MCKESSON CANADA CORPORATION, Appellant, v. HER MAJESTY THE QUEEN,, 2013 TCC 404

Docket: 2008-2949(IT)G BETWEEN: MCKESSON CANADA CORPORATION, Appellant, and HER MAJESTY THE QUEEN, Respondent . ____________________________________________________________________ Appeal heard on common evidence with the appeal of McKesson Canada Corporation 2008-3471(IT)G on October 17 to 20, 2011, October 25 to 28, 2011, October 31 to November 2, 2011, November 15 to 18, 2011, November 29 to December 2, 2011, December 12 to 15, 2011, January 16 to 20, 2012 and January 31 to February 3, 2012 at Toronto, Ontario Before: The Honourable Justice Patrick Boyle Appearances : Counsel for the Appellant: Paul B.

Schabas Ryder Gilliland Jeffrey Trossman Ilan Braude Kaley Pulfer Counsel for the Respondent: Guy Laperrière Janie Payette Sylvain Ouimet Chantal Roberge ____________________________________________________________________ JUDGMENT The appeal from the reassessment made under the Income Tax Act with respect to the Appellant’s 2003 taxation year is dismissed, with costs, in accordance with the attached Reasons for Judgment. IT IS ORDERED THAT: The parties are to file written submissions on costs within 30 days or such later date that the Court may agree to within that time.

The written submissions are to include advising the Court whether a hearing on costs is requested.

The parties are to advise the Court within 30 days of their proposal for promptly addressing the proper identification for the Court of any confidential information in the Court record prior to public access to the record being reinstated. This may take the form of a Case Management Conference. The parties are to advise the Court in writing within 3 days if they believe any confidential information is contained in the Court's Reasons for Judgment which should be addressed before being released to the public.

Until then, the Reasons for Judgment are released to the parties and their counsel only and are not to be further disseminated by any party. Signed at Edmonton, Alberta this 13 th day of December 2013. "Patrick Boyle" Boyle J. Docket: 2008-3471(IT)G BETWEEN: MCKESSON CANADA CORPORATION, Appellant, and HER MAJESTY THE QUEEN,

Respondent. ____________________________________________________________________ Appeal heard on common evidence with the appeal of McKesson Canada Corporation 2008-2949(IT)G on October 17 to 20, 2011, October 25 to 28, 2011, October 31 to November 2, 2011, November 15 to 18, 2011, November 29 to December 2, 2011, December 12 to 15, 2011, January 16 to 20, 2012 and January 31 to February 3, 2012 at Toronto, Ontario Before: The Honourable Justice Patrick Boyle Appearances : Counsel for the Appellant: Paul B.

Schabas Ryder Gilliland Jeffrey Trossman Ilan Braude Kaley Pulfer Counsel for the Respondent: Guy Laperrière Janie Payette Sylvain Ouimet Chantal Roberge ____________________________________________________________________ JUDGMENT The appeal from the reassessment made under the Income Tax Act with respect to the Appellant’s 2003 taxation year is dismissed, with costs, in accordance with the attached Reasons for Judgment. IT IS ORDERED THAT: The parties are to file written submissions on costs within 30 days or such later date that the Court may agree to within that time.

The written submissions are to include advising the Court whether a hearing on costs is requested. The parties are to advise the Court within 30 days of their proposal for promptly addressing the proper identification for the Court of any confidential information in the Court record prior to public access to the record being reinstated. This may take the form of a Case Management Conference. The parties are to advise the Court in writing within 3 days if they believe any confidential information is contained in the Court's Reasons for Judgment which should be addressed before being released to the public.

Until then, the Reasons for Judgment are released to the parties and their counsel only and are not to be further disseminated by any party. Signed at Edmonton, Alberta this 13 th day of December 2013.

"Patrick Boyle" Boyle J. Citation: 2013 TCC 404 Date: 20131213 Dockets: 2008-2949(IT)G 2008-3471(IT)G BETWEEN: MCKESSON CANADA CORPORATION, Appellant, and HER MAJESTY THE QUEEN, Respondent. REASONS FOR JUDGMENT TABLE OF CONTENTS 1. Overview 2. The Financing Transactions

a) The RSA Discount Formula (

i) The Yield Rate (ii) The Loss Discount (iii) The Discount Spread 3. The TDSI Opinions on Arm’s Length Terms & Conditions and Pricing

a) Eligibility Criteria

b) Termination Events (

i) Delinquency Ratio Trigger (ii) Loss Ratio Trigger

c) Discount Rate (

i) The Yield Rate

(ii) The Loss Discount 1. Designated Obligors 2. Other Obligors (iii) The Discount Spread 1. Servicing Discount 2. Prompt Payment Dilutions Discount 3. Accrued Rebate Dilutions Discount 4. Interest Discount 4. TDSI’s Supplemental Report on Servicing Fees 5. The Law (

a) GlaxoSmithKline (

b) Reasonableness (

c) Relevant Series of Transactions (

d) Scope of Adjustments Permitted Under Paragraph 247(2)( c ) (

e) Factors that Exist Only because of the Non-Arm’s Length Relationship (

f) The Rule in Browne v. Dunn and Opinions Within a Witness’ Expertise (

g) The Court’s Analytical Approach to be Followed in this Case 6. The Position of the Appellant 7. The Position of the Respondent 8. The Witnesses, the Expert Reports and the PwC Report (

a) Mr. Brennan (

b) Ms. Hooper and the TDSI Reports (

c) The PricewaterhouseCoopers Report (

d) The Frisch Expert Report (

e) The Reifsnyder Expert Report (

i) Factors One and Two – Servicing Fees and Prompt Payment Discounts (ii) Factor Three – Credit Risk (iii) Factor Four - $900MM Commitment to Finance (

f) The Becker Expert Report (

g) The Finard Expert Report (

h) The Glucksman Expert Report (

i) The Other Expert Reports 9. The Appropriate Methodology

10. Analysis of Transfer Pricing Issue

a) The Discount Rate (

i) The Yield Rate (ii) The Loss Discount (iii) The Discount Spread 1. Servicing Discount 2. Prompt Payment Dilutions Discount 3. Accrued Rebate Dilutions Discount 4. Interest Discount

b) Summary of Court’s Estimate of Discount Ranges 11. Conclusion on Transfer Pricing Adjustment 12. Timeliness of

Part XIII Assessment of McKesson Canada

a) The Issue

b) The Provisions of the Income Tax Act and the Treaty

c) Position of the Parties

d) The

Interpretation of Treaties

e) Analysis

f) Conclusion re:

Part XIII and the Treaty 13. Dismissal of Appeals Boyle J. [ 1 ] The principal appeal by McKesson Canada Corporation (“McKesson Canada”) concerns the amount of the transfer pricing adjustment made by the Canada Revenue Agency (“CRA”) to its income under paragraphs 247(2) (

a) and (

c) of the Income Tax Act [1] (the “ Act ”) in respect of financial transactions involving McKesson Canada and several of its non-arm’s length and related non-Canadian affiliates during its 2003 taxation year. The related appeal involves the secondary issue of McKesson Canada’s liability under the Act for its failure to withhold and remit to CRA an amount equal to the

Part XIII non-resident withholding tax from the disallowed amounts paid by it to its non-resident parent. [ 2 ] As described in greater detail below, in 2002 it was decided by the McKesson Group that McKesson Canada would sell the receivables owing to it from its customers to a related non-resident McKesson Group entity at a discount. A facility was put in place pursuant to which the receivables would be transferred by McKesson Canada daily at a discount from the face amount of each transferred receivable. 1.

Overview [ 3 ] McKesson Canada is the principal Canadian operating company in the McKesson group of companies owned by the U.S. multinational McKesson Corporation (“McKesson U.S.”). McKesson U.S. is a United States public company and is the 15 th ranking

largest public company in the Fortune 20 list of companies. Its annual revenues are an excess of US$100 billion. It is the largest U.S. health care company. It has over 32,000 employees worldwide. It has been said that McKesson U.S. is the biggest company no one has ever heard of. [ 4 ] Worldwide, and in Canada, the core business of the McKesson group of companies (“McKesson Group”) is the wholesale distribution of over-the-counter and prescription pharmaceutical medicine products. This accounts for about 97% of its revenues.

