MARZEN ARTISTIC ALUMINUM LTD., Appellant, v. HER MAJESTY THE QUEEN,, 2014 TCC 194

Docket: 2010-860(IT)G BETWEEN: MARZEN ARTISTIC ALUMINUM LTD., Appellant, and HER MAJESTY THE QUEEN, Respondent . Appeal heard on February 25, 26, and 27, 2013 and September 3, 4, 5 and 6, 2013 at Vancouver, British Columbia. Before: The Honourable Justice G. A. Sheridan Appearances : Counsel for the Appellant: Steven M. Cook Natasha Reid Erin L.

Frew Counsel for the Respondent: Michael Taylor Selena Sit JUDGMENT In accordance with the attached Reasons for Judgment, the appeals of the 2000 and 2001 taxation years are allowed, in part, and the reassessments are referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that an arm’s length’s party would have paid an amount to Starline International Inc. that exceeded the fees paid by Starline International Inc. to Starline Windows Inc., but only in the amount of US$32,500 in each of 2000 and 2001.

In view of the Appellant’s limited success in these appeals, costs are awarded to the Respondent. Signed at Ottawa, Canada, this 10 th day of June 2014. “G. A. Sheridan” Sheridan J. Citation: 2014 TCC 194 Date: 20140610 Docket: 2010-860(IT)G BETWEEN: MARZEN ARTISTIC ALUMINUM LTD., Appellant, and HER MAJESTY THE QUEEN, Respondent. REASONS FOR JUDGMENT

REASONS FOR JUDGMENT Sheridan J. I. Introduction [ 1 ] These appeals arise out of a transfer pricing adjustment made by the Minister of National Revenue (the “Minister” ) under paragraphs 247(2)(

a) and (

c) of the Income Tax Act (the “ Act ” ) in respect of fees paid by the Appellant to Starline International Inc. (“SII”), a Barbados-based corporation wholly owned by the Appellant.

In computing its income for 2000 and 2001, the Appellant deducted the fees paid to SII of CAD$4,168,551 and CAD$7,837,082, respectively. [ 2 ] In 2000 and 2001, SII paid to Starline Windows Inc. (“SWI”), another corporation in the Appellant’s group of companies, a total of US$1,383,723 and US$1,811,992, respectively, for the secondment of its employees to perform certain services for SII. [ 3 ] In 2000 and 2001, SII declared dividends of CAD$2,011,500 and CAD$5,299,620, respectively. The Appellant included these amounts in its income for Canadian tax purposes in the 2000, 2001 and 2002 taxation years.

The dividends were then deducted from the Appellant’s taxable income pursuant to

section 113 of the Act on the basis that they had been paid out of SII’s exempt surplus. [ 4 ] In reassessing the Appellant’s 2000 and 2001 taxation years, the Minister disallowed the deduction of any amounts in excess of the fees SII paid to SWI [1] : 2000 2001 Paid by the Appellant to SII $4,168,551 $7,837,082 Paid by SII to SWI ($2,058,049) ($2,811,892) Difference $2,110,502 $5,025,190 [ 5 ] A transfer pricing penalty of CAD$502,519 was levied under subsection 247(3) of the Act for the 2001 taxation year only . II. Witnesses A. Appellant’s Lay Witnesses

(1) Mr. Ron Martini [ 6 ] During the years in question, Mr. Martini, was the president and sole director of the Appellant. With only a grade 7 education, Mr. Martini immigrated to Canada at the age of 18. After working for two years as a welder, he and three partners incorporated the Appellant in 1970. Approximately 20 years later, Mr. Martini and his wife had become the sole owners of the company and by 1995, the Appellant was the largest window manufacturer in British Columbia. [ 7 ] Mr. Martini struck me as a man whose many years of experience in the industry had made him a knowledgeable and astute businessman.

(2) Mr. Art Fabian [ 8 ] Like Mr. Martini, Mr. Fabian also immigrated to Canada and established himself in a successful business career. He earned a Bachelor of Science in Education in the Philippines where, after graduating, he taught high school physics. He then became a medical sales representative for GlaxoSmithKline in Manila, receiving regular promotions until 1989 when he and his family immigrated to Canada. He immediately began work as a shoe salesman in Vancouver and by late 1990, had become the company’s area supervisor.

He left that employment to sell windows for a business which soon after, was purchased by the Appellant. In 1991, Mr. Martini placed Mr. Fabian in charge of overseeing the company during the transition period. With his background in science, sales and management, Mr. Fabian soon worked his way up to becoming what Mr. Martini described at trial as his “right-hand man” in the Appellant’s business operations. [ 9 ] Mr. Fabian was the first witness to be called and spent all of one day and most of the next morning on the stand.

He was very thorough in his explanation of, among other things, the business of selling windows, the different requirements of the single home residential market and the high-rise condominium market and especially, the nature of the Appellant’s various operations. However, he was less forthcoming when it came to explaining the role played by Mr. Csumrik in respect of the functions of SII and SWI.

(3) Mr. David Csumrik [ 10 ] Mr. Csumrik is a lawyer with a background in accounting and an impressive history in various business dealings in Canada and the US. As of the time of trial, Mr. Csumrik was the principal of Longview Associated Limited (“Longview”), a company engaged in establishing international business corporations in Barbados and providing management and administrative support services to them. [ 11 ] Mr. Csumrik’s testimony often left me with the impression that there was more to the story than the Court was hearing.

His overall credibility was further weakened by discrepancies between his sworn evidence at trial and certain written representations he provided during the audit in respect of the role he played in the functions of SII and SWI. More will be said about this later.

B. The Respondent’s Lay Witness

(1) Mr. Thomas Stasiewski [ 12 ] The Respondent called Mr. Thomas Stasiewski, a former employee of the Canada Revenue Agency (“CRA”) who performed all but the preliminary steps of the audit of the Appellant’s 2000 and 2001 taxation years. Mr. Stasiewski has a Certified General Accountant designation and began work with the CRA in 1975. He held various positions in the auditing field throughout his career; by the time the Appellant’s audit began in 2003, Mr. Stasiewski was in a

section of the International Audit Department that dealt with transfer pricing issues. I found Mr. Stasiewski to be a credible witness. [ 13 ] Although initially intended to be the Respondent’s nominee on examination for discovery, Mr. Stasiewski retired prior to the conduct of discoveries. He declined to attend on the Respondent’s behalf because of Treasury Board policies restricting the amount of his remuneration. As a result, Ms. Tanya Fleck, another CRA auditor became the Respondent’s nominee on discovery. [ 14 ] At trial, the Appellant moved to have Mr. Stasiewski excluded as the Crown’s witness.

That motion was dismissed for the reasons given at pages 793 to 798 of the Transcript. [ 15 ] For ease of reference, Mr. Stasiewski is referred to herein as the “Primary Auditor” and Ms. Fleck, as the “Nominee Auditor”. C. Expert Witnesses

(1) Appellant’s Expert: Mr. Barry MacDonald [ 16 ] The Appellant called as its expert witness Mr. Barry MacDonald, a partner at PricewaterhouseCoopers LLP with some 30 years experience in transfer pricing and international tax planning. Mr. MacDonald was duly qualified as an expert witness for the Appellant and his expert report entered in evidence as Exhibit A-2 (“Appellant’s Expert Report”).

(2) Respondent’s Expert Witness: Mr. Oliver Rogerson [ 17 ] The Respondent’s expert witness was Mr. Oliver Rogerson, the Chief Economist for the CRA based in Ottawa. Mr. Rogerson began his career with the CRA in 1999 and specializes in transfer pricing analysis. [ 18 ] After Mr. Rogerson was duly qualified as the Respondent’s expert witness in the field of economic analysis of transfer pricing, the Appellant objected to the admissibility of the report he had prepared. After hearing the submissions of counsel, the report was excluded for the reasons given at pages 798 to 807 of the Transcript.

There was no objection to Mr. Rogerson’s Rebuttal Expert Report and it was duly admitted in evidence as Exhibit R-1 (“Respondent’s Rebuttal Expert Report”). III. Evidence A. Background [ 19 ] The parties filed a Statement of Agreed Facts and a Joint Book of Documents [2] . Portions of the examinations for discovery were read in at the hearing. [ 20 ] At all relevant times, the Appellant was engaged in the design, manufacture and sales of aluminium and vinyl window products (“Window Products”) in Langley, British Columbia. The Appellant’s sole director was Mr. Ron Martini. Mr.

