Alberta Printed Circuits Ltd. v. The Queen

Alberta Printed Circuits Ltd. v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2011-04-29
Neutral citation
2011 TCC 232
File numbers
2008-714(IT)G
Judges and Taxing Officers
Frank J. Pizzitelli
Subjects
Income Tax Act
Decision Content
Docket: 2008-714(IT)G
BETWEEN:
ALBERTA PRINTED CIRCUITS LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
Appeal heard on February 7, 8, 9, 10, 11, 14, 15, 16 and 17, 2011,
at Calgary, Alberta.
Before: The Honourable Justice F.J. Pizzitelli
Appearances:
Counsel for the Appellant:
R. Paul Jacobson, Q.C.,
Shaun T. MacIsaac and
Elsy D. Gagné
Counsel for the Respondent:
William L. Softley and
Margaret A. Irving
___________________________________________________________________
JUDGMENT
The appeals from the reassessments made under the Income Tax Act (the “Act”) for the Appellant’s 1999, 2000 and 2001 taxation years are allowed, and the reassessments are referred back to the Minister of National Revenue for reconsideration and reassessment on the following bases:
1. There shall only be the following transfer price adjustments added to the Appellant’s income:
1) for the 1999 taxation year - $242,625.13,
2) for the 2000 taxation year - $344.821.92, and
3) for the 2001 taxation year - $293,121.88,
for a total of $880,568.93.
2. The penalties on such adjusted amounts shall be calculated in accordance with the provisions of subsection 247(3) of the Act.
3. The parties shall have 14 days either to advise the Court that they have reached a settlement as to the issue of costs in this matter or to submit to the Court their written representations with respect to costs.
Signed at Ottawa, Canada, this 29th day of April 2011.
“F.J. Pizzitelli”
Pizzitelli J.
Citation: 2011 TCC 232
Date: 20110429
Docket: 2008-714(IT)G
BETWEEN:
ALBERTA PRINTED CIRCUITS LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Pizzitelli J.
[1] This is the appeal of Alberta Printed Circuits Ltd. (the “Appellant”) from the reassessments made by the Minister of National Revenue (the “Minister”) under the Income Tax Act (the “Act”) for the Appellant’s 1999, 2000, and 2001 taxation years.[1] By Notice of Reassessment dated September 16, 2005, the Minister reassessed the Appellant for its 1999 taxation year on the basis that the Appellant had overpaid a non-resident corporation, APCI, Inc. (“APCI”), by the amount of $1,066,073, and added that amount to the Appellant’s income pursuant to paragraph 247(2)(a) of the Act. By Notices of Reassessment dated May 18, 2006, the Minister reassessed the Appellant for its 2000 and 2001 taxation years, also on the basis of overpayment to APCI and added the amounts of $1,065,727 and $1,422,775 to the Appellant’s income for those years respectively. The Appellant further appeals the Minister’s assessment pursuant to subsection 247(3) of the Act of penalties totalling $106,572 for 2000 and $142,278 for 2001.
The Issues
[2] There are four issues to be decided in this matter:
(1) Whether the reassessments were statute-barred by the application of the limitation period described in Article IX(3) and Article XXVII(3) of the Agreement Between Canada and Barbados for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion With Respect to Taxes on Income and on Capital (the “Treaty”),[2] or whether the limitation period determined by subparagraph 152(4)(b)(iii) of the Act applies;
(2) Whether the Appellant was dealing with ACPI at arm’s length;
(3) Whether the Minister was correct and acting in accordance with paragraph 247(2)(a) of the Act in including the amounts of $894,263, $1,065,727, and $1,422,775, in the Appellant’s income for its 1999, 2000, and 2001 taxation years, respectively; and
(4) Whether the subsection 247(3) penalties were properly assessed.
[3] It should be noted that, although the reassessed amount for the 1999 taxation year was $1,066,273, the Respondent conceded it should only have been $894,263, effectively granting the Appellant the reduction to match its internal economist’s calculations.
[4] It was also conceded by both parties that, notwithstanding references to the deductibility of the reassessed adjustments in the pleadings, the issue of the deductibility of such amounts pursuant to paragraph 18(1)(a) of the Act was no longer relevant as the Act’s transfer pricing provisions now work so as to only adjust income.
[5] The Respondent also conceded that, for the purposes of determining whether the parties were at arm’s length (issue (2) above), the Appellant and APCI, a Barbados corporation, were not de jure controlled by the same group of people and that the only issue in this regard is whether, as a question of fact, they, as persons not related, were dealing at arm’s length or not.