Its other related business is that of hospital software technology. [ 5 ] The McKesson Group’s wholesale pharmaceutical business has an impressive market share. The McKesson Group delivers one-third of all medicare to the public in the US. In the years in question, McKesson Canada had about one-third of the Canadian market.

It distributes the products of a large range of pharmaceutical companies, and sells to drug store chains large and small, to large grocery store and department store chains that have pharmacies and/or sell over-the-counter medicinal products, to independent pharmacies, to hospitals, and to long-term care institutions. [ 6 ] In the year the receivables facility was put in place, 2002, McKesson Canada had sales of $3 billion, profits of $40 million, 2,400 employees and the largest share of the Canadian market. Its Canadian customers included a number of Canada’s largest retailer grocers and drug store chains.

It had credit facilities available to it in the hundreds of millions of dollar range with major financial institutions. Its public ultimate parent, McKesson U.S., had a solid investment grade credit rating and the interest rates on the available lines reflected that. [2] The McKesson Group had a very considerable cash surplus built up in its Irish affiliate. [ 7 ] At that time, and in the years leading up to it, McKesson Canada had its own successful and sizeable credit department which managed its credit and collection policies and practices. Credit and collections results were trending favourably.

McKesson Canada’s receivables were managed with considerable success, having a roughly 30 day payment average, [3] and a 0.043% bad debt experience [4] with its customers overall. That is, 99.96% of its receivables proved to be good and collected when managed by McKesson Canada’s credit department applying McKesson Canada’s credit and receivables collection policies.

This was very important to McKesson Canada’s success given that the wholesale drug business was low-margin – in the range of 2% - on high volumes. [ 8 ] There was no evidence that there was any pending imminent or future change expected, anticipated or planned for in the make- up, nature or quality of McKesson Canada’s receivables or customers, although there was always the future risk of unforeseen adverse change. [ 9 ] At that time, McKesson Canada had no identified business need for a cash infusion or borrowing, nor did McKesson Group need McKesson Canada to raise funds for another member of the group.

There was a so-called double-dip Nova Scotia Unlimited Liability Company or ULC financing which was coming to maturity and would need to be recapitalized in some fashion; this was for a fraction of the amount of the new receivables facility. McKesson Canada did not approach its traditional lenders or conventional financial institutions (nor anyone else) before entering into its own non-arm’s length receivables facility and related transactions.

The McKesson Group had previously put in place a tax-effective international corporate structure and inter-group transactions that allowed it to amass very large amounts of cash in Ireland. The non-Canadian members of the McKesson Group were able to use this money to finance all of the purchases of McKesson Canada’s receivables under the facility. [ 10 ] The non-Canadian McKesson Group company that purchased the receivables had the right to put non-performing receivables back to McKesson Canada for a price equal to 75% of the face amount, later readjusted to the amount actually collected on it by McKesson Canada.

The purchaser did not otherwise have recourse to McKesson Canada for unpaid purchased receivables. [ 11 ] The non-Canadian McKesson Group entity that purchased the receivables borrowed all the money needed from another non- Canadian McKesson Group entity.

The borrower’s obligations to the lender under the loan was fully guaranteed by yet another non- Canadian McKesson Group entity, which also indemnified the borrower for any shortfall between what the borrower received from McKesson Canada’s receivables and what it needed to pay on the loan. [ 12 ] As described below, the non-resident affiliate also paid McKesson Canada to continue to have McKesson Canada’s credit and collections department manage the receivables applying McKesson Canada’s credit and receivables collection policies and practices.

Under the agreements these policies and practices could not be changed without consent. Similarly, McKesson Canada could only continue to grant other discounts or rebates in the ordinary cause of its business and in accordance with its usual practices when the facility was entered into. [ 13 ] Most of the proceeds of the initial $460,000,000 receivables sale were returned by McKesson Canada to its non-resident

shareholder affiliate, a portion was loaned for a period to another Canadian corporation to permit its tax losses to be used, and about 1% of the proceeds were used by McKesson Canada for its general corporate purposes. [ 14 ] The CRA has challenged these related party transactions for McKesson Canada’s 2003 taxation year on the basis that the amounts paid to the non-Canadian McKesson entity pursuant to the receivables purchase transactions differ from those that would have been paid between arm’s length persons transacting on arm’s length terms and conditions.

The discount upon the purchase of the receivables in accordance with the revolving facility was a 2.206% discount from the face amount.

While this discount rate and the overall transactions between the parties are considered in greater detail below, this discount rate for receivables that on average were expected to be paid within about 30 days can be restated as an annual financing cost payable by McKesson Canada for its rights under the facility in the range of 27% per annum. [5] [ 15 ] A direct result of these discounts was that McKesson Canada ceased to be profitable for its 2003 taxation year and reported a tax loss in the year in issue in this appeal.

McKesson Canada’s profits in later years were similarly significantly reduced. [ 16 ] The taxation year of McKesson Canada under appeal ending March 29, 2003 was a short taxation year of approximately three and a half months, having started upon its amalgamation as part of a Canadian restructuring of the McKesson Group’s Canadian interests. Its taxation and financial year ends on the last Saturday in March of each year. Its financial year is divided into a 13 four week Accounting Periods.

CRA’s 2003 transfer pricing adjustment was approximately $26,610,000, reflecting a 1.013% discount for the purchased receivables. [6] No transfer pricing penalty was assessed. [ 17 ] The receivables facility was a five-year revolving facility. As detailed below, the purchaser had several rights to terminate the agreement in the event of any anticipated deterioration in the quality of receivables generated in McKesson Canada’s business. [7] [ 18 ] As discussed further below, the predominant purpose of McKesson Canada entering into the transactions was the reduction of its Canadian tax on its profits.

None of the raising or freeing up of capital, reducing credit risk from its customers, nor improving its balance sheet was McKesson Canada’s predominant purpose; they were results of the transactions. [ 19 ] This trial was a very lengthy and hard fought 32 day trial heard over a period of five months from October 2011 to February 2012. Formidable groups of lawyers represented each of the Appellant and the Crown. The Court heard from two material witnesses and five expert witnesses. Reams and reams of documentation were entered into evidence, including further expert reports whose authors did not testify.

After oral argument both parties made further written submissions and further responding submissions. Following the Supreme Court of Canada’s decision in Canada v. GlaxoSmithKline Inc. , 2012 SCC 52 , [2012] 3 S.C.R. 3 in October 2012, both parties made further written submissions. [8] 2.

The Financing Transactions [ 20 ] McKesson Canada and its Luxembourg immediate parent company (“MIH”) entered into a Receivables Sales Agreement (the “RSA”) and a Servicing Agreement effective December 16, 2002. [ 21 ] Under the RSA, MIH agreed to purchase all of McKesson Canada’s eligible receivables as at that date (about $460,000,000) and committed to purchase all eligible receivables daily as they arose for the next five years unless earlier terminated, and subject to a $900,000,000 cap. [ 22 ] Eligible receivables were generally trade receivables owing by an arm’s length customer who was not in default on other receivables and whose receivables would not, except in specific circumstances described below, represent in the aggregate more than 2% of the then outstanding receivables pool.

The 2% concentration limit on eligibility did not apply to McKesson Canada’s handful of its largest named customers who accounted for about one-third of sales and whose receivables each already exceeded 2% of McKesson Canada’s outstanding receivables pool (the “Designated Obligors”). All hospitals were also defined to be Designated Obligors. The RSA has specific provisions, including discount rate calculation considerations, applicable to these Designated Obligors.

The RSA contemplated the 2% concentration limit being waived or additions being made to the list of Designated Obligors with MIH’s consent. [ 23 ] The RSA provided that if a termination event occurred, MIH could direct McKesson Canada to advise its customers of the sale. In accordance with the related Servicing Agreement, McKesson Canada would continue to service and collect the receivables in accordance with its credit and collection policies and practices which were not to be changed without the consent of MIH.

[ 24 ] The Servicing Agreement provided that McKesson Canada was to be the initial servicer but could be replaced upon the occurrence of a termination event under the RSA. MIH agreed to pay a fixed annual fee of $9,600,000 to the servicer to service the outstanding transferred receivables regardless of the amount outstanding. [9] [ 25 ] McKesson Canada did not warrant or guarantee the collectibility of the receivables or any portion thereof.