Martini and his family controlled directly or indirectly the Appellant, SII and SWI. Thus, the Appellant, SII and SWI are deemed under the Act not to deal at arm's length. [ 21 ] SWI was located in Washington State. SWI was a tax resident of the United States (“US”) where it filed tax returns for the taxation years 1998 to 2001. Mr. Rick Stark became the general manager of SWI in April 1998. [ 22 ] SII, a tax resident of Barbados, was incorporated in Barbados by Mr. David Csumrik, also a resident of Barbados, on September 29, 1998. Mr.

Csumrik acted as the company’s initial director and on February 11, 1999 became its managing director. Two other directors were also appointed at that time, Mr. Stark and Mr. Terry Vipond, Mr. Martini’s son-in-law. [ 23 ] Mr. Csumrik was also the principal of Longview. Neither Mr. Csumrik nor Longview was related to the Appellant, SII or SWI for the purposes of the Act. B. Activities Prior to July 1, 1999

(1) Appellant’s Direct Sales to US – 1993 to early 1998 [ 24 ] By 1995, the Appellant was the largest window manufacturer in British Columbia with the majority of its customers in the Lower Mainland and branches in Kamloops, Kelowna and on Vancouver Island. Ninety per cent of its sales revenue was attributable to the single-family residential market, the remaining ten per cent to high-rise buildings. [ 25 ] While most of its sales were in Canada, from 1993 to early 1998, the Appellant also attempted, with limited success, to sell

Window Products directly from its location in British Columbia to customers in the US residential market.

(2) SWI’s Sales Activities in US – April 1998 to June 1999 [ 26 ] In 1998, Mr. Martini decided to shift this role to SWI. SWI had been incorporated in Washington State sometime prior to 1993 and was reinstated as a Washington State corporation on September 21, 1993 where it remained inactive until 1998. [ 27 ] In April 1998, SWI opened a sales office and storage facility near Seattle, Washington. Mr. Stark, an experienced general manager in the Appellant’s Victoria sales office, was transferred to the SWI office to act as its general manager. Mr.

Stark hired and trained a staff of approximately 20 employees to provide sales, administrative, accounting, storage and delivery services for SWI. SWI carried its own property and liability insurance. [ 28 ] Like the Appellant in Canada, SWI’s focus in Washington State was the residential market. SWI purchased Window Products from the Appellant at a price which would provide a margin of 15-18%. SWI had access to the Appellant’s computer system, including its price list.

SWI personnel solicited orders for Window Products from US customers and entered those orders directly into the Appellant’s system for manufacture at the British Columbia plant. [ 29 ] During the 1998 fiscal period, SWI realized sales revenue of US$551,320 and incurred a loss of US$487,309. Mr. Martini asked Mr. Fabian to look into the company’s failure to penetrate the Washington State residential market. After discussions with Mr. Stark, Mr. Fabian determined that SWI was being outflanked by its larger and better-established US competitors. [ 30 ] Around this time, Mr. Martini and Mr.

Fabian also met with counsel for the Appellant at Thorsteinssons LLP in Vancouver to discuss the utilization of SWI’s losses. During his examination-in-chief Mr. Martini explained that counsel “…suggested that if I needed a marketing person he knew of one that could have probably, possibly help us” . [3] That person was Mr. David Csumrik.

(3) Mr. Csumrik and Longview [ 31 ] At the time of counsel’s discussions with Mr. Martini and Mr. Fabian, Mr. Csumrik was living in Barbados. In the 15 years prior to his relocation there in 1997, Mr. Csumrik had been involved in various businesses in Canada and the US. He invested in and acted as the CEO of a Vancouver company selling specialized lighting systems to theatres in the US. Next, he and a partner established a computer software development and licensing company. His partner provided the technical know-how and Mr. Csumrik, the business expertise.

That venture ultimately led to the sale of one of the company’s products to Microsoft Windows for an undisclosed amount, reportedly a $20-million-dollar transaction [4] . [ 32 ] After the sale, Mr. Csumrik carried on as a consultant in Vancouver obtaining software licensing agreements and raising investment capital for other companies. Looking to invest some of the profits from the Microsoft deal, Mr. Csumrik then teamed up with two Toronto-based real estate developers. That endeavour was ultimately unsuccessful and Mr.

Csumrik returned to Vancouver. [ 33 ] In 1996, he collaborated with his former high-tech partner to launch a plant biotechnology company. To undertake this project, certain exploitation rights had to be acquired from the Carnegie Institution of Washington (“Carnegie”). According to Mr. Csumrik, his partner “… was instrumental in convincing them that we would use more efforts to exploit the technology than would Monsanto” [5] ; Mr. Csumrik’s role was to conduct negotiations to secure the licensing agreement with Carnegie’s chief financial person. [ 34 ] Mr.

Csumrik sought advice from Thorsteinssons LLP as to how to structure the new endeavour in a “tax efficient manner” [6] . He and his partner ultimately decided to establish the company in Barbados and in 1997, Mr. Csumrik moved to Barbados where they: … formed a company called Linnaeus Inc. in Barbados, licenced it as an international business company in Barbados, set up the attendant bank accounts, the requisite licensing agreements with Carnegie, and … did business as Linnaeus and still do business as Linnaeus Inc. from Barbados. [7] [ 35 ] In the spring of 1998 Mr.

Csumrik established Longview, a company which he described as providing “one-stop accounting, corporate administration, corporate secretarial, office facility; like a packaged office with, as I say, accounting, clerical, administrative and corporate secretarial” [8] for companies incorporated in Barbados. He set up Longview after being approached by a client referred to him by Thorsteinssons LLP looking to incorporate in Barbados. This was followed by two other Thorsteinssons LLP referrals and subsequently, other clients who had heard of Longview by word of mouth. [ 36 ] On cross-examination, Mr.

Csumrik provided further details of Longview’s services: it provided staff to maintain the books of account and prepared financial statements of the international business corporation, kept business registrations current with the Barbados authorities, prepared Barbados tax returns, provided someone to answer the phone and handle correspondence, maintained the corporate records required to operate the company, provided legal referrals in Barbados to set up additional corporations or trusts, opened bank accounts in Barbados or elsewhere in the world, as required. [9] The usual fee for such services was US$30,000 annually. [ 37 ] For an annual fee of US$2,500 [10] , Mr.

Csumrik (through Longview) would also provide his personal services as managing director to Longview’s corporate clients. As such, he would perform the following tasks: A As the manager I would direct the staff to fulfill all the requirements of -- the daily requirements of the business, be it taking orders, processing orders, paying bills, dealing with customer queries.

I would then oversee the corporate -- I would be the general manager of the business as it operated in Barbados, or from Barbados. [11] Q Now, the staff, for example, or the business activities of the company, would that be something [the client would] supply to you? Would [the client] provide the staff and you manage them? Or would Longview provide … the staff as well?

A It would be by circumstance. In certain instances we would -- Longview would supply the accounting, staff the clerical. In some cases we have supplied customer support whereby we have -- customers would phone in to get support and they would phone a person in Barbados. We would supply that. In other instances we would manage the sales people or the technical support people throughout the world. We would manage them from Barbados.

They would report to us although they would get paid either as independent contractors and/or if they were in the U.S. they would get paid by a facilitating company that would be a non-arm’s-length company to the group, not -- Q Something like SWI was. A Yes, exactly, yes. [12]

(4) Discussions between the Appellant and Mr. Csumrik; the Incorporation of SII [ 38 ] In late summer 1998, Mr. Martini and Mr. Fabian met with Mr. Csumrik in Vancouver. Mr. Csumrik recounted his successful business record and experience in management and negotiation in Canada and the US. For their part, Mr. Martini and Mr. Fabian explained the nature of the Appellant’s business and failure to penetrate the Washington State residential window market. Over the next few weeks, they gave Mr.

Csumrik what he described as a “very condensed course” [13] on the making of windows, including a visit to the Appellant’s manufacturing plant. Mr. Csumrik also met with Mr. Stark to learn about SWI’s activities in Washington State. [ 39 ] Shortly after meeting Mr. Martini and Mr. Fabian, Mr. Csumrik incorporated SII in Barbados on September 29, 1998 with Mr. Csumrik acting as its first director. Neither he nor Mr. Martini was concerned about the possible loss of the approximately $2,000 in incorporation costs should their discussions not bear fruit. Mr.

Csumrik said the company could always be used for some other client looking to incorporate in Barbados. [ 40 ] Discussions continued between Mr. Martini and Mr. Csumrik and it was understood that Mr. Csumrik expected to be compensated for whatever assistance he might ultimately provide. By the end of 1998, Mr. Csumrik had concluded that the Appellant was focussed on the wrong market. He advised Mr. Martini and Mr.