[6] Finally, it should be noted that there is no dispute between the parties as to the calculation of penalties pursuant to the formula in subsection 247(3) of the Act, if it is in fact determined that there is to be a transfer pricing adjustment pursuant to subsection 247(2) of the Act. The parties accept that such penalties would apply as a consequence of that first provision.
The Background
[7] At the beginning of the trial, the parties submitted a Statement of Agreed Facts, which, together with the evidence submitted during the trial, generally indicates that the relevant facts to consider in this matter are as set out below.
The Canadian Business
[8] By way of background, the Appellant began its operations in 1984, manufacturing custom prototype circuit boards in Calgary using a then new “serial” manufacturing process developed by Wayne Bamber that allowed the company to provide circuit board designers with samples of their design in very low quantities – with a minimum order being only two pieces. This allowed the Appellant to provide designers with prototype circuit boards at a price cheaper than its competitors, who were then using a different system that required the production of more pieces than designers would need to prove their design, resulting in higher costs. The manufacture of prototypes allowed circuit board designers to ensure their designs were sound before proceeding to mass production. The Appellant’s founders and original owners, Wayne and Geraldine Bamber, were joined by Daniel McMuldroch in the late 1980s.
[9] Very simply put, the production of custom circuit boards involves the receipt of customer data, its preparation for use in manufacturing (called “set up”), and the manufacture of the board itself. At the time Wayne Bamber developed his “serial” manufacturing process, and until well into the 1980s, the set-up process used in custom circuit board production was entirely manual. When customer data was received a staff member would produce a two-dimensional mock-up for a local photo lab, which would then create a film negative using the mock-up; the negative was then returned to the company and used to manufacture a physical circuit board by applying layers of different products. This process was later automated by the use of computers, with drafting software and electronic manufacturing machinery eliminating the need for photo negatives entirely.
[10] The Appellant is a Canadian-controlled private corporation. Its fiscal year end is January 31. In 1996, the Appellant’s shares were owned 25 percent by Daniel McMuldroch and 75 percent by Bamber Electronics Ltd. (“BE Ltd.”). BE Ltd.’s shares were owned by Wayne Bamber (60%) and his wife, Geraldine Bamber (40%). In 1996, these three individuals were the directors of the Appellant.
[11] Mr. McMuldroch first came into contact with the Appellant in 1984 or 1985 when he contracted with the Appellant for the manufacture of circuit boards as a customer. He testified that he worked part-time for the Appellant in 1989 in network administration, web development, and software development. He began to work for the Appellant in full-time employment in 1989, becoming involved with all aspects of the business, including learning the manufacturing processes and working on the development of a bulletin board system to send and receive data to and from clients and of the “set up” system, which, as stated above, was initially a manual one.
[12] Mr. McMuldroch stated that he first became a 25% shareholder of the Appellant in 1987, despite his evidence that he did not start working for it full‑time until 1989. In 1996, before leaving to reside in Barbados, he continued to own 25% of the Appellant and was involved primarily in software design, web design, and the set-up function.
Set-up and Organization of the Barbados Company
[13] In 1995, Mr. McMuldroch attended a seminar about doing business in Barbados. He and the Bambers were concerned about asset protection and contemplated moving the manufacturing of the circuit boards outside of Canada due to the high-risk nature of their business.
[14] Instead, after negotiation between the Bambers and Mr. McMuldroch, it was decided that the “set up” operations ‑ which I will describe in more detail later ‑ would move to Barbados and be carried on by a Barbados corporation.
[15] Both Mr. Bamber and Mr. McMuldroch acknowledged that they were aware of the tax benefits of operating in Barbados and that their team of accountants and lawyers had considered this when weighing their planning options. However, the evidence of Mr. Bamber was that he was not to be involved as a shareholder, director or officer of the Barbados company and that this venture was something Mr. McMuldroch wanted to do on his own, in hopes of developing the software further and selling it to other customers. Mr. McMuldroch testified that one of the benefits of the move for the Appellant was that it would allow the Appellant to focus on its manufacturing strengths.
[16] At Mr. McMuldroch’s request, Mrs. Bamber visited Barbados in October of 1996 in order to find a location for the new business and set up a Barbados corporation and bank account.
[17] Mr. McMuldroch provided her with $10,000 to apply towards the initiation of the company’s incorporation and as a deposit on a lease. The Appellant also provided her with a $1,000 advance for the trip; the evidence is that her hotel, meal, taxi, and film expenses, totalling $1,399 (inclusive of the above-mentioned $1,000 advance), were paid by the Appellant.