MIH had the right to put a defaulted receivable back to McKesson Canada for an amount equal to the lesser of (i) 75% of its face amount, and (ii) the amount ultimately collected on it. When exercised, McKesson Canada was to pay the 75% amount to MIH and any ultimate downward adjustment was to be made subsequently. [ 26 ] MIH could terminate its obligations to purchase any further McKesson Canada receivables upon the occurrence of certain defined termination events, generally designed to identify or anticipate deteriorating creditworthiness of McKesson Canada or its pool of customers generating the receivables.

These events included financial defaults of McKesson Canada or its affiliates, increases in the delinquency ratio or loss ratio of the receivables beyond specific thresholds, a downgrade in the credit rating of McKesson U.S., McKesson Canada’s name being changed to drop the word McKesson, McKesson Canada ceasing to be controlled by McKesson U.S., McKesson U.S. ceasing to guarantee McKesson Canada’s bank and commercial paper lenders, and any event occurring which materially adversely affected the enforceability or collectibility of the receivables or MIH’s rights under the agreements. [10] It can be noted that the termination events were not limited to things in McKesson Canada’s control, and included events in the control of its direct and indirect shareholders/parent corporations. [ 27 ] McKesson Canada continued to collect the receivables in the ordinary course.

While ownership of the receivables was transferred daily, settlement (i.e. payment by the purchaser MIH) was more or less monthly. [11] McKesson Canada was not required under the RSA or the Servicing Agreement to segregate the funds collected on MIH’s behalf as they came in, unless MIH required it following a termination event. Each month the amount collected on the receivables for MIH’s benefit would be used first to pay McKesson Canada for newly generated receivables and any balance would be remitted to MIH.

If there was a shortfall because newly originated receivables exceeded amounts collected, MIH was required to put McKesson Canada in funds. [12] [ 28 ] While the RSA was for up to a five-year term, it was clearly a revolving facility. Purchased receivables could be expected to be collected by MIH within about a month.

MIH could be expected to know within a short period of time if any obligor’s payment history or prospects were declining or deteriorating, or if McKesson Canada’s creditworthiness was declining or deteriorating, and could take immediate steps to protects its interests and its future exposure, without waiting five years. [ 29 ] The RSA provided that McKesson Canada would pay MIH’s costs and expenses related to the transactions, including the costs of an inter-company transfer pricing study. [13] [ 30 ] The RSA provided that the purchase price payable by MIH to McKesson Canada for each receivable would be at a formulaically determined discount from its face amount.

This is described in greater detail immediately below. [ 31 ] Any dilution or reduction to the face amount of a receivable resulting from discounts, rebates, disputes or returns, or by way of set-off under the terms of the receivable or otherwise, were deemed collections by McKesson Canada as servicer and to be accounted for to MIH as such. This did not apply to prompt payment discounts for reasons that were not directly explained in the evidence.

The scope and nature of how the dilution risk relating to prompt payment discounts is dealt with under the agreements is in issue in this appeal. [ 32 ] During the term of the RSA it was discovered that interest received on the transferred receivables had not been accounted for and was retained by McKesson Canada. This was not consistent with the RSA. [14] The parties agreed not to account for the past error or to correct it going forward.

In 2005, the parties agreed in writing that the interest and late payment charge obligations on the transferred receivables were never intended to be transferred – something that is difficult to reconcile with the RSA language or on any arm’s length basis. [ 33 ] The agreements are governed by Luxembourg law. [ 34 ] MIH, McKesson Canada’s direct parent, borrowed all of the money in Canadian dollars to purchase the receivables from an Irish company in the McKesson Group (alluded to above), that was one of its indirect parents.

The purchase of receivables under the RSA was MIH’s stated use of the funds in its loan agreements. The interest payable by MIH was a direct function of the discount enjoyed by it under the RSA. MIH’s obligation to repay its borrowings to its Irish affiliate was fully guaranteed by its indirect parent, another related Luxembourg company (“MIH2”). In addition, MIH enjoyed an indemnity from MIH2 under a Memorandum of Understanding for any amounts payable in accordance with the RSA that were not received from McKesson Canada in order to allow

MIH to fully re-pay its borrowings from its Irish affiliate. [15] MIH, McKesson Canada’s counter-party to the RSA and the Servicing Agreement, did not take any financial risk under this group of contemporaneous, inter-woven agreements all of which were financially and legally linked and related. All such risk was borne by other entities in the McKesson Group. That risk ultimately remained economically with McKesson U.S., everyone’s ultimate parent company, both before and after the RSA transactions.

a) The RSA Discount Formula [ 35 ] The amount payable for a purchased receivable under the RSA was the product obtained from multiplying (

i) the face amount of the receivable and (ii) one minus the Discount Rate expressed to four relevant digits. [16] By way of illustrating the method in which this formula worked, if the Discount Rate (as defined itself by a further formula) worked out to 0.0150, MIH would pay $98.50 for every $100 of receivables [17] , buying them at a 1.5% discount from face. [ 36 ] The Discount Rate is defined in the RSA to be the sum of (

i) the Yield Rate, (ii) the Loss Discount, and (iii) the Discount Spread. (

i) The Yield Rate [ 37 ] The Yield Rate was the 30 day Canadian dollar bankers’ acceptance (BA) rate, or CDOR, [18] on the first business day of the relevant settlement period. This operated as the floating base rate. This was intended to reflect a current, risk-free market rate of return. It is not challenged as an appropriate floating base rate for this Canadian dollar, Canadian obligor transaction. (ii) The Loss Discount [ 38 ] The Loss Discount was intended to reflect the credit risk of the McKesson Canada customers who were the receivables debtors. The Loss Discount was made up of two parts: (

i) a Loss Discount component applicable to the Designated Obligors (whose receivables each exceeded 2% of the pool) and (ii) a Loss Discount component applicable to the other smaller Obligors making up the more diversified majority of the receivables pool. [ 39 ] The RSA expressed a fixed Loss Discount of 0.23% applicable to the initial purchase of receivables in 2002 to the end of 2003. This applied to the year under appeal. [ 40 ] For the remaining term, the Loss Discount was to be recalculated each year starting January 1, 2004.

Also, if at any time MIH felt that the ratio of Designated Obligors’ receivables to other Obligors’ receivables in the pool was materially different than originally calculated for a year, MIH could require the Loss Discount to be recalculated that month. McKesson Canada as seller did not have any similar right. The result was that the RSA required the Loss Discount to be recalculated annually, and permitted only MIH to require it to be recalculated as often as monthly in the event of such a material change in risk. [ 41 ] For the larger Designated Obligors, a

schedule to the RSA fixed their Individual Loss Discounts for the entire five-year period. In computing the aggregate Loss Discount for Designated Obligors, the weighted average of these fixed Individual Loss Discount amounts (weighted by each Designated Obligor’s share of the receivables pool as at the end of the prior year) was used.

Since the Individual Loss Discounts were intended to reflect the unique credit risk of each Designated Obligor, there was a considerable range within the scheduled amounts (ranging from approximately 0.04% to 0.35% - a nine-fold range). [ 42 ] For each of the other Obligors (comprising about two-thirds of the pool), the RSA fixed an Individual Loss Discount at 0.2380% for the entire five-year term. The mechanics of how this number was arrived at was not apparent from the RSA as the agreement simply stipulated a fixed number for the entire duration.

In computing the Loss Discount for these other Obligors, the weighted average of this fixed 0.2380% (weighted by the total of these other Obligors’ share of the receivables pool as at the end of the prior year) was used. [ 43 ] The Loss Discount was the sum of the weighted Individual Loss Discount for all Obligors.

[ 44 ] The initial fixed Loss Discount of 0.23% applicable to the first full year was in fact calculated on this same basis. The amount thereof is significantly in issue in this appeal. (iii) The Discount Spread [ 45 ] The RSA fixed the Discount Spread at 1.7305% for the entire duration of the agreement. Since this was fixed, the agreement does not describe how this number was arrived at. The evidence is that generally this relates to (

i) the risk that McKesson Canada’s creditworthiness deteriorated significantly, and receivables debtors might set off their rebate entitlements in such event, (ii) the risk that McKesson Canada’s customers might increase their take-up of available prompt payment discounts, (iii) the risk that MIH might decide to appoint a new servicer following any termination event who might require a greater servicing fee than provided for successor servicers in the Servicing Agreement and (iv) the need for the Discount Rate to fully cover MIH’s cost of funds. [ 46 ] There was no corresponding consideration given to the possibility of McKesson Canada’s creditworthiness improving, customers taking less advantage of prompt payment discounts, or the impact of more prompt payments on the DSO.