Fabian to shift the Appellant’s efforts from Washington State’s residential market to the burgeoning high-rise market in southern California, with a view to targeting western Canadian developers in the area. Mr. Csumrik admitted that he himself had no contacts with such developers and could not recall how he had come to know about their projects in southern California: Q So when you met with Mr. Fabian and Mr. Martini and then you agreed to assist them and you undertook the structure, you suggested to them that they should focus on the high-rise market instead of the residential market.

That’s one of the things you suggested as a marketing strategy, is that correct? A Yes. Q And you suggested to them that some Canadian developers would be looking to build in the United States and that might give Marzen an in to the U.S. market. Is that also fair? A If I said “in” I didn’t -- I thought it might help them with a – level the playing field vis-à-vis competition, yes. Q And you mentioned specifically to them Bosa and Pinnacle as two developers from Canada that you believed would be taking on projects in the United States. A Yes.

Q What was the source of your belief that Bosa and Pinnacle would be expanding into the U.S.? A I don’t know if I read it in newspapers, read it in the trade magazines. I don’t even know where I would have garnered that from, but I somehow came to possess that knowledge. Q But you weren’t in contact with people at Bosa or Pinnacle from your days in real estate development? A No. [14] [ 41 ] As noted at paragraph 11 of these Reasons, this testimony is at odds with certain written representations made by the Appellant at the audit stage.

These documents were put to the Primary Auditor by counsel for the Appellant in furtherance of the Appellant’s position that the Primary Auditor had wrongly rejected the Appellant’s claims regarding the extent of Mr. Csumrik’s involvement with SII and SWI. In these documents, Mr. Csumrik was described as having useful contacts with Canadian developers with projects in the US. The first document was authored by Mr.

Csumrik: Two such developers are the Pinnacle Group and Bosa Ventures, both of whom were well known to me through my previous working life as a lawyer/businessman in the Vancouver area. [15] [Emphasis added.] [ 42 ] The following description appears in a letter from counsel for the Appellant to the Primary Auditor: Mr. Csumrik has extensive experience in managing sales forces in the US for other products. He has key contacts and personal connections with significant Canadian builders who were entering the southern California real estate market. It is through Mr.

Csumrik’s contacts that the Company was able to penetrate the California market. [16] [Emphasis added.] [ 43 ] Like Mr. Csumrik, the Appellant had had no prior dealings with such companies but Mr. Csumrik believed the Appellant’s successful history in the British Columbia residential window business could be leveraged to its advantage. Mr. Csumrik also testified that he advised Mr. Martini and Mr.

Fabian that because the high-rise market in southern California was fundamentally different from the residential market in Washington State, SWI’s sales personnel would have to embrace new skills and marketing techniques. Mr. Csumrik’s evidence was that he had learned the importance of this tactic when dealing with US customers in his theatre lighting business. [ 44 ] On February 11, 1999, SII’s organizational resolutions were passed with the Appellant as SII’s sole shareholder. Mr. Stark and Mr. Vipond joined Mr. Csumrik as directors of the company. Mr. Martini was aware of Mr.

Csumrik’s intention to remain in Barbados

and that he expected to be compensated for his marketing advice. Both parties were interested in reaching an agreement and discussions continued on how that could be accomplished. [ 45 ] Mr. Martini asked Mr. Fabian to summarize what had emerged from their discussions with Mr. Csumrik over the past few months and in particular, to identify the possible options. In his Case Study to Mr. Martini dated April 5, 1999 [17] , Mr. Fabian “highly recommended” the third option, that the Appellant “acquire the services of a fully established sales and marketing firm” to market Window Products in the US . Mr.

Fabian prepared a second document dated April 26, 1999 and entitled “A Study of the Three Major Industry Segment that Will Directly Affect Our Successful Business Launching and Bolster Market Share in the United States of America”. [ 46 ] By the early spring 1999, Mr. Martini and Mr. Csumrik had reached an agreement regarding his compensation. According to their testimony, they had a “hand-shake” agreement that if his advice proved successful, Mr. Csumrik, in his personal capacity, would be remunerated by Mr. Martini and/or the Appellant in some fashion at an undetermined time in the future. Mr.

Csumrik’s evidence was that he was comfortable with this loose arrangement first, because both he and Mr. Martini were “old style” businessmen who trusted each other. He added that this had always been his preferred manner of doing business. [ 47 ] In support of his claim of a separate remuneration arrangement with Mr. Martini and/or the Appellant, Mr. Csumrik referred to letters dated January 5, 2004 [18] and June 2, 2008 [19] , respectively, in which Mr. Martini had invited him to pursue business opportunities involving the sale of certain products manufactured by the Appellant and/or companies under Mr.

Martini’s control. I note that their oral agreement was not reduced to writing until after the audit began on April 16, 2003. Mr. Csumrik admitted that, as of the time of trial, he had not exploited either of these opportunities, explaining that in 2004, he was too busy with his own businesses to take on an additional project and was also embroiled in a matrimonial dispute. As for the 2008 proposal, Mr. Csumrik said that while he initially found it attractive, the onset of the US financial crisis later in that year ultimately made it less so. But both he and Mr. Martini testified that it was still open to Mr.

Csumrik to avail himself of these opportunities should he choose to do so. [ 48 ] At the same time Mr. Martini and Mr. Csumrik were discussing how he would be compensated, Mr. Martini was receiving legal and accounting advice from Thorsteinssons LLP and other professional advisors on how best to structure the new marketing approach. Mr. Martini was asked on cross-examination about his understanding of the reasons for establishing SII in Barbados: Q And you believe that that was necessary because Mr. Csumrik was living in Barbados? A No, that was a structure that the lawyers and accountant came up.

Q What did you understand about the reasons for adopting that structure? A The reason was that Barbados had a lower tax rate than the Canadian tax rate. Q All right, so income that was earned in Barbados would be taxed at a lower rate. A That’s correct. Q And also I suppose you must have been aware that income earned in Canada that -- income taxed in Canada to Marzen would be reduced by marketing fees that Marzen paid to a marketing company. That would be deductible. A Yes.

Q And you also understood that to the extent that business income was earned in Barbados by Starline International and tax was paid in Barbados, that under the Canadian tax regime that money could be paid as a -- that after-tax money could be paid as a dividend to Marzen as the Canadian parent. A That’s correct, yeah. Q And Marzen would not be taxable on those dividends received in Canada. A Yes. Q I imagine this made the structure very appealing to you. A The structure was appealing, but unless we sold something, the structure would be worth nothing. [20] [ 49 ] Mr.

Csumrik was also asked on examination-in-chief about the decision to locate SII in Barbados; at no point during that exchange did he confirm that his residency in Barbados had anything to do with Mr. Martini’s decision to incorporate SII in Barbados [21] . When Mr. Martini was given the opportunity to provide further details about this decision on cross-examination, he candidly acknowledged that Mr. Csumrik’s desire to remain in Barbados had not been a factor: Q Did you believe that it was necessary to have a company in Barbados in order for Mr. Csumrik to provide his assistance to your marketing efforts?

A It didn’t have to be in Barbados, no, but he was in Barbados. Q Right. All right. Did you believe it was necessary to have a marketing company for Mr. Csumrik to provide his services to your company? A I didn’t believe it was necessary for them, no. Q But you went along with the structure that was proposed to you A That’s correct. [22] [ 50 ] Counsel for the Respondent also asked Mr.