[18] On November 17, 1996, APCI was incorporated in Barbados. APCI is a Barbados International Business Company incorporated under the Barbados Companies Act,[3] and is entitled to a special tax benefit under the Barbados International Business Companies (Exemption From Income Tax) Act (the “IBC Exemption from Income Tax Act”).[4] Its fiscal year-end is December 31.
[19] Mr. McMuldroch admits the Barbados corporation was incorporated with him as its sole director, president and chief executive officer (“CEO”). Mr. McMuldroch also admitted under cross-examination that, in the application for incorporation, the APCI, Inc. name was the first choice of the parties because the letter APCI were the initials of the “sister” company, which Mr. McMuldroch confirmed meant the Appellant. There is also evidence in Mr. McMuldroch’s application for a work visa in Barbados that he was to be the CEO, that he was then the vice-president of the Appellant (described as a “related company”), that the job required a specialist who was previously employed by the “parent company”, and that he had specialized training received and experience acquired in the employ of APCI’s “affiliated company”. This document contained a declaration sworn by Mr. McMuldroch. He confirmed under cross-examination that references to the parent company, related company, and affiliated company all meant the Appellant. In the declaration, he also confirmed that he was to be supervised by the board of directors of APCI, but that their supervision would be “consultive and infrequent”.
[20] Mr. McMuldroch obtained loan advances of approximately $140,000 from the Appellant against his expected bonus of approximately $220,000 for 1996. He testified that he repaid it mainly by application of the after-tax bonus amount of $120,381.80 against the loan, as evidenced by the accounting ledger, and the offset of other funds owed to him against it. The evidence is that he used these funds to purchase equipment and goods for APCI, as well as to provide Mrs. Bamber with the $10,000 for use on her above-mentioned trip to Barbados.
[21] On December 31, 1996, Mr. McMuldroch resigned as a director of the Appellant. BE Ltd. purchased the shares of Mr. McMuldroch in the Appellant on December 31, 1996, for a $500,000 promissory note. This note was repayable over 20 years, with principal instalments of $25,000 per year commencing on December 31, 1997, and ending December 31, 2017, with interest, but which was repaid in full by May 26, 1999, with interest, as per the accounting ledger of the Appellant and as confirmed by Mr. McMuldroch and Mrs. Bamber. There was evidence of the actual payment cheques issued by BE Ltd. to Mr. McMuldroch for those payments and I am satisfied that he was paid in full for those shares.
[22] Both Mr. and Mrs. Bamber and Mr. McMuldroch testified that they had an agreement to split the profits of the Barbados Company on the basis that two‑thirds would go to the Bambers and one-third would go to Mr. McMuldroch, or to their respective families.
Off-shore Tax Planning Sidebar
[23] There is strong documentary evidence, confirmed by Mr. McMuldroch and both Gerry Bamber and Wayne Bamber, that the Bambers and Mr. McMuldroch, in consultation with their accountants and lawyers, considered off-shore planning and initially contemplated the creation of a Barbados tax‑exempt corporation. Further, this corporation was to be owned by a Guernsey, Channel Islands, corporation by the name of Ludex, which was actually incorporated on December 2, 1997, and which, in turn, would be owned by two discretionary trusts for which deeds of settlement were executed: one named the Excelon Settlement, the other named the Leduc Settlement, and one holding a one-third interest on behalf of the McMuldroch family, the other a two-thirds interest on behalf of the Bamber family, as confirmed by their oral evidence.
[24] By a fax dated February 3, 1998, the above-mentioned Canadian accountants wrote to their Channel Islands affiliates and advised that, due to changes in Canadian tax law, the above structure was to be dismantled. Mr. McMuldroch confirmed that this trust approach was abandoned in favour of using “Morville”, as he put it, and Mrs. Bamber confirmed this end to the trust approach as well.
[25] In the organizational resolutions of APCI which was incorporated on November 17, 1996, Mr. McMuldroch, as the sole director, approved the issuance of 100 fully paid common shares to Morville Ltd. (“Morville”), located in Guernsey in the Channel Islands. Morville was only registered on May 20, 1998. Mr. McMuldroch explained that there were delays in setting up the insurance policies, which are referred to later as the “individual plans”. These plans were to ultimately own Morville’s shares and were the reason a correcting resolution was passed, backdated to November 8, 1996, changing the name of the sole shareholder from Morville to Mr. McMuldroch, as per instructions given by Mr. McMuldroch to the corporate secretary, PriceWaterhouseCoopers, on May 13, 1999, prior to his returning to Calgary. As confirmed by Mr. McMuldroch and the Bambers in their testimony, the need to abandon the initial trust approach to the off-shore planning in February 1998 was the reason for the further delays in finalizing the ownership structure of APCI.