These imbalances were never explained. [ 47 ] This 1.7305% amount, it being a fixed amount, and the extent of MIH’s exposure to McKesson Canada credit risk under the agreements in the circumstances, are also significantly in issue in this appeal. 3. The TDSI Opinions on Arm’s Length Terms & Conditions and Pricing [ 48 ] The RSA and all related agreements were first signed as of December 16, 2002. The conception, structuring, planning and drafting was under way for an unknown amount of time before that.

This process seems to have been lead primarily by the Vice- President of Taxes of McKesson U.S., together with the tax and banking lawyers at Blake, Cassels & Graydon LLP (“Blakes”).

Some general transfer pricing advice on approaches to, and issues in, structuring such a transaction was obtained in the summer of 2002 from Horst Frisch, a U.S. consulting company specializing in transfer pricing. [19] McKesson Canada’s role was limited to providing support and information regarding such things as its customers, its receivable portfolio, its projections, and its credit and collection policies et cetera. [ 49 ] In the weeks before the signing of the agreements, probably around December 1, 2002, Toronto Dominion Securities Inc. (“TDSI”) was retained by Blakes to provide advice on certain arm’s length aspects of certain of the terms and conditions of the RSA and of certain components of the discount calculation.

The TDSI engagement letter was sent to TDSI on December 3 rd . It is clear from TDSI’s advice that by the time that TDSI was consulted, the structure and pricing approach and formulae were largely settled. It is not clear that any significant changes were made to these to reflect any advice or information given by TDSI. This is consistent with the testimony of Mr. Hooper of TDSI. [ 50 ] It can be noted that in 2002 the Act included contemporaneous arm’s length transfer pricing documentation/analysis requirements to defend the 10% transfer pricing penalty provisions.

In fact, the TDSI opinions were relied on as the only contemporaneous basis to successfully contest CRA’s pre-reassessment proposal to impose transfer pricing penalties. [20] [ 51 ] TDSI’s advice was initially sought on (

i) receivables eligibility criteria (ii) termination events/triggers and (iii) the appropriateness of the discount pricing. Somewhat oddly and not explained, Blakes’ engagement letter specifically identifies and raises the possible need to address the effect of a potential replacement servicer under the Servicing Agreement as part of the discount. [ 52 ] McKesson Canada had a pre-existing business relationship with the Toronto Dominion Bank group. The full scope of that was not put clearly in evidence, however, several years earlier, McKesson Canada had done a receivables factoring transaction with TD Factors.

The TD Factors transaction was an entirely tax-driven year-end short-term transaction designed to avoid Canadian federal capital tax and seems to have been priced accordingly. It is entirely unreasonable to suggest this was a truly comparable transaction for arm’s length pricing purposes to the one in issue in this appeal. [ 53 ] Barbara Hooper is the person at TDSI that Blakes chose to contact. She was known to be a senior member of TDSI’s securitization group.

Her advice was sought notwithstanding that everyone knew the RSA and related transactions were not structured as securitization transactions, were not intended to be securitization transactions, and that the purpose, objective and characteristics of the RSA transactions were significantly and materially different than a securitization transaction. No advice or information was sought from

anyone other than the TDSI securitization group (and the TD bond traders briefly and casually consulted by Ms. Hooper’s group.) [ 54 ] Barbara Hooper was and is clearly a recognized professional and experienced expert (as a business person would use that word) in securitization matters, including trade receivables securitizations. She testified in this hearing as a material witness and not a qualified expert witness.

Since her role as a material witness in offering the TDSI opinions involved her exercise of her professional judgment, she was allowed to fully explain in her testimony those opinions, including her reasons, and her supporting information, bases and subsidiary opinions. [ 55 ] Clearly Ms. Hooper’s experience with trade receivables securitizations qualified her to give valuable advice to the McKesson Group entities participating in the transaction and to the Court.

She is certainly very knowledgeable about the risks associated with transfers of trade receivables, how those risks can be identified, and how those risks can be minimized in a receivables securitization transaction. Her experience and expertise did not however extend to pricing those risks if the risks were to be transferred, nor did it extend to market discount rates applicable to outright non-recourse or limited recourse sales or factoring of trade receivables.

She did not hold out or suggest otherwise in the TDSI opinions or in her testimony. [ 56 ] Her testimony and TDSI’s involvement in the RSA transactions have been helpful to the Court. The TDSI opinion followed the conceptual approach dictated by the RSA presented to it by the McKesson Group. As is often the case with expert and other opinion evidence, the Court found much of the detailed explanation and reasoning behind the opinions, as well as some of the data and information supporting the opinions, helpful notwithstanding that the Court does not arrive at entirely the same conclusion in the end.

a) Eligibility Criteria [ 57 ] The TDSI opinion deals with this in a single short three-sentence paragraph. It concludes, without explanation or analysis, that the definition of eligible receivables in the RSA is within the range of normal in an arm’s length transaction of this nature.

While it uses the words “transaction of this nature”, I can only conclude this is a reference to a securitization transaction involving receivables given the description of the experience TDSI brought to bear. [ 58 ] It goes on to identify that the exposure to the receivables pool concentration levels associated with McKesson Canada’s Designated Obligors would not be present in a securitization, will need to be addressed by TDSI in addressing the Discount Rate, and that this component of the Discount Rate will need to be dynamic, reflecting possible changes in the relevant balance of Designated Obligor receivables in the pool from time to time.

b) Termination Events [ 59 ] TDSI is satisfied that the triggers in the RSA definition of termination event are within the range of normal in an arm’s length transaction “of this nature”. I repeat my earlier observations about her use of this phrase in the TDSI opinion. [ 60 ] The TDSI opinion makes specific reference to the role of such termination triggers as protection for poor performance of receivables or declining creditworthiness of the seller. It identifies McKesson Canada’s creditworthiness as seller as relevant in part because of its obligations to remit collections to MIH.

TDSI is of the express view that “because [McKesson Canada] is so closely tied and important to [McKesson U.S.], it is reasonable to use the public debt ratings of [McKesson U.S.] as an indication of [McKesson Canada’s] creditworthiness”. [ 61 ] The TDSI opinion goes on to specifically consider

i) the receivables pool’s delinquency ratio trigger in the RSA, and ii) the receivables pool’s loss ratio trigger in the RSA. (

i) Delinquency Ratio Trigger [ 62 ] TDSI considered the improving two year historical trend in the delinquency ratio of McKesson Canada’s receivables and the recently maintained 1.0% rate. The 2.5% trigger rate in the RSA would, in TDSI’s opinion, represent a significant adverse deviation from the current steady state of 1% and so considered reasonable. TDSI highlighted the importance of the dynamic four-month rolling average approach to measuring the delinquency ratio in the RSA, and uses this approach in its analysis. TDSI confirmed that this is consistent with the three to six month periods generally used for such purposes.

(ii) Loss Ratio Trigger [ 63 ] TDSI looked at three years of historic bad debt experience on McKesson Canada’s receivables portfolio. TDSI identified the difference between accounting write-offs and the 90 day delinquency definition of losses for purposes of the loss ratio in the RSA, with the result that the latter ratio could be expected to exceed the former. TDSI opined that a dynamic loss ratio, which measured a four- month average 90 day delinquency, and with a trigger of 0.25%, appeared reasonable given that, although write-offs to sales on a monthly basis at times reached this level, it had never exceeded 0.10% on a four-month rolling average. [21]

c) Discount Rate [ 64 ] The TDSI Report says its assessment of the appropriate compensation was set by (

i) where possible, looking at pricing of comparable risks in the market and (ii) “where pricing comparables were unavailable, we assessed the potential cost to [MIH] of assuming the risk”. [22] [ 65 ] In its

summary paragraphs on the total discount at the end of its report, TDSI addressed the total discount following the RSA definition of Discount Rate as the sum of (

i) the Yield Rate, (ii) the Loss Discount, and (iii) the Discount Spread. In summarizing the TDSI Report on the Discount Rate, it is easiest for the Court to follow this same order in its Reasons rather than the different order more loosely followed in the body of the TDSI Report. (

i) The Yield Rate [ 66 ] TDSI identifies that the RSA used the 30 day Canadian dollar CDOR/BA Rate as the floating base rate component and that the 30 day CDOR Discount Rate needs to be adjusted to reflect the receivables’ DSO. [ 67 ] Notwithstanding the

definitions of Discount Rate and Yield Rate in the RSA (even after it was amended and restated, and after being further clarified), the Court observes that the Yield Rate component of the Discount Rate in fact needs to be adjusted to reflect that the 30 day CDOR Rate is expressed as an annual rate and therefore needs to be adjusted to reflect the receivables pool’s DSO by multiplying it by the DSO and then dividing by 365. [ 68 ] TDSI selected the receivables pool’s three year average monthly DSO it calculated as 32.