Martini about his expectations regarding the dividends that the structure could generate if the marketing strategy was successful: Q At the time the structure was entered, was it your expectation that dividends would be declared to the extent that cash was available? A My expectation were there, yes. If I can add to that, the kind of volume that we were achieving, we had to restructure Canada, we had to spend millions of dollars in equipment and buildings and the money was needed in this country. Q I’m not disputing that you had a use for the money. I’m just asking you about your expectation. A Okay. [23]

C. Activities after July 1, 1999

(1) Agreements and Arrangements under the Barbados Structure as of July 1, 1999 (

a) Arrangement between Appellant and SWI [ 51 ] On July 1, 1999 the Appellant continued to supply Window Products to SWI for resale but with a change in their cost to SWI. Under the Barbados Structure, the Appellant supplied Window Products at a cost equal to SWI’s sale price to US customers thus resulting in no profit being recognized by SWI. The Appellant measured its Window Products sales in the US market by reference to its sales to SWI. (

b) The Four Agreements under the Barbados Structure [ 52 ] On July 1, 1999, four agreements were executed putting in place the new structure for marketing the Appellant’s Window Products in the US (“Barbados Structure”). (

i) Marketing and Sales Services Agreement – Appellant/SII (“MSSA”) [24] [ 53 ] The MSSA is the transaction under review. In the

preamble, SII is described as being “in the business of marketing products such as” the Appellant’s Window Products. [ 54 ] Under Clause 1.1 of the MSSA, SII agreed to provide, inter alia , the following services to the Appellant in jurisdictions other than Canada or the Caribbean, most particularly in the US: (

a) to use its best efforts to improve the Appellant’s business by marketing Window Products in the US; (

b) to receive offers to purchase Marzen products from potential purchasers and forward them to the Appellant; (

c) to prepare and maintain offer or order schedules and daily sales report summaries; (

d) to send out in accordance with the Appellant’s directions, notices to potential purchasers who have placed orders to confirm approval, rejection or variance of the order and then send out additional information as directed; (

e) to provide follow-up correspondence to purchasers in respect of specific queries that may be raised related to a particular sale of Marzen products; (

f) to undertake evaluations and analysis of Marzen sales through SII as directed by Marzen. [25] [ 55 ] Under Clause 3.2, the Appellant also agreed to advance to SII “such reasonable amounts as may be requested by SII from time to time” to assist SII with the costs of providing its services to the Appellant. Mr. Csumrik explained the effect of this clause as follows: … the marketing sales agreement provided that if we needed working capital, they [the Appellant] must provide it.

So we didn’t have any working capital requirements other than very nominal amounts. [26] [ 56 ] Under Clause 3.1, the Appellant agreed to pay to SII a monthly fee equal to the greater of US$100,000 or 25% of gross sales initiated by SII of Window Products. [ 57 ] On cross-examination, Mr. Martini testified that he was responsible for determining the fees the Appellant would pay under the MSSA and explained how he had come up with the 25% formula: Q And I think you referred to comparing your Canadian markup and your Starline Windows 1998 markup as factors in deciding that 25 percent was reasonable.

A That’s correct. Q Could you take me through that decision-making process again, please? A The cost of sales in Canada for Marzen was 14 percent, 14 to 15 percent. Our cost here in Canada. So we are selling in a market where everybody knows we don’t have to go and look for new customers, repeated customer. I felt that if we go in the new country and if I have to market to people that don’t know us, 25 percent was reasonable. Q And where did the 18 percent markup that you were applying within SWI in 1998 enter into that decision?

A The 18 percent, the 18 percent that we ended up as a markup in 1998 was not done beforehand. That’s the result of us selling to the marketplace, we ended up with an 18 percent markup. So with an 18 percent markup we still lost 430,000 that year. Q I just want to take a step back to make sure I understand correctly. The 18 percent markup you’re referring to in SWI in 1998, how was that determined? A We would sell a window to SWI. They would buy it from us, our cost plus some overhead, and then they would go out on the market and sell them to whatever money they could get. So the market decides what the price is.

We don’t decide what the customer pays for it. And they were actually able to achieve at the end of the day, 18 percent market. Q So there wasn’t a formula in place to determine what price Marzen would charge to SWI for the product?

A There was a formula, was cost plus -- I forget, plus some overhead. I forgot what it was but almost at cost. Q So what you’re saying is under that structure, SWI could realize an 18 percent markup. A That’s correct. Q And that wasn’t enough to cover its costs. A It wasn’t, no. [27] [ 58 ] Although Mr. Martini acknowledged the 25% marketing fee was greater than SWI’s costs under the pre-July 1999 regime, his evidence was that he believed the Appellant could still make a profit because of the increased volume of sales.

He said he did not use any comparable businesses in determining the fee formula because he could not identify any but also admitted he had not sought professional assistance to assist him to that end. He had not reduced to writing the basis for his decision. [ 59 ] Mr. Martini was asked on cross-examination whether SII’s status as a non-arm's length party had influenced the amount of the fees under the MSSA: Q In determining that you were prepared to pay 25 percent as a marketing fee, did the fact that the company you were paying to was controlled by Marzen influence your decision?

A I thought it was a common sense decision. Does that answer the question? Q I’m not entirely confident it does. What I’m asking you is, did you, in deciding that 25 percent was a reasonable amount you were prepared to pay, did you take into account the fact that the company you were paying to was controlled by Marzen, was your subsidiary and not an unrelated company? A I would probably have done that with an unrelated company if that was what they presented to me.

Q Now, if you had paid marketing fees to an unrelated company, you would not have secured the same beneficial tax results whereby Marzen could deduct the fees, the company could pay tax in another jurisdiction, and then pay a dividend back to Marzen. A No, we would not. Q But you would have done it anyway. A I would have done it because in times like now, they would be losing money, so it’s beneficial both ways. [28] (ii) MSSA Bonus Payment Agreement [ 60 ] Pursuant to an exchange of letters between Mr. Martini and Mr.

Csumrik [29] in August 2000, the MSSA was amended to provide that the Appellant would pay SII a one-time bonus of 10% on all confirmed contracts in the California market on condition that SII achieve at least US$10 million in net sales between August 1, 2000 and December 31, 2001 (“MSSA Bonus Payment”; references herein to the MSSA after the amendment include the MSSA Bonus Payment). [ 61 ] Mr. Martini testified that he authorized Mr. Csumrik’s request for the Appellant to pay SII the MSSA Bonus Payment but did not know how Mr. Csumrik had arrived at the 10% formula. When Mr.

Csumrik was questioned about this during his examination-in- chief, he provided the following explanation: Q And when you set up the 10 percent bonus amount, what was the rationale for asking for 10 percent? Was there any analysis that you’d undertaken? A No. No. I knew we were going to have some increased costs. I wanted Starline International Inc. to increase its level of profitability because I knew I would look better if that was to happen, and because Marzen owned SII and I wasn’t getting any of this money anyways, he should have been indifferent.

Q Did you ultimately direct Starline Windows to increase its presence in the California market after this agreement was acknowledged? A I believe we opened up a sales office. I can’t remember if it was a result of this or if this was a result of opening up a sales office in California. Q You’re satisfied there’s some link though. A I’m satisfied that that would have been -- there’s some connection between the two. [30] [Emphasis added.] [ 62 ] Mr. Martini testified that he had no reason to think the 10% amount was unreasonable, especially since he countered Mr.

Csumrik’s request with the condition that a minimum of US$10 million in sales would be achieved during the period. As it turned out, the total sales greatly exceeded the required minimum resulting in an MSSA Bonus Payment of US$2,090,422. [ 63 ] On cross-examination, Mr. Martini was asked what the amounts under the MSSA and the 10% MSSA Bonus had been paid for: Q Now, you would agree with me that to the extent that bonus [the 10% MSSA Bonus Payment] reflected expenses that SII incurred to pay SWI for extra workers or extra marketing efforts in California, that that bonus went to fund the marketing.

You agree with that. A Yes. Q And if -- you would also agree, I think, that if SII spent less than the $2 million that you paid as a bonus on the cost of SWI, that that amount was received by SII as income. A Yes. Q And you would also agree that no part of that $2 million went to benefit Mr. Csumrik. A I agree.

Q And in fact wouldn’t you agree that of all of the fees that Marzen paid to SII in 2000 and 2001, which I think totals close to $12 million Canadian, only the $32,500 per year went to benefit Mr. Csumrik or Longview? A That’s correct. Q And only the amounts that SWI invoiced SII for to recover the costs of the sales staff went to benefit the sales people who were making the sales. A That’s correct. Q So whatever their compensation was, could be salary, could be bonus, that’s paid for through the cost recovery from SWI to SII. A That’s correct.

Q And then additionally SII has to pay SWI some fees for administrative services, access to display models. A Yes. Q Those features. But all the rest of the money, whatever’s left over in the marketing fee paid to SII, that’s income of SII. A Yes. Q And it doesn’t provide any benefit to the people that did the marketing sales work, Mr. Csumrik or the sales people. A No. [31] [Emphasis added.] (iii) Personnel Secondment Agreement – SII/SWI (“PSA”) [32] [ 64 ] In the

preamble to the PSA, SII is described as being “in the business of marketing windows and doors designed and manufactured by [the Appellant] in the United States and elsewhere” . SWI is described as having “qualified personnel employed in the sales and marketing of windows and doors to be marketed by SII”. [ 65 ] Under Clause 1.1 of the PSA, SWI agreed to “provide the services of personnel on an exclusive basis (‘the Seconded Personnel’) to be retained and engaged by SII in the marketing of [the Appellant’s] products in the US and elsewhere (‘the Services’)”.

