Marzen Artistic Aluminum Ltd. v. The Queen

Marzen Artistic Aluminum Ltd. v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2014-06-10
Neutral citation
2014 TCC 194
File numbers
2010-860(IT)G
Judges and Taxing Officers
Georgette Anne Sheridan
Subjects
Income Tax Act
Decision Content
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 10th 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
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”; under 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