There was no discussion of why a shorter period’s average monthly DSO was not used, nor was there any discussion in the TDSI Report of a dynamic rolling average approach to DSO. [ 69 ] TDSI recognized that the DSO for the initial purchase of approximately $460,000,000 of receivables would very significantly overstate the expected payment term for these receivables as they were a pool of mature short-term receivables (i.e. some would be paid the following day because they had been outstanding for between 1 and 30 days or more). [ 70 ] TDSI’s approach was to instead use a 16 day DSO for the initial purchase.

However, it did not in fact calculate the Discount Rate for the initial December 16, 2002 purchase using a 16 day DSO; it instead averaged the “missing” 16 days across the entire five years of the RSA term, and set a fixed DSO of 31.73 days for all Discount Rate calculations for all receivables purchases under the RSA. It is obvious that the effect of this was to double this portion of the Discount Rate for the December 2002 purchase thereby providing a significant timing benefit to the McKesson Group in respect of McKesson Canada’s tax reduction for the 2003 year in issue. (ii) The Loss Discount 1.

Designated Obligors

[ 71 ] TDSI begins its Loss Discount analysis by determining the monthly write-offs to sales from the 3 to 4 years of data provided to it for McKesson Canada, together with the same numbers computed on a three and 12 month rolling average basis. They conclude that, viewed from this dynamic perspective, McKesson Canada’s write-offs to sales are “very low”. [ 72 ] TDSI identifies a concentration risk issue associated with the larger Designated Obligors that losses on their receivables have an increased likelihood of deviating from historical levels (presumably not necessarily adversely).

TDSI does not attempt to quantify that increased likelihood, nor most importantly, does it analyze the historic data associated with Designated Obligors separately to try to validate the increased risk. [23] [ 73 ] TDSI looked at the Designated Obligors separately from the other Obligors and looked at each Designated Obligor individually (treating all hospitals as a single Designated Obligor), as contemplated by the RSA. [ 74 ] TDSI thought it appropriate to consider each Designated Obligor’s public debt rating, or if a Designated Obligor did not have one of its own, its parents’ rating without adjustment.

If neither was rated, the TDSI Report assumed a non-investment grade credit rating. TDSI then looked at each Designated Obligor’s 180 day risk credit spreads in the public debt market.

TDSI thought it was appropriate to treat MIH’s risk under the RSA as 180 day risk which would allow for TDSI’s estimate that it would take 90 days to wind down the pool and liquidate the portfolio upon termination. [ 75 ] TDSI estimated the Individual Loss Discount for each Designated Obligor using this market based discount, first adjusted for the DSO and then applied to (multiplied by) its total receivables at that time (December 2002). These numbers were then fixed in the RSA’s

Schedule D of Designated Obligors’ Individual Loss Discounts. [24] 2. Other Obligors [ 76 ] The TDSI Report uses one month historic data to assess the Loss Discount attributable to the smaller Obligors comprising the majority of the receivables pool. The report gives no reason for choosing the one month historic average instead of either the three or 12 month rolling averages also computed and set out in this portion of the TDSI Report (or, for that matter, the four month rolling average set out and used by TDSI in the portion of its report opining on loss trigger termination events).

The TDSI Report does not appear to even break out the Designated Obligor portion of the pool for this purpose to look only at the other Obligor performance. Neither the report nor Ms. Hooper’s evidence provided any explanation. [ 77 ] TDSI goes on to note that the multi-year data it has been provided does not cover a full economic cycle of Canadian trough-to- peak-to-trough. The report does not say more historic data was asked for, nor that it was unavailable. For this reason, it “suggests” adding three standard deviations from mean (although TDSI only set out average not mean in its charts).

No reason is given for this suggestion that three standard deviations be used.

This suggestion, combined with the selection of monthly numbers, had the result of driving the .03% actual monthly average loss to 0.24% - that is an eight-fold increase. (Though the TDSI Report then uses 0.2380%; presumably more accurate four digit calculations had been done outside the report). [ 78 ] It can be noted from TDSI’s chart that, while the computed standard deviation was .07% for monthly historic averages, it was a fraction of that for the rolling 12 month and three month historic loss performance (.02% for 12 month and .04% for three months).

It can be observed readily that had this same approach of adding three standard deviations to twelve month historic rolling average losses been taken, the twelve month average of .04% would only increase to .1% - which would still be a two and one-half fold increase (and still without any given reason for using three standard deviations). [25] [ 79 ] TDSI correctly points out that this approach to the Loss Discount percentage applicable to other Obligors is a function of losses on the dollar amount of receivables, not an annual or other rate that is a function of time, and thus does not need to be adjusted for the DSO. [ 80 ] The TDSI Report then simply totals the pool’s weighted DSO adjusted credit spread for each Designated Obligor consistent with the RSA, and the other Obligors’ 0.2380% weighted to their share of the receivables pool owing by the other Obligors. [ 81 ] TDSI described the annual (or earlier at MIH’s request) adjustment of the Loss Discount component of the Discount Rate as appropriate.

It did not discuss why it considered those appropriate.

(iii) The Discount Spread [ 82 ] The set and fixed discount spread in the RSA of 1.7305% appears from the TDSI Report to have been built up by TDSI. The TDSI Report built up this number from four components (1) a servicing discount, (2) a prompt payment dilutions discount, (3) an accrued rebate dilutions discount, and (4) a credit spread interest discount. [ 83 ] It is not at all clear from the RSA, the TDSI Report, or the witnesses why these four risks are addressed by something called a discount spread.

In any event, it is clear that the parties to the RSA and related transactions, and their advisors, considered these the material risks associated with the RSA transactions other than the risk of loss on the receivables themselves resulting from Obligors’ financial defaults. 1. Servicing Discount [ 84 ] The TDSI opinion begins its analysis with the points that (

i) the RSA requires MIH to service the purchased receivables, (ii) under the Servicing Agreement the servicer (including the initially appointed servicer, McKesson Canada) will be paid a fixed fee of $9,600,000 annually, paid monthly, to service the receivables pool regardless of size, and (iii) the Servicing Agreement contemplates the prospect of MIH choosing to, or needing to, appoint a replacement servicer. [ 85 ] TDSI ties the “very possible” need for a replacement servicer to the fact that MCC is not a highly-rated credit on a stand alone basis.

The connection is not described further and is not obvious. [ 86 ] TDSI then set out the replacement servicer pricing it obtained from a single source (believed to be perhaps a major accounting firm). This indicated collection fees for current accounts in the range of 1.0% to 3.0% of the face amount of the receivables.

TDSI did not seek replacement servicer pricing from TD Factors. [ 87 ] TDSI observed again that a replacement servicer would only be needed for a short period of time once the agreement was terminated and no further receivables were purchased by MIH. [ 88 ] TDSI then chose to use a 2% replacement servicer fee for the reason that it was the midpoint of the 1% to 3% range. [ 89 ] TDSI observed that the approximately $800,000 fee payable monthly under the Servicing Agreement would be in the range of 0.2% assuming that approximately one-half of the $900,000,000 cap, or about the original purchased amount of receivables, was outstanding throughout the term.

No attempt is made in the report to explain or substantiate the “expected sales” volumes. [26] No explanation is made of the relevance of a $900,000,000 cap that does not relate to expected sales. No attempt is made to explain the tenfold difference between the 0.2% charged by McKesson Canada and TDSI’s selection of 2% from the range of 1% to 3% for a replacement servicer.

Nor is this last issue dealt with in TDSI’s supplemental report. [ 90 ] The TDSI Report then notes that a Moody’s publication consulted by it indicated that, in the previous year, 9.41% of companies with McKesson U.S.’ rating were downgraded to the RSA trigger rating or had their rating withdrawn.