Under Clause 3.1, SII agreed to pay SWI a monthly fee to cover SWI’s aggregate costs of the employment of the Seconded Personnel plus a service fee of 10%. [ 66 ] Under Clause 1.2, SWI agreed to “ensure that the Seconded Personnel seconded to SII to provide the Services are competent and duly qualified”; u nder Clause 2.1, SII was “solely responsible for the direction, administration and management of the Seconded Personnel”. [ 67 ] On cross-examination, Mr.

Fabian was asked whether, under the PSA, SWI was in the business of providing personnel and how it was determined that SWI be paid an additional 10% over its actual costs: Q … I said SWI is now carrying on a little business of providing employees to somebody else for profit. A Well, again, at the end of the day, sir, I would say, I'm looking at more when you said “business”, like personal [ sic , “personnel”], temporary business. You know, where you have a temp guy, you need somebody at temp. That's the business that I'm more looking at when you told me that.

But, this one is just incidental, that these people were hired and being used by SII and therefore SWI should get some profit out of it. Simple, simple, a simple business thing I believe. Q Are you saying that there was some sort of negotiation where SWI demanded to be compensated for this and SII agreed? A There was no, nothing like that. Again, it's not really their business to provide, like, you know, a temporary company, a temp company who provides secretarial or accounting. It's not really like that.

They have an existing client, so again, you know, probably just to be profitable they have ten percent. [33] (iv) Administrative and Support Services Agreement – SII/SWI (“ASSA”) [34] [ 68 ] Under the ASSA, SWI agreed to provide certain secretarial and other administrative support services to SII. SII agreed to pay to SWI monthly fees, as amended from time to time, of US$23,000 (July 1999 – June 2000); US$30,000 (July 200-June 2001); and US$35,000 (July 2001- December 2001). [ 69 ] In the

preamble to the ASSA, SWI is described as being “in the business of providing services related to the marketing and distribution of products designed and manufactured by [the Appellant]”. [ 70 ] Under Clause 1.6, SWI was “solely responsible for the administration and management of its employees including pay, supervision, discipline and all other matters arising out of the relationship between SWI and its employees” . (

v) Delivery/Depot/Repair & Maintenance Services Agreement – Appellant/SWI (“DDRMA”) [35] [ 71 ] Under the DDRMA, SWI is described as related to the Appellant and carrying on “the business of storage, delivery, repair and maintenance, and collection services in relation to the [Appellant’s] products” . [ 72 ] Under the DDRMA, SWI agreed to provide certain services in relation to the delivery, depot, repair and maintenance of Window Products as well as certain bill collection and enforcement duties. The Appellant agreed to pay the amounts set out in the Statement of Agreed Facts at paragraph 22(d). The effect of this agreement was that the Appellant covered all of SWI’s costs related to

these services. (

c) Arrangements between SII and Mr. Csumrik/Longview [ 73 ] Under a separate arrangement, Longview provided SII with Mr. Csumrik’s personal services as managing director of SII for US$2,500 annually. Longview provided its local management and administrative services for US$30,000 annually. These amounts were in accordance with Longview’s usual rates for such services.

(2) Services Performed by SII, SWI and Mr. Csumrik/Longview under the Barbados Structure [ 74 ] During his examination-in-chief, Mr. Martini summarized the operation of the new marketing structure as follows: A The new marketing structure was Mr.

Csumrik, the architect of the marketing system, seconded the people that work at [SWI]. [SWI] would sell the product in the U.S. and they would buy from [the Appellant], and when [SWI] received the money from the customer, the same amount would go right through [the Appellant], and then [the Appellant] would pay a 25 percent fee to [SII] for the sales costs. [36] [ 75 ] Although having described Mr. Csumrik as the “architect” of the new structure, Mr. Martini later admitted that he had no personal knowledge of what Mr. Csumrik actually did; he relied on reports from Mr. Fabian and Mr. Stark [37] . Mr.

Stark, SWI’s general manager, was not called as a witness at the hearing. [ 76 ] Mr. Csumrik that he was in regular contact with Mr. Fabian: Q What was the purpose of those conversations? A The purpose of those conversations – it should be appreciated that there’s a learning curve that happens when you get involved in a new business. I wasn’t -- I didn’t understand the business. Mr. Fabian did understand the business. So we would talk about, okay, an order goes in, when is it going to ship? You know, what are the problems? How come those are -- how come something got returned?

How are we going to ship, you know, this big order if $3 million worth of windows comes in? This wasn’t a carry-on of previous business down there. This was -- you know, this was expanding their capabilities and it was all new business so it was a learning process. So we probably spoke weekly if not more. [38] [Emphasis added.] [ 77 ] Mr. Fabian testified that he was closely involved with the Appellant’s day-to-day operations. Mr.

Fabian provided a detailed explanation of the complicated process of bidding on, ordering and invoicing and scheduling the supply of windows to high-rise developers in southern California. What came out of this was that Mr. Fabian was worthy of Mr. Martini’s description of him as his “right-hand man”. A s shown in the testimony below, he was the overseer of all aspects of the Appellant’s sales and marketing in the US, including the activities of Mr. Stark in the US and Mr. Csumrik in Barbados. He testified that he normally called Mr. Csumrik once a week: Q And what would you discuss in your weekly call?

A We were discussing about the new project that they have, also discussing about the updates of how Mr. Csumrik and his team are doing in terms of implementing the concept and strategy that we have put in place with this new marketing agreement. And also there are times that we have discrepancy with the books where, for example, the sales has to be reconciled with what we have and what they have and what Starline Windows Inc. has.

So we have to practically reconcile and making sure we are not missing anything or we’re not over charged by Starline Windows Inc. or Starline International Inc. [39] [ 78 ] However, Mr. Fabian also kept in close contact with SWI’s general manager, Mr. Stark: Q And how much interaction did you have with Mr. Stark? A I have so much interaction with Mr. Stark too, mainly because Mr. Stark is a non-technical guy, he is actually a salesman, a good salesman so he would ask me questions about technical issues about the windows.

And I would also ask him how they are progressing with their target in the high-rise market in the areas that Mr. Csumrik would have asked them to target, just to get an update. And also to update me on current coming sales or whatever it is that is on the plan so that we would know or I would know and I can relay that information to Mr. Martini at the end of the day. [40] [ 79 ] Mr. Fabian also kept Mr. Martini informed of the progress being made in southern California. Although described as a “hands- off” employer, Mr.

Martini was still keeping an eye on sales under the Barbados Structure, just as he had done prior to July 1, 1999. Of particular interest to him were the sales results as documented in the company’s “Red Book” : Q So is that -- when you mention the red book, is that the

summary that you received? A I received a monthly

summary but it’s -- of course is an addition of all the days, yeah, yeah. Q So you didn’t get the weekly report, you got a report that took the weekly results and accumulated them and it was for each month. A Yes, yeah. Q And what was the value of that red book to you and the information that was contained on it?

A Information was -- that’s how I could tell the performance for the sales team. We always had it from day one actually. And also it allow us to

schedule the work that was coming up, went to manufacture and what -- and if we had actually enough room in those days. [41] [Emphasis added.] [ 80 ] It is clear from the above testimony that Mr. Fabian was the hub of the Appellant’s wheel of operations both before and after July 1, 1999. As such, he was very familiar with the activities of SWI personnel during both periods and was asked on cross-examination to compare their duties, having reference to SII’s sales and marketing obligations to the Appellant under Clause 1.1 of the MSSA (see paragraph 55, above).

After reviewing each of these items on cross-examination, Mr. Fabian conceded that, with the exception of sub- clause 1.1(a), prior to July 1, 1999, SWI had performed essentially the same tasks now ascribed to SII under the MSSA: Q Now, we’ve just looked at a list of six things that SII is responsible to do for [the Appellant] under the marketing and sales services agreement. It seems like all of that stuff was previously done be SWI employees, is that correct? A What do you mean?

Q Well marketing products, receiving orders, transmitting them, preparing schedules, summarizing sales, corresponding with purchasers, all that stuff was done by SWI employees before you set this structure in motion. A By SII? Q Before SII came on board all of these things were done by SWI. A Yes, they did actually but our result is minus $487,000. Yes, they did, but they were not effective in doing the -- Q Yes. But let’s leave the marketing aside. The receiving orders, the reconciling sales reports, the corresponding with purchasers, all of that was done by SWI. A That's right. … [42] [ 81 ] However, Mr.