[26] On May 1, 1998, Mr. McMuldroch transferred his shares in APCI to Morville. Three months later the shareholder’s register of Morville showed that these shares were owned by Nordben Life and Pension Insurance Company Ltd. as follows: 19 shares for Plan A/C-IP00923 and 9 shares for Plan A/C‑IP00919. These shareholdings were confirmed in annual returns filed by Morville in Guernsey in January of 1999 and 2000. The returns demonstrated that the nominees of the two Plans held one share initially and must have transferred it to the Plans, as the latest returns show Plan A/C-IP00923 as having 20 shares and Plan A/C-IP00919 as having 10 shares, all of which is consistent with the 2 to 1 ratio the Bambers and Mr. McMuldroch agreed was the ratio of the profits of APCI they were respectively entitled to. The evidence disclosed that A/C‑IP00919 referred to an insurance plan pursuant to which Mr. McMuldroch had the power to appoint designated beneficiaries, and those he designated were his father, his father’s spouse and their children and remoter issue, as well as his father-in-law and father-in-law’s spouse and their children and remoter issue; in effect, it was an individual plan for the benefit of Mr. McMuldroch’s family and he had control over who the designated beneficiaries would be. Likewise, A/C‑IP00923 referred to an insurance plan that gave Wayne Bamber the right to appoint designated beneficiaries, and those he designated were his father, his father-in-law and their respective spouses and children and remoter issue; it was in effect a plan for the benefit of his family. Mrs. Bamber also confirmed in her testimony that the Plans were for the benefit of the families of Mr. McMuldroch and the Bambers, although she stated that to date the Bambers have received no benefit from their Plan. Mr. Bamber nevertheless acknowledged under cross‑examination that the Plans, as they read, clearly allow the designated beneficiaries to cash in some of the Plan units if they wish; however, he stated that his contact had told him that this was not allowed. In fact, under an endorsement to the Plans, it was in fact their investment manager who had the right to cash in the Plans. Notwithstanding that the terms of the individual plan permit cashing in, Mr. Bamber acknowledged that any investments in the Bamber Plan were for the benefit of his family, which is also clear from the Plans themselves.
[27] Mr. McMuldroch confirmed on cross-examination that APCI transferred by wire transfer the sum of $1,000,000 from its Barbados account to Morville’s account to be applied to the purchase and creation of the above-mentioned individual plans comprising the life insurance and investment components, two‑thirds for the benefit of the Bamber Plan and one-third for the benefit of his own family Plan. Documentary evidence also showed that each of the Plans had appointed an investment manager, Spread International Investment Limited, and that affiliates of this manager, Spread Services Limited and Co-Sign Services Limited, acted as directors of Morville. Mr. McMuldroch testified that Wayne Bamber had requested confirmation that this money was sent. As mentioned earlier, Mr. McMuldroch testified that it was the delay in funding the Plans and setting them up that caused the confusion in the initial shareholdings of APCI, which started off with Morville even before its incorporation, being shown as the shareholder, but Morville was corrected to read Mr. McMuldroch which was then changed back to Morville in May 1998 after the incorporation of that entity on May 20, 1998, all after the creation of the two Plans, both issued on April 21, 1998.
[28] It is an agreed fact that between August 13, 1998 and December 22, 2000, APCI paid dividends of $4,283,573 to Morville.
Moving the Set-up Operations to Barbados
[29] Based on passport stamps, Mr. McMuldroch was in Barbados from December 2 until December 23, 1996, to install computers and software and to ready the facility for operation. Brandi Lewinske, previously employed by the Appellant in its set-up department, arrived December 19 and immediately commenced full-time employment with APCI.
[30] The only other staff member the Appellant had in its set-up division at the time was Mr. David Wu. Mr. Wu was the newest member of the division. He had less experience and was incapable of performing all of the set-ups required by the Appellant on a daily basis as well as performing his main duties of collecting data from the email attachments sent by clients. As mentioned above, a manual process was used in 1997 before it was replaced by a new, electronic data collection system developed by Mr. McMuldroch.
[31] After the departure of the set-up division to Barbados, Mr. Wu remained responsible for checking to ensure all data was present in each file before it was transmitted to Barbados. The evidence is that he also checked the set-up, once the completed file was transmitted from Barbados to the Appellant, to ensure there were no obvious errors and to check that the file had not been corrupted during transmission.