From there, without any further explanation, TDSI then used a “conservative” “assumption” of a 25% “chance” that a replacement servicer would need to be appointed. [27] [ 91 ] Using these numbers alone, TDSI then multiplies 2.0% times 0.25, and 0.2% times 0.75, and adds these to arrive at a “reasonable expected cost of servicing” of 0.65%.

This number, three and one-quarter times what McKesson Canada or a replacement servicer is to be paid to service the receivables under the Servicing Agreement, is then used to discount each receivable (including the $465,000,000 worth purchased upon signing the agreement which appeared to have virtually every likelihood of being paid in orderly fashion beginning the very next day, and including those purchased on the next day, and the day after that, et cetera). [ 92 ] Several months after the transactions were in place, TDSI was asked for follow-up advice on the fixed fee payable to the servicer under the Servicing Agreement.

TDSI’s supplemental report is described further below.

2. Prompt Payment Dilutions Discount [ 93 ] As described above, the RSA does not treat prompt payment discounts enjoyed by McKesson Canada’s customers as deemed collections on their receivables. The TDSI Report accepts this without question and without even addressing whether this would be normal in arm’s length securitization transactions.

It is not self-evident why prompt payment discounts are not treated in the same manner as other dilutions such as volume rebates to customers. [ 94 ] Thus, TDSI identifies the risk in the RSA that there may be a change in the extent to which McKesson Canada’s customers take up the prompt payment discounts offered by paying their receivables earlier than past individual or overall experience might suggest. For example, if MIH purchases $100 of receivables and the purchaser promptly pays $98 in full satisfaction, McKesson Canada does not have to account to MIH for the $2.

The RSA pricing therefore had to somehow address the fact that prompt payment discount rights would be exercised by McKesson Canada customers. MIH would be overpaying if the embedded take-up was underestimated and McKesson Canada would be underpaid if the embedded take-up was overstated. TDSI computed McKesson Canada’s prompt payment discounts historically on an annual basis as 0.5% of sales and observed this is “very consistent”. [28] [ 95 ] TDSI then suggested that a 20% “buffer” be added to bring the 0.5% to 0.6%. The TDSI Report does not attempt to explain why a 20% buffer was chosen.

It does not acknowledge, much less address, the fact that if up to 20% more customers start enjoying prompt discount payments on the terms already offered, there would be a corresponding favourable impact on the DSO of the receivables pool which would have a correspondingly material impact on risk and pricing as MIH would be paid materially more quickly. [ 96 ] Unstated and unexplained, but implicit in the TDSI Report, is that TDSI is fine with the prompt payment discount risk being estimated at the outset, fixed throughout at historic levels, plus an unexplained buffer, instead of it being reflected in its rolling average actual performance throughout the RSA’s term, and even though it is to be incorporated in the MIH RSA risks instead of being treated as a deemed collection. 3.

Accrued Rebate Dilutions Discount; [ 97 ] McKesson Canada’s volume rebates are paid separately to its customers and are not enjoyed at point of purchase or time of payment. Rebates are instead paid directly by McKesson Canada to its customers periodically. The risk that transferred receivables would be subject to a reduction for rebates was therefore not transferred to MIH nor accounted for under the RSA. However, there was nonetheless the risk that a customer would choose to set-off its McKesson Canada payables by the amount of an anticipated or earned but yet unpaid rebate owing to it from McKesson Canada.

TDSI speculated this may happen if customers became concerned about McKesson Canada’s financial situation. [29] The RSA expressly and clearly requires such a set-off risk to be fully borne by, and indemnified by, McKesson Canada. Thus, TDSI identifies that the RSA has MIH taking McKesson Canada (MIH’s direct subsidiary) credit risk for McKesson Canada’s indemnity obligation. [ 98 ] TDSI computed the three-year historic rebates as a function of sales numbers. The average was 3.8%. The minimum was 2.13% and the maximum was 5.53%. Each of these percentages is a total of all accrued rebates.

Thus, without further adjustment, using these raw numbers would reflect the situation where all of McKesson Canada’s customers decide it is time to set-off rebates. Without any explanation other than to be conservative, TDSI selected the highest maximum number of 5.53% of the receivables balance as the amount at risk for set-off. No suggestion is made by TDSI that a dynamic rolling average approach should be taken or considered through the term of the RSA.

TDSI does not address the prospect that MIH might be expected to have and exercise termination rights if McKesson Canada’s financial situation were to become such that MIH was concerned about its financial viability. The TDSI Report does not say they are aware that any such set-off has ever been made, claimed, threatened or even asked for. [ 99 ] To this maximum set-off amount, TDSI applies a factor selected by it to reflect McKesson Canada credit risk.

For this purpose they assessed a 5.25% credit spread (that is the amount charged above a lender’s floating fixed base rate) for McKesson Canada on the basis that, without its own credit rating, they should use non-investment grade credit spreads as a proxy. (Non-investment grade borrowers’ bonds in the bond market are also referred to as high yield bonds or junk bonds).

This, even though several times elsewhere in the TDSI Report, they use unrated Obligors’ parent ratings as their proxy, and accept McKesson U.S.’s credit rating risk as reflective of McKesson Canada’s creditworthiness risk in the discussions of termination event and triggering event. The TDSI Report does not explain the relationship of its estimated 5.25% credit spread to McKesson Canada’s actual rates available to it from its available lenders and facilities which, as described elsewhere, are very different.

Notably, given that the RSA clearly did not require McKesson Canada to segregate collections (absent a termination event), the McKesson Group and MIH had little apparent concern about McKesson Canada’s creditworthiness or financial situation. After all, the risk of collections not being passed through to a purchaser of receivables is one of the significant risks in a factoring transaction.

[ 100 ] The TDSI Report does not address MIH’s rights under the RSA to have the funds segregated and not commingled at any time there has been a termination event including a material adverse change.

Nor does it address whether the failure to segregate absent a termination event and the willingness to accept commingling risk in the RSA about termination is consistent with market practices in arm’s length negotiated agreements such as those involving securitizations or arm’s length servicers. [ 101 ] TDSI multiplies the 5.53% maximum historic set-off risk by the 5.25% non-investment grade borrower credit spread (adjusted for the DSO because credit spreads are expressed as an annual rate) to arrive at a fixed discount of 0.0244% for the accrued rebate dilutions discount for the entire term of the RSA.

There is no explanation offered for accepting a fixed approach. 4. Interest Discount [ 102 ] This aspect is dealt with in a single paragraph of the report.

It is not a risk- based assessment but reflects TDSI’s observations that “in addition to being compensated for the risks it is assuming, [MIH] must also cover its cost of capital out of the discount.” [ 103 ] TDSI then says that because MIH is “exceptionally thinly capitalized” [30] it is again appropriate to use non-investment grade bond market credit spreads as a proxy. [ 104 ] These statements may be correct from a profitable business transaction point of view, however TDSI does not address the possibility that the transaction exactly as structured could not be done profitably on arm’s lengths terms and conditions, or the fact that cost of funds/source of financing is an expense to a buyer that does not generally increase or decrease the value of a seller’s assets, or any other issues raised thereby. [ 105 ] TDSI was not made aware of MIH’s sources of financing, and was therefore unaware it also enjoyed a full guarantee and indemnity from its parent company in the McKesson Group. [ 106 ] The TDSI Report then goes on to add a five-year swap spread for non-investment grade bond (i.e. junk) issuers of 5.25% (as described above with respect to rebates) to the 30 day CDOR rate because of the five-year term of the agreement. [ 107 ] This non-investment grade/high yield/junk bond rate is thus factored into the discount pricing twice by TDSI, once to reflect McKesson Canada’s creditworthiness with respect to the maximum rebate exposure potential, and again to reflect MIH’s needed return to cover its cost of the full amount borrowed by it. [31] [ 108 ] TDSI does not explain why it uses five year pricing for funds needed by MIH in a monthly settled revolving facility with a DSO of about a month and which TDSI estimates (twice) in its report as perhaps as much as 180 day exposure (which includes a 90 day allowance to wind up). [ 109 ] As with the other components of the Discount Spread, the TDSI Report does not address the appropriateness of the Interest Discount credit spread being at a fixed rate throughout the five-year term. [32] [ 110 ] Overall, it appears clear that each of the four components of the Discount Spread have clearly been computed using the maximum numbers even arguably justifiable (not necessarily being, or clearly being, the maximums within a reasonable range), and then fixed each of those at those maxed out numbers for the entire five-year term without adjustment or recalculation on any basis even though there are dynamic monthly and annual components (some of which are very similar) and material adverse change or MAC rights elsewhere in the RSA agreements.