Fabian went on to say that sub-clause 1.1(

a) was by far the most important of SII’s obligations under the MSSA. Like Mr. Martini, Mr. Fabian credited Mr. Csumrik, on SII’s behalf, with having designed and implemented the marketing services: … [because of the $487,000 loss] we need somebody to train Mr. Rick Stark to focus on the things that he has to do, and during the time that this was not in place … Mr. Rick Stark is not achieving anything. Probably they know that this is part of their job, but nobody's coaching them on what to do. Nobody is training them, nobody is leading them, nobody is directing them; nobody is quarterbacking those people.

That's why Mr. Csumrik came to me and start quarterbacking, leading these people, directing them, telling them, you need to hire people who are technically inclined, that knows exactly or that they can sit down with the developer and discuss projects without being like, “What are you talking about?” They also need to make sure that there is customer service, customer service, follow-up. All these things have to be done. So in SWI, prior to 1999, they know that this is part of -- it's a marketing concept that has to be followed by any marketing company. However, … Mr.

Rick Stark and his group are not doing it the right way. That's why we need somebody like marketing director like Mr. Csumrik who can lead this thing so that we can move forward and start earning -- start profiting in SWI. [43] [ 82 ] Although counsel for the Respondent invited both Mr. Fabian to elaborate on what Mr. Csumrik did as “coach” or “quarterback”, he was unable to do so. Such vagueness was completely at odds with Mr. Fabian’s other detailed testimony and his natural willingness to provide full answers whenever he could. [ 83 ] Similarly, Mr.

Csumrik, who had given candid and detailed descriptions of his prior personal business successes, had little say about the practicalities of his coaching duties on behalf of SII. Like Mr. Fabian, he also resorted to generalities in describing his role – indeed, his evidence only became detailed when explaining what he did not do: … I wasn't -- I didn't make sales. I'm not a salesman. I didn't intend to learn all the ins and outs of the windows themselves. I didn't intend to -- I wasn't earning a finder's fee. That's not what I was doing. I was just trying to tell [Mr.

Stark] how to do business down there and who I thought he should do business with, and you know, why I thought that. So I guess I was like a mentor, a coach, a director. [44] [ 84 ] However, Mr. Csumrik did provide some specific examples of his activities. Mr. Csumrik said he was concerned that Mr. Stark would be unable to make the transition from the residential sales strategy based on “relationships” to the technical sales requirements of the high-rise market. For that reason, he said, he stayed in regular contact with Mr. Stark to keep him focused on these objectives. Mr.

Csumrik cited one example of correspondence [45] where Mr. Stark appeared to be “reverting to his legacy” [46] ; that is to say, focussing on the Washington State residential market. Mr. Csumrik’s reaction was effectively to ignore such behavior because he “… wasn’t very interested in the residential sales. I was interested in the high-rises that were projects that had been recently sold, and asked [Mr. Stark] for a list so I could review it.” [47] [ 85 ] Mr.

Csumrik also described his role in reviewing the “ Red Book ” and gave examples of occasions where he had identified reporting errors of a clerical nature affecting SII’s financial obligations to SWI. He said he reviewed bids and if ever there were problems, discussed them with Mr. Stark. A weakness of his evidence was there was little documentary evidence to support claims of close involvement in SWI’s operations. Mr. Csumrik explained that was because he was more comfortable using the phone or email [48] .

On the rare occasions he reduced such communications to writing, he explained, the purpose was “… frankly, because I wanted to build a file for reasons of taxation for the most part. … this was sort of just to show that there was some business being conducted in Barbados for the most part.” [49] [ 86 ] As noted above, Mr. Csumrik had no contacts among the Canadian developers with projects in southern California which limited his capacity to steer SWI employees to an particular potential client: Q What was your involvement in the process of the sales staff going to Bosa and making that sale, getting that contract?

A I didn’t have any direct involvement in that process. Q Did you tell Mr. Stark or his project coordinator or sales people or whoever it was what to do or what to say to Bosa or who to go to? A No. Q And you didn’t talk to anyone at Bosa and say, you know, “Remember me? I think you should give these guys a look. They’ve got a good product.” Nothing like that? A No Q So after recommending that they should target particular developers and particular projects, you left it to the sales team to go out there and do the legwork and make it happen. A Yeah, left it to the sales team to do their jobs, yes. [50] [ 87 ] Mr.

Csumrik went on to explain the level of his involvement in pursuing new projects once the initial sale had been made, including how he came to know about them: Q Then after the Horizon project there were more sales, more sales to Bosa and more sales to other developers. What was your involvement in securing those contracts? A I wasn’t a salesman. I had no involvement in securing any contracts. Q Did you direct the sales team back to more projects? A Yes. Q And how were you aware of those projects?

A Again, if you read the industry papers and the -- over the internet, which is how I would do it because I was in Barbados, people talk about it, pending projects, da da da, Bosa doing a big expansion into San Diego and on and on. So you hear it from the architects. I didn’t hear it from the architects in San Diego but it comes back. So you just -- you know. I mean you would know if you were in the business. Q Was there no one at Starline Windows Inc. or Marzen who could also follow those developments and that information? A Well, Mr. Stark wasn’t.

I wasn’t familiar with anybody else whose position it was to make it their business to do that, but Mr. Stark, that was not his level or his comfort zone. Q Now, after that first contract was secured, the Horizon one, what do you know about how the bid to Bosa for the next project was received? Do you know anything about that, other than that a contract was secured? A I'm sorry, the question? Q All right. Well, it just seems to me that after -- maybe after Starline has done the Horizons project, Bosa now sort of knows them. When Bosa is going to do the next project, maybe they’re more receptive to Starline.

Would you agree with that? A You would hope they would be. Q And that’s the whole point of the marketing strategy, isn’t it? A Again, you would hope that you did a good job on the first contract and they would be comfortable with the pricing and the service and the value they derived from the first contract. You would hope that that would help you get the second contract, yes. D. The Audit; Examination for Discovery “Admissions”; Cross-examination of the Primary Auditor; and the Primary Auditor’s Penalty Recommendations

(1) The Audit [ 88 ] Because the Appellant raised certain issues regarding the Primary Auditor’s conclusions upon which the reassessments were based and the approach taken to the imposition of penalties under subsection 247(3), it is useful to set out a brief

summary of the relevant aspects of the audit process. [ 89 ] The audit began as a domestic audit but was later assigned to the International Audit Department because of the international nature of the Appellant’s operations. Notice of the audit was first sent to the Appellant by Primary Auditor’s predecessor on April 16, 2003 [51] . A little over a year later, the file was reassigned to the Primary Auditor.

Although there had been at least one meeting and some correspondence [52] between the former auditor and the Appellant, the Primary Auditor said that when he took over the file, he “started from scratch” . [ 90 ] In a letter to the Appellant dated June 2, 2004, the Primary Auditor requested certain documentation from the Appellant [53] . In response to that request, counsel for the Appellant wrote to the Primary Auditor describing, among other things, the corporate entities involved and their roles together with that of Mr. Csumrik and Longview [54] .

The Appellant ultimately delivered several boxes of documentation to the Primary Auditor which he testified he reviewed before reaching the conclusions reached in his Functional Analysis [55] , Audit Report [56] and Proposal Letter [57] .

(2) Examination for Discovery of the Nominee Auditor: “Admissions” [ 91 ] As noted above, although the Primary Auditor performed the lion’s share of the audit, he was not the Respondent’s nominee in examination for discovery; that role fell to the Nominee Auditor. In his opening remarks, counsel for the Appellant indicated to the Court his intention to show that certain answers given by the Nominee Auditor on discovery amounted to admissions that some crucial findings made at the audit stage by the Primary Auditor - particularly those relating to the functions performed by SII, SWI and/or Mr.

Csumrik – were incorrect. In support of these contentions, counsel for the Appellant read in certain portions of the examination of the Nominee Auditor which he submitted contradicted the Primary Auditor’s conclusions that:

1. there was “no evidence” of meaningful services by SII [which corresponds to Assumption 9(kk)]; 2. marketing of the Appellant’s Starline Window Products in the US was undertaken “exclusively” by employees of SWI [which corresponds to Assumption 9(ii)]; 3. SII provided “no meaningful value-added services”; and 4. the value of Mr. Csumrik’s services was “zero”.

(3) Cross-Examination of the Primary Auditor [ 92 ] The Primary Auditor accepted the Nominee Auditor’s answers as given and admitted they qualified to some extent his findings as set out above. However, he maintained that the Appellant had still failed to provide sufficient proof of its claims regarding the role played by Mr.

