Loewen v. The Queen, [2007] 1 CTC 2151, at para. 14.
  9.       It is proper to ask questions to ascertain the opposing party’s legal position: Six Nations of the Grand River Band v. Canada (Attorney General), 2000 CanLII 26988 (ON SCDC), [2000] OJ No. 1431, at para. 14.
  10.    It is not proper to ask questions that to go the mental process of the Minister or his officials in raising the assessments: Webster v. The Queen, Ibid.
[14] Justice C. Miller in HSBC Bank Canada v The Queen, 2010 TCC 228 (CanLII), 2010 DTC 1159, at paragraphs 14 and 15, after quoting the Kossow principles, added the following to his review of the scope of discovery questions:

[14] The following additional principles can be gleaned from some other recent Tax Court of Canada case authority:

  1.       The examining party is entitled to “any information, and production of any documents, that may fairly lead to a train of inquiry that may directly or indirectly advance his case, or damage that of the opposing party”: Teelucksingh v. The Queen, 2010 TCC 94 (CanLII), 2010 DTC 1085.
  2.       The court should preclude only questions that are “(1) clearly abusive; (2) clearly a delaying tactic; or (3) clearly irrelevant”: John Fluevog Boots & Shoes v. The Queen, 2009 TCC 345 (CanLII), 2009 DTC 1197.
[15] Finally in the recent decision of 4145356 Canada Limited v. The Queen, 2009 TCC 480 (CanLII), 2009 DTC 1313, I concluded:

(a) Documents that lead to an assessment are relevant;

(b) Documents in CRA files on a taxpayer are prima facie relevant, and a request for those documents is itself not a broad or vague request;

(c) Files reviewed by a person to prepare for an examination for discovery are prima facie relevant; and

(d) The fact that a party has not agreed to full disclosure under section 82 of the Rules does not prevent a request for documents that may seem like a one-way full disclosure.

[15] The Federal Court of Appeal in The Queen v Lehigh Cement Limited, 2011 FCA 120 (CanLII), 2011 DTC 5069, at paragraphs 34 and 35, described the general limits respecting discoveries:

[34] The jurisprudence establishes that a question is relevant when there is a reasonable likelihood that it might elicit information which may directly or indirectly enable the party seeking the answer to advance its case or to damage the case of its adversary, or which fairly might lead to a train of inquiry that may either advance the questioning party’s case or damage the case of its adversary. Whether this test is met will depend on the allegations the questioning party seeks to establish or refute. See Eurocopter at paragraph 10, Eli Lilly Canada Inc. v. Novopharm Ltd. 2008 FCA 287 (CanLII), 381 N.R. 93 at paragraph 61 to 64; Bristol-Myers Squibb Co. v. Apotex Inc. at paragraphs 30 to 33.

[35]  Where relevance is established the Court retains discretion to disallow a question. The exercise of this discretion requires a weighing of the potential value of the answer against the risk that the party is abusing the discovery process. See Bristol-Myers Squibb v. Apotex Inc. at paragraph 34. The Court might disallow a relevant question where responding to it would place undue hardship on the answering party, where there are other means of obtaining the information sought, or where “the question forms part of a ‘fishing expedition’ of vague and far-reaching scope”: Merck & Co. v. Apotex Inc., 2003 FCA 438 (CanLII), 312 N.R. 273 at paragraph 10; Apotex Inc. v. Wellcome Foundation Ltd., 2008 FCA 131 (CanLII), 166 A.C.W.S. (3d) 850 at paragraph 3.

[16] Finally, a party may be compelled to answer questions that relate to any issue contained in the pleadings, regardless of whether a party has advised or undertaken that it will no longer place reliance on that position or provision (ExxonMobil Canada Hibernia Co. v The Queen, 2014 FCA 168 (CanLII), 2014 DTC 5086).

[17] The jurisprudence is comprehensive and the guidelines well established. As many cases have noted, there is no formula that can be applied in determining whether questions should be answered. The ultimate purpose is to fairly, reasonably and expeditiously move matters along to a hearing. Given those parameters, it is nonetheless surprising that such a multitude of questions are before me. It is even more surprising that, shortly before issuing these reasons, as the case management Judge, I received a request from the Respondent stating that the Crown was intending to bring a motion with respect to the Appellant’s answers to undertakings that was expected to last one day. I cannot conclude that common sense is the driving force behind these motions which come increasingly before this Court. In fact, it appears common sense is so uncommon in these types of motions that it is almost non-existent. I would have thought that Respondent counsel might at least want to review my reasons respecting its refusals in the Appellant’s questions before embarking on yet another motion. That might well negate the necessity of bringing a further motion or, at the very least, limit it in scope. After all, that would be the prudent, common sense and economical approach in acting in a client’s best interests.”

A contentious double transfer pricing case to follow closely in the coming months indeed…

Burlington Resources Finance Company v. The Queen, 2015 TCC 71 (CanLII)

Robert Robillard, Ph.D., CPA, CGA, Adm.A., MBA, M.Sc. Econ., M.A.P.
Senior Partner, RBRT Inc.
514-742-8086; robertrobillard “at” rbrt.ca
www.rbrt.ca

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