This lack of balance in favour of MIH is not expressly identified, and not discussed at all in the TDSI reports or evidence. 4. TDSI’s Supplemental Report on Servicing Fees [ 111 ] In April 2003, after the execution and implementation of the RSA and related transactions, TDSI was asked to report to McKesson

Canada, MIH and Blakes on whether the fixed monthly fee of $800,000 paid under the Servicing Agreement to administer and collect all the receivables in the pool was within the range of normal for this type of arrangement. [ 112 ] TDSI again begins by being clear that its expertise in this area is based upon TDSI’s experience arranging Canadian trade receivables securitization transactions, which are structured without a separate servicing fee being paid or negotiated and “accordingly, we do not have ready knowledge of comparable situations”. [ 113 ] The TDSI servicing report carries on: The level of the servicing fee must be assessed relative to the resources required to effectively service the portfolio.

The resource requirements will depend upon the size and composition of the receivables portfolio. [ 114 ] It then notes, however, that under the Servicing Agreement, McKesson Canada is paid a fixed fee each month regardless of the size of the portfolio. TDSI computes that the fixed annual fee at $9,600,000 works out to somewhat in excess of a 1% per annum fee on the $900,000,000 limit and somewhat in excess of a 2% fee on the then current $460,000,000 range pool.

TDSI’s investigations turned up servicing fees of 1% per annum recorded by Bell Canada in a $1,000,000,000 receivables securitization and 2% per annum by Telus in a $650,000,000 receivables securitization. TDSI notes that these receivables would involve primarily Telus and Bell’s retail customers’ phone bills. [33] [ 115 ] TDSI then looked at the Servicing Agreement fee as a function of the dollars to be collected and determined this was approximately 0.1% of the maximum eligible pool size of $900,000,000 and a 32 day DSO, and approximately 0.2% based on the receivables balance at closing.

TDSI’s investigations found only one U.S. transaction with relevant information disclosed publicly which reflected a servicing fee equal to 0.1% of collections. [ 116 ] Finally, TDSI contacted two large rating agencies with considerable involvement in rating securitization transactions. According to Moody’s, negotiated servicing fees between buyers and sellers are typically in the range of 1% to 2% of the average receivables balance. According to Standard & Poor’s, servicing fees are usually 1% per annum of the average receivables balance.

Note that both rating agencies describe it as a dynamic fee, based on average receivables balances during the year. [ 117 ] In its closing opinion, TDSI again notes it is unusual that the servicing fee is fixed. Based on the amount of receivables transferred at closing, TDSI concludes that the fee is somewhat higher than the few comparables. It is clear that by somewhat, TDSI meant up to 100%. [ 118 ] TDSI’s servicing opinion is dated April 25, 2003. The 2003 year under appeal ended in March 2003.

I assume from the TDSI Report and discussion that the size of the receivables pool did not increase materially between the mid-December 2002 initial closing and the end of the year under appeal in March 2003. 5.

The Law Subsection 247(2) of the Act provides as follows. ( 2) Transfer pricing adjustment -- Where a taxpayer or a partnership and a non-resident person with whom the taxpayer or the partnership, or a member of the partnership, does not deal at arm's length (or a partnership of which the non-resident person is a member) are participants in a transaction or a series of transactions and 2) Redressement -- Lorsqu'un contribuable ou une société de personnes et une personne non-résidente avec laquelle le contribuable ou la société de personnes, ou un associé de cette dernière, a une lien de dépendance, ou une société de personnes dont la personne non-résidente est une associé, prennent part à une opération ou à une série d’opérations et que, selon le cas :

(

a) the terms or 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, or

a) les modalités conclues ou imposées, relativement à l’opération ou à la série : (

b) the transaction or series

b) les faits suivants se vérifient relativement à l’opération ou à la série : (

i) would not have been entered into between persons dealing at arm's length, and (

i) elle n’aurait pas été conclue entre personnes sans lien de dépendance, (ii) can reasonably be considered not to have been entered into primarily for bona fide purposes other than to obtain a tax benefit, (ii) il est raisonnable de considérer qu’elle n’a pas été principalement conclue pour des objets véritables, si ce n’est l’obtention d’un avantage fiscal, any amounts that, but for this

section and

section 245, would be determined for the purposes of this Act in respect of the taxpayer or the partnership 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, Les montants qui, si ce n’était le présent

article et l’article 245, seraient déterminés pour l’application de la présente loi quant au contribuable ou la société de personnes pour une année d’imposition ou un exercice font l’objet d’un redressement de façon qu’ils correspondent à la valeur ou à la nature des montants qui auraient été déterminés si : (

c) where only paragraph (

a) applies, the terms and conditions made or imposed, in respect of the transaction or series, between the participants in the transaction or series had been those that would have been made between persons dealing at arm's length, or

c) dans le cas où seul l’alinéa a) s’applique, les modalités conclues ou imposées, relativement à l’opération ou à la série, entre les participants avaient été celles qui auraient été conclues entre personnes sans lien de dépendance ; (

d) where paragraph (

b) applies, the transaction or series entered into between the participants had been the transaction or series that would have been entered into between persons dealing at arm's length, under terms and conditions that would have been made between persons dealing at arm's length.

d) dans le cas où l’alinéa b) s’applique, l’opération ou la série conclue entre les participants avait été celle qui aurait été conclue entre personnes sans lien de dépendance, selon des modalités qui auraient été conclues entre de telle personnes. [ 119 ] The Minister’s reassessments rely upon paragraphs 247(2) (

a) and (

c) to make a transfer pricing adjustment in respect of the RSA.

These subparagraphs apply if a taxpayer (McKesson Canada) and a non-resident person with whom the taxpayer does not deal at arm’s length (MIH) are participants in a transaction [34] (each of the RSA and the Servicing Agreement) or a series of transactions (the RSA, the Servicing Agreement, and MIH’s loan agreement with its Irish indirect parent, the related guarantee thereof from MIH2 to the Irish company, and the related indemnity of MIH2 in favour of MIH regarding McKesson Canada’s obligations under the RSA), and the terms or conditions thereof differ from those that would have been made by arm’s length persons.

If the “terms and conditions” do so differ, then the “amounts” that would otherwise be used by the taxpayer for purposes of the Act shall be “adjusted” to the “quantum or nature” of the amounts that would have been determined had the “terms and conditions” been those that arm’s length parties would have agreed to. (

a) GlaxoSmithKline [ 120 ] The Supreme Court of Canada in GlaxoSmithKline had occasion to address the scope of the review of the relationships and circumstances that a Court is to undertake in a transfer pricing appeal: [35]

(1) A judge is to take into account all transactions, characteristics and circumstances that are relevant (including economically relevant) in determining whether the terms and conditions of the transactions or series in question differ from the terms and conditions to which arm’s length parties would have agreed.

(2) The transfer pricing provisions of the Act govern and are determinative, not any particular methodology or commentary from the OECD Guidelines, or any source other than the Act . I would add the observation that OECD Commentaries and Guidelines are written not only by persons who are not legislators, but in fact are the tax collection authorities of the world. Their thoughts should be considered accordingly. For tax administrators, it may make sense to identify transactions to be detected for further audit by the use of economists and their models, formulae and algorithms.

But none of that is ultimately determinative in an appeal to the Courts. The legal provisions of the Act govern and they do not mandate any such tests or approaches. The issue is to be determined through a fact finding and evaluation mission by the Court, as it is in any factually based issue on appeal, having regard to all of the evidence relating to the relevant facts and circumstances.

(3) Arm’s length prices are established having regards to the independent interests of each party to the transaction. In this appeal, this means that the RSA transactions must be looked at from both the perspectives of McKesson Canada and of MIH.

(4) Other arm’s length transactions can be relied upon as comparables in a transfer pricing analysis only if either there are no material differences that would affect pricing, or if reasonably accurate adjustments can be made to eliminate the effects of such differences.