Csumrik, on behalf of SII, as the designer and director of the marketing operations implemented by SWI. [ 93 ] Counsel for the Appellant then took the Primary Auditor through some of the written representations to determine why the Primary Auditor insisted on “doggedly maintaining that the Appellant’s documents were not evidence of anything” . Counsel for the Appellant put to the Primary Auditor certain of the Appellant’s documents provided during the audit describing Mr.

Csumrik’s role: two documents prepared by counsel for the Appellant [58] (referred to herein as “Tab 54” and “Tab 57”, respectively ) and one by Mr. Csumrik [59] (referred to herein as “ Tab 59 ” ) at the audit stage. [ 94 ] Turning first to counsel’s description of Mr.

Csumrik’s role in Tab 54, that document is a letter from counsel for the Appellant dated July 9, 2003 in response Primary Auditor’s request for information when he took over the Appellant’s file in June 2003: Q And the second last paragraph it says: “ During the course of our recent meeting you had the opportunity to meet and interview David Csumrik, who is the managing director of SII. Mr. Csumrik has extensive experience in managing sales force in the United States for other products.

He has key contacts and personal connections with significant Canadian builders who are entering the southern California real estate market. It was through Mr. Csumrik's contacts that the companies were able to penetrate the California market. ” [Emphasis added.] So you reviewed that and rejected it. A There was no evidence to support it. Q You gave it zero weight. A I considered it, but in short of having something to support it, what was I going to do? [60] [Emphasis added.] [ 95 ] Counsel for the Appellant also took the Primary Auditor through each page of Tab 59, the job description drafted by Mr.

Csumrik personally and enclosed in counsel’s letter to the Primary Auditor dated June 16, 2005. Beginning at the bottom of page 1, in pages 2 and 4 of the document Mr. Csumrik described his duties as managing director of SII. [ 96 ] On page 3 of Tab 59 Mr. Csumrik set out what “generally could be referred to as coordination of the sales and marketing activities and indirect supervision of the seconded [SWI employees]”. Mr. C sumrik then continued to describe his services as follows: … Again, as you are aware these services mimic the services that SII by agreement is obligated to provide to … [the Appellant].

The sales and marketing functions are provided by the sales and marketing personnel seconded by SII from [SWI]. The supervision of these personnel is undertaken in a couple of ways, firstly by being in constant contact with the General Manager of SWI and secondly by receiving and reviewing the “Red Book Sales” on a weekly basis. Red Book Sales provides me on a weekly basis with each person’s orders for that particular month broken down by territory and providing the amount of the discount from list price.

Rick and I would then discuss and correspond on the specific location and timing of various projects. [ 97 ] After reviewing this description with the Primary Auditor, counsel for the Appellant put the following questions to him: Question So [Mr. Csumrik’s] given a general description of what he does in the second and third paragraph with respect to coordinating the sales staff. Do you agree that that's what he's doing? A That's what he says he's doing. Question And you don't accept that that's what was done? A That's the whole point, I think. We don't accept that.

There's no evidence to support it. [61] [Emphasis added.] [ 98 ] Returning, now, to Tab 59 for the conclusion of Mr. Csumrik’s explanation of his role, he wrote: From time to time I will direct the sales/marketing team to projects that I have knowledge are in the works. You may be aware that a significant amount of our expansion in the US market has come from the California market, initially the San Diego/Carlsbad area and more recently the San Francisco area. What you may not be aware of is the fact that Vancouver based developers led the way in both of these markets.

Two such developers are t he Pinnacle Group and Bosa Ventures, both of whom were well known to me through my previous working life as a lawyer/businessman in the Vancouver area. Certainly my previous experience as a lawyer and business person has been invaluable in my role with the company. My previous real estate development activities certainly provided me with the experience and expertise to allow me [ sic ] understand the business and to assist it in providing leadership from here in Barbados. [Emphasis added.] [ 99 ] A similar statement appears in paragraph 2 of page 3 of Tab 57, counsel’s description of Mr.

Csumrik’s role: … In addition to Mr. Csumrik’s exploiting his direct relationship with certain Canadian real estate developers undertaking significant projects in California , Mr. Csumrik was also responsible for coordinating the selling efforts of the seconded employees of SII in the

United States. … [Emphasis added.] [ 100 ] After having reviewed these various documents and upon being asked for his reaction to them, Primary Auditor had this to say: Q And just again, looking at the description on page 3 of the letter of what Mr. Csumrik does, second paragraph down, you gave that no weight? A There is no evidence. I had no evidence to support any of this. This is just a statement. [62] [Emphasis added.]

(4) Primary Auditor’s Penalty Recommendations [ 101 ] Another issue canvassed by counsel for the Appellant during his cross-examination of the Primary Auditor was his recommendation to the CRA’s Transfer Pricing Review Committee regarding the basis for the imposition of a penalty under paragraph 247(4)(

a) of the Act : Q And I think the last thing I want to explore is you said in your testimony that if you had received a response to your proposal letter you might have adjusted it. A Well I would have -- definitely if you had concerns with the functional analysis we would have entertained your thoughts on it. Q Now would you agree with me that the assessing proposal that you set out put the appellant in the worst possible position? So you’ve simply allowed or you’ve allowed nothing in relation to the services that are provided to the appellant save and except for the costs that are incurred by SWI ? A Right .

Q You’ve given no value at all for anything else ? A Right . Q And you’ve also been able to impose -- would you agree that the limitation for imposing a penalty is you have to be in excess of $5 million in adjustments? A Yes, I believe that’s correct. Q And then for the 2001 year they are just over that threshold, aren’t they? A I believe they were if I look at this, wherever it is. Yes, they were. Q So if we had -- if there had been any credit given in relation to the services provided by SII, they would have been under the $5 million threshold?

A If anything had changed in the audit, they very well could have been. [63] [Emphasis added.] [ 102 ] And again, at the end of the cross-examination of Primary Auditor, counsel verified the Primary Auditor’s conclusions regarding what value ought to be ascribed to the services the Appellant received under the MSSA: Q Mr. Stasiewski having regard to the documents that we’ve gone through today and the submissions, I suggest to you that in the course of your audit you had ample clear evidence of the functions performed by the parties including the involvement of Mr.

Csumrik, the nature of their relationships, the amounts paid by Marzen to SII, the huge increase in the U.S. sales following the adoption of the new marketing strategy, and the value that was received by Marzen as a result of the strategy being implemented. Would you agree with that? A I had a pretty good idea of what was going on. Q And having regard to all that you concluded that the value that SII brought, together with the seconded employees who were performing services on behalf of it, was no greater than the amounts that were being paid by SII to SWI ? A That's correct . [64] [Emphasis added.] E.

Financial Results under the Barbados Structure [ 103 ] It is an agreed fact that Window Products sales increased from US$551,320 in 1998 to US$4,952,859 in 1999 to US$11,983,554 in 2000 and US$13,230,737 in 2001. Almost all the sales achieved in 2000 and 2001 were made to two Canadian developers in southern California, Bosa Brothers and Pinnacle. [ 104 ] In 1999, 2000 and 2001, the Appellant paid SII fees under the MSSA of US$755,700, US$2,803,326 and US$3,051,668, respectively. In 2001, the Appellant also paid SII a one-time bonus amount of US$2,090,422 under the MSSA Bonus Payment.

The Canadian dollar amounts for the total fees paid in 2000 and 2001 are CAD$4,168,551 and CAD$7,837,082, respectively. [ 105 ] In 1999, 2000 and 2001, SII paid SWI fees under the PSA and the ASSA totalling US$606,732, US$1,369,721 and US$1,811,922.

The Candian dollar amounts for the total fees paid in 2000 and 2001 are CAD$2,058,049 and CAD$2,811,892, respectively. [ 106 ] In addition to its sales revenue, SWI included in its income the fees received from SII under the secondment and administrative services agreements (including the employee cost recovery amounts, not just the 10% markup), and from the Appellant under the delivery/depot agreement. [65] [ 107 ] In its financial statements, SWI deducted the expenditures that were cost-recovered from SII pursuant to the secondment agreement, and from the Appellant pursuant to the delivery/depot agreement. [66]

[ 108 ] In 1999, 2000 and 2001 SWI’s net profits were US$274,032 in 1999, US$241,499 in 2000 and US$733,432 in 2001. [ 109 ] In computing income from operations in the 1999 to 2001 taxation years, the Appellant deducted the marketing fees paid to SII as an expense. In its income statement, the Appellant included dividends received from SII as “other income” and added to it income from operations in determining income before taxes.