(5) Quoting from GlaxoSmithKline : 61 As long as a transfer price is within what the court determines is a reasonable range, the requirements of the

section should be satisfied. If it is not, the court might select the point within a range it considers reasonable in the circumstances based on an average, median, mode, or other appropriate statistical measure, having regards to the evidence that the court found to be relevant. I repeat for emphasis that it is highly unlikely that any comparisons will yield identical circumstances and the Tax Court judge will be required to exercise his best informed judgment in establishing a satisfactory arm’s length price. (

b) Reasonableness [ 121 ] While GlaxoSmithKline involved the former subsection 69(2) transfer pricing rule, which was worded differently, I see no compelling reason to depart from the Supreme Court of Canada’s approach and comments in GlaxoSmithKline . While

section 247 does not use the words “reasonable in the circumstances” or “fair market value”, arm’s length persons should generally be assumed for purposes of

section 247 to act neither irrationally nor unreasonably having regard to all relevant circumstances. Similarly, arm’s length persons should generally be expected to transact for products and services at amounts within the range of their fair market value having regards to all relevant circumstances. This is not inconsistent with the wording of

section 247. (

c) Relevant Series of Transactions [ 122 ] The Supreme Court of Canada in Copthorne Holdings Ltd. v. The Queen , 2011 SCC 63 , mandates an expansive approach to the issue of series, given the inclusive nature of the meaning to be given to “series of transactions” in subsection 248(10). The starting point is the common law series in which each transaction in the series is pre-ordained to produce a final result.

Then, subsection 248(10) deems any related transaction completed in contemplation of a series to be part of that series. [36] [ 123 ] The determination of the existence of a series and its constituent transactions is a question of fact to be determined on a balance of probabilities. While only amounts under the RSA have been challenged, clearly the Servicing Agreement, MIH’s Loan Agreement, and MIH2’s guarantee and indemnity are also all part of a series of transactions that included the RSA.

In addition, their existence and terms also each meet the threshold of being relevant to a consideration of the RSA as described by the Supreme Court of Canada in GlaxoSmithKline . Each of these agreements are contemporaneous and interdependent in fact and in law. These agreements were needed to fund and to repay the RSA between McKesson Canada and MIH. They relate directly to the trade receivables of McKesson Canada’s business.

McKesson Canada may not be a party to each of these agreements, but they each expressly refer to the terms and conditions of the RSA, or the sale, servicing, or collections on those receivables, et cetera.

[ 124 ] Given that all of these transactions meet the threshold test of relevance in GlaxoSmithKline for purposes of considering the transfer pricing within the RSA itself, and given that the Crown has only challenged the amount of the discount used in the RSA, the Court does not need to rely further on the fact that these transactions together constitute a series of transactions for purposes of

section 247. (

d) Scope of Adjustments Permitted Under Paragraph 247(2)( c ) [ 125 ] A reassessment under subparagraphs 247(2)(

a) and (

c) does not permit a recharacterization of the transactions entered into by non- arm’s length parties, nor can another different transaction entirely be substituted therefor. This would only be permitted under subparagraphs 247(2) (

b) and (

d) which have not been pleaded and the Crown is not relying upon. A transfer pricing recharacterization is only permitted under those provisions if arm’s length parties would not have entered into the transaction chosen by the non-arm’s length parties even with different terms and conditions and amounts, and if the only bona fide primary purpose of the transaction was to obtain a tax benefit. [ 126 ] However, it is clear from the provisions of

section 247 that under subparagraphs (

a) and (

c) the Court is not limited to making adjustments with respect to the quantum of an amount in a term or condition that incorporates an amount. I do not accept the taxpayer’s submission that I am so limited. Paragraph 247(2) (

a) is triggered when terms or conditions differ from those terms and conditions that arm’s length parties would agree to. There is no such limiting restriction on the phrase terms and conditions. Paragraph 247(2)(

c) then mandates an adjustment to the quantum or nature of an amount used by the taxpayer for purposes of the Act to reflect the quantum or nature of that amount that would have been used had the “terms and conditions” conformed to what arm’s length parties would have agreed to. [ 127 ] Perhaps there is a point at which the extent of changes to the agreed non-arm’s length terms and conditions needed to reflect arm’s length terms and conditions in a transaction can constitute an effective recharacterization of the transaction only permitted to be affected under paragraph 247(2) (

d) and only in the circumstances described in paragraph 247(2)(

b) which provisions are not engaged in this appeal. Perhaps there also may be some terms and conditions in a transaction that are so fundamental that any particular change thereto could constitute in effect a recharacterization of the transaction. The Court does not need to venture anywhere close to that line in disposing of this appeal. That can be left for another day. In this case the Court is able to limit itself to a consideration of terms and conditions which it finds to not be on arm’s length terms and that directly relate to pricing. (

e) Factors that Exist Only because of the Non-Arm’s Length Relationship [ 128 ] Within a transfer pricing review, the question arises whether factors that exist only because of the non-arm’s length relationship are assumed away in the notional arm’s length analysis or remain relevant characteristics and circumstances. [ 129 ] This question may not arise to any extent in the context of a single purchase at a fixed price. The question does appear significant in the context of a long-term commitment to do things over a period of time.

For example, in transactions such as those involving the RSA, does the Court assume a notional arm’s length MIH would still enjoy the benefit of the Irish company loan supported by the MIH2 guarantee and indemnity? In looking at transactions like the RSA, does the Court assume the notional arm’s length MIH still has the power throughout the term of the notional arm’s length contract to change McKesson Canada’s name, sell McKesson Canada, or do something else in order to trigger a termination event at will?

Does the Court assume that the notional arm’s length purchaser still has the right to cause McKesson Canada to agree to change terms as they apply to future transactions under the agreement? Does the Court assume that the notional arm’s length MIH still has access to all of the financial information of McKesson Canada and information regarding its receivables portfolio and its entire business even though it may not be specified or required in the RSA? [ 130 ] This issue was addressed by Justice Pizzitelli in Alberta Printed Circuits v.

The Queen , 2011 TCC 232 : It is important to note that factors or circumstances that exist solely because of the non-arm’s length relationship of the parties should not be ignored, otherwise the reasonable businessman would not be standing entirely in the Appellant’s shoes … … In General Electric , the Federal Court of Appeal confirmed that no error of law was made in taking into consideration the Appellant in that case, as a sub of its larger parent company, stood in the position of having an implicit guarantee by its parent of its bank debts. [37]

[131] Based on this, all circumstances, including those that arise from, derive from or are rooted in the non-arm’s length relationshipshould be taken into account. [132] I think the better view is therefore that the Court can and should consider notional continued control type rights in appropriatecircumstances when looking at term or executory contract rights. Not to do so would be to not look at all of the relevant characteristicsand circumstances of the relationships.

If these were to be ignored by a Court, companies within wholly controlled corporate groupscould enter into skeletal agreements conferring few rights and obligations to the non-resident participant, (such as financial informationdisclosure, use of funds, financial covenants et cetera), all with the view to obtaining a more favourable transfer price to reduce Canadiantaxes. Not approaching this issue this way would seem entirely inconsistent with this Court and the Federal Court of Appeal in G.E.Capital having focused on implicit unwritten, unenforceable guarantees of the parent company of the borrower.

However, in this case, Ido not need to do so in order to fully dispose of the appeal with respect to the proper transfer pricing adjustment, as detailed below. Thistoo can be left for another day. (

f) The Rule in Browne v. Dunn and Opinions Within a Witness’ Expertise [133] The rule in Browne v. Dunn, (1893), 1893 CanLII 65 (FOREP), 6 R. 67 (H.L.) generally requires counsel to give notice to thosewitnesses that the cross-examiner intends later to impeach. This allows the witness the opportunity to explain, and reflects a sense of fairplay and fair dealing with the witness and his or her evidence. [134] In response to an objection by Appellant’s counsel, the Court had to rule in the course of the hearing on the applicability of therule in Browne v.

Dunn to the opinion and supporting evidence of the Appellant’s experts in respect of which the testimony of one of theRespondent’s experts expressed different views. The Court again had to rule on the same issue in response to a further objection byAppellant’s counsel as it related to one of the Respondent’s experts having different views from the TDSI Report and Ms. Hooper’stestimony regarding her opinion and her reasoning expressed therein. In both cases the Court denied the Appellant’s objection to theevidence of the Respondent’s expert. [135]

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