The Appellant’s financial results included the following, shown in Canadian dollars: 1999 Year Revenues $38,876,749 Gross margin $9,396,094 Income from operations $43,377 Other income (no dividend from SII) $24,108 Income before taxes $67,485 2000 Year Revenues $44,650,187 Gross margin $13,557,642 Income from operations $450,290 Other income (no dividend from SII) $1,988,037 Income before taxes $2,438,237 2001 Year Revenues $54,440,728 Gross margin $17,431,267 Income from operations ($748,018) Other income (no dividend from SII) $5,560,931 Income before taxes $4,812,913 [ 110 ] In both the 2000 and 2001 taxation years, the marketing fees paid to SII were the largest expense on the Appellant’s income statements. [67] [ 111 ] Paragraphs 54-56 of the Statement of Agreed Facts show that SII’s financial results in 1999, 2000, and 2001 included the following (US$): 1999 Year Revenue Marketing fees $755,701 Expenses ($674,986) Net Income $80,715 2000 Year Revenue Marketing fees $2,850,174 Interest $5,072 Expenses ($1,453,341) Net Income $1,401,905 2001 Year Revenue Marketing fees $5,236,186 Interest $5,309 Expenses ($1,847,106) Net Income $3,394,119 [ 112 ] SII’s pre-tax profits from 1999 to 2001 totalled US$4,876,739 (approximately CAD$7.3 million). [68] [ 113 ] According to its 1999 through 2001 Barbados corporate tax returns, SII paid total income taxes in Barbados of US$121,985, as follows [69] : 1999 $2,086 2000 $35,047 2001 $84,952 TOTAL $121,985 [ 114 ] It is an agreed fact that commencing in April 2000, SII began declaring and paying quarterly dividends to the Appellant as follows, shown in US dollars: 2000 Year April 24 $75,000 August 15 $675,000 December 15 $600,000 Total $1,350,000 (Cdn $2,011,50)

2001 Year May 31 $360,000 July 26 $375,000 October 22 $175,000 December 31 $2,525,956 Total $3,435,956 (Cdn $5,299,620) [ 115 ] Mr. Csumrik explained how these amounts were determined and paid: Q Were you given any instructions with respect to when to declare a dividend, or how much the dividend should be? A I would advise -- at the end of each quarter, I would advise the shareholder as to how much cash and retained earnings were available should they want the directors to declare a dividend. So -- Q So would it be then the shareholders’ decision to have a dividend declared? A Well, in law the directors do it.

But I believe we consulted with the shareholder. Q Now, if we just go back to the April 2000 dividend, after that is declared, the retained earnings remaining in the company are about $3,000. By August 15th, 2000, you don’t know what the financial results for 2000 will be, do you? A No. Q And you don’t know what retained earnings there will be at the end of 2000. A No. Q But you were able to pay a dividend of $675,000. A Well, yes, we paid it, yes. Q And what was that determination based on? A That was based on the results for the first quarter ended March 31.

Sorry, it is probably for the first two quarters ended June 30th. We would have had enough cash in the bank, together with enough retained earnings for current fiscal period, six-month period earnings to pay 675. Q So if you didn’t know the retained earnings for that year and there was no retained earnings from 1999, this would be based on how much cash was on hand and your estimate of what was actually needed as working capital? A No. It would be based on the actual earnings for the six-month period ended June 30th, 2000.

It was -- we didn’t have any working capital requirements, in essence, because the agreement provided if we had any, we’d get the money from Marzen. I forget which paragraph that was in both the administrative -- sorry, I think it was the secondment agreement. No, sorry, the marketing sales agreement provided that if we needed working capital, they must provide it. So we didn’t have any working capital requirements other than very nominal amounts. [70] IV. Legislation [ 116 ] The relevant portions of subsection 247(2) of the Act read as follows: 247(2).

Where a taxpayer … and a non-resident person with whom the taxpayer does not deal at arm's length … are participants in a transaction or series of transactions and (

a) the terms and conditions made or imposed, in respect of the transaction or series, between any of the participants in the transaction or series differ from those that would have been made between persons dealing at arm's length… any amounts that but for this

section and

section 245, would be determined for the purposes of this Act in respect of the taxpayer … for a taxation year or fiscal period shall be adjusted (in this

section referred to as an “adjustment”) to the quantum or nature of the amounts that would have been determined if, (c)… the terms and conditions made or imposed, in respect of the transaction or series had been those that would have been made between persons dealing at arm's length… V. Issues [ 117 ] It is agreed that the Appellant and SII were not dealing with each other at arm's length under the MSSA.

The issues in these appeals are as follows: 1. whether the terms and conditions imposed in respect of the MSSA between the Appellant and SII differ from what would have been agreed to by persons dealing at arm's length; 2. if yes, what adjustments should be made to the quantum of the fees that the Appellant paid to SII under the MSSA so that it is equivalent to the price that would have been paid had the Appellant and SII been dealing at arm's length; in other words, whether the Appellant would have paid SII any fees under the MSSA in excess of the amounts allowed by the Minister had they been dealing at arm's length; and 3. whether the Appellant is liable to a penalty under subsection 247(3) of the Income Tax Act in respect of the transfer pricing adjustment made for its 2001 taxation year. [ 118 ] Each of these issues will be dealt with separately under the headings below.

A. Issue 1: Whether the price paid by the Appellant to SII under the MSSA differs from what would have been paid had they been dealing at arm's length.

(1) Appellant’s Position [ 119 ] The Appellant’s position is that having regard to the marketing structure put in place by the Appellant and SII, the terms and conditions adopted by the parties regarding the services provided directly and indirectly by SII do not differ from those that would have been agreed upon between arm's length parties. The Appellant contends that the Court must take into account both the direct services provided by SII and also the indirect services rendered by SWI employees under the secondment agreements between SWI and SII.

Indeed, the Appellant argues that SWI and SII must be treated as one entity referred to as an “amalgam” whose functions included Mr. Csumrik’s involvement. As will be discussed below, this factual assumption formed the basis of the Appellant's Expert Report and informed its approach to the transfer pricing analysis. [ 120 ] According to the Appellant, upon the establishment of the Barbados Structure on July 1, 1999, SII - under the direction of Mr. Csumrik and in collaboration with SWI - undertook the marketing of the Appellant’s Window Products in the US. Mr.

Csumrik, on behalf of SII, developed the marketing strategy used under the Barbados Structure and provided on-going supervision and advice to SWI in furtherance thereof. Because of these relationships, the Appellant submits that SII and SWI must be viewed as acting as one entity under Mr.

Csumrik’s direction in the performance of SII’s obligations to the Appellant under the MSSA. [ 121 ] The Appellant further contends that the “proof is in the pudding”, noting that under the Barbados Structure, the Appellant achieved an impressive increase in sales, proof in itself that the payment of the fees under the MSSA was justified. [ 122 ] The Appellant also argued that the admissions of the Nominee Auditor on discovery and the Primary Auditor’s testimony at trial dealt a grievous blow to the assumptions underpinning the Minister’s reassessments.

According to counsel, the combined effect of the Nominee Auditor’s answers on discovery and the Primary Auditor’s cross-examination showed him to be “incapable of articulating any basis for rejecting” [71] the Appellant’s position during the audit that: 1. the Appellant received service of substantial value under the MSSA; 2. Mr. Csumrik provided on-going direction to the SWI sales team; and 3. without the direction and participation of Mr.

Csumrik, the Appellant would not have successfully penetrated the US high-rise market. [72] [ 123 ] In these circumstances, it is the Appellant’s position that a reasonable business person standing in the shoes of the Appellant and dealing at arm's length from SII would have paid the fees under the MSSA.

(2) Respondent’s Position [ 124 ] The Respondent’s position is that there is no evidence to show that SII provided any meaningful services, or that such services would have justified, to an arm's length person, the payment of the majority of the fees under the MSSA. [ 125 ] The Respondent rejects out of hand the Appellant’s treatment of SII and SWI as a single entity under the Barbados Structure, arguing that the arm's length principle requires an entity-by-entity approach to a transfer pricing analysis. [ 126 ] The Respondent also contends that the Appellant has not met its onus of proving incorrect the assumptions underpinning the reassessments.

In reassessing the Appellant’s 2000 and 2001 taxation years under subsection 247(2) of the Act , the Minister made the following general assumptions as set out in paragraph 9 of the Reply to the Notice of Appeal: 9(uu) the terms and conditions made or imposed between the Appellant, SWI and SII with respect to the Barbados Marketing Structure differed from the terms and conditions that would have been made or imposed had those parties been dealing at arm's length; 9(vv) an arm's length’s party would not have paid SII the marketing f

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