[32] The only other party who performed technology services for the Appellant was Clifford Johnson, who was hired on contract, and later as an employee of the Appellant, to develop a program for regulating the movement of circuit boards through the process line, i.e., the manufacturing process, to maintain the Appellant’s internal network, and to provide technical support to customers experiencing difficulties with the Appellant’s data collection systems.
[33] Mr. McMuldroch returned to Calgary on December 23, 1996, to take care of outstanding personal issues, including listing his home for sale, but worked evenings and weekends, while in Calgary, completing set-up functions for the Appellant on behalf of APCI before going back to Barbados.
[34] On January 24, 1997, before departing for Barbados, Mr. McMuldroch caused APCI to purchase any copyrights that Clifford Johnson had in the new printed circuit computer programs that Mr. Johnson had helped develop under Mr. McMuldroch’s direction while under contract with the Appellant. A fee of $500 was paid in order to ensure that Mr. Johnson would not lay claim to any proprietary rights and impede the sale of such software systems in the future. No consideration was paid to the Appellant for any rights it may have had therein.
[35] In January 1997, Mr. McMuldroch severed his ties with Canada, became a resident of Barbados, and took over the management of APCI. At this time Mr. McMuldroch was the sole director of APCI.
[36] It is clear from the evidence that, following the move to Barbados, Mr. Bamber was in charge of the manufacturing and chemical processes, Mrs. Bamber was the bookkeeper and in charge of administration, and Mr. McMuldroch focused on software development and data systems as well as the set-up process, that is, the pre-manufacturing stage, and the development of the Appellant’s world website. All parties testified consistently that, after Mr. McMuldroch’s departure to Barbados, there was no one left in Calgary that could perform set-ups for the Appellant, and that they were dependent on APCI during those years for set-ups. In fact, as the Respondent brought to the Court’s attention, the January 31, 1999 financial statements of the Appellant contained an accountant’s note that reads:
7. ECONOMIC DEPENDENCE
The company is dependent upon one of its suppliers for a key component in its production process. Without this supplier, the company would be unable to meet its production schedule.
[37] Although it is not clear in the context of the note which supplier is referred to, Mr. Bamber confirmed in cross-examination that this was a reference to APCI.
[38] The Respondent, on cross-examination of Mrs. Bamber, produced a list of employees of the Appellant after the move to Barbados and submitted that they could have also done the set-up work. Mrs. Bamber’s testimony was that they could not have, as they were only capable of doing housekeeping work on data, i.e., inputting and collecting. All of the Appellant’s witnesses were consistent on this point and credible. The Respondent disagrees with them.
[39] Mr. McMuldroch returned to Barbados on February 2, 1997, and started recruiting staff from the local population. APCI had to purchase as many as ten Lavenir software licenses at one time, Lavenir being the other set-up software used in the set-up operations and which allowed staff to work using an electronically displayed, visual circuit board.
[40] Recruiting proved difficult in Barbados, particularly when it came to finding employees with sufficient computer skills, and APCI went through a half‑dozen people in the process, selecting potential employees and restarting training every time. The evidence is that it took six months of training before Mr. McMuldroch could have confidence in what the employee was doing, and another six months for the employee to work at the required speed.
Functions Performed by APCI
[41] APCI and the Appellant entered into four annual contracts setting out APCI’s role and its compensation. The evidence is that these contracts were prepared by Mr. McMuldroch on APCI letterhead and that only two were signed by Wayne Bamber, although Mr. Bamber later testified that he recalled signing all of the contracts. There is no dispute they were used by the parties for determining fees charged and paid. Their interpretation is the source of great dispute between the parties, a matter which I will discuss shortly.
[42] The contracts were described as being structured in three parts, dealing generally with developing, supplying, and maintaining the database systems software (Part 1), providing set-up functions to replace the Appellant’s set-up department (Part 2), and developing and maintaining the website of the Appellant (Part 3). Mr. McMuldroch stated that the part of the contracts setting out the role of APCI (Part 1) was a “wish-list”, in which the Appellant laid out what it wanted the systems and processes to be in the future.
[43] The Appellant testified that before the Barbados era, the Lavenir software used was basic and did not allow for multiple versions of circuit boards to be placed on a single panel, the website was not interactive and hence did not allow customers to complete an order form with its required data online, and the different software systems did not communicate with each other, resulting in excess data inputting.
[44] After the Barbados corporation was founded, APCI received customer data on APCI servers via communications with the Appellant’s server in Calgary by means of the software developed by Mr. McMuldroch. It was through such software that Calgary initially obtained data by electronic means, such as email and, later, an interactive website. The software was developed by Mr. McMuldroch by 1998. At first, it opened customer files, but was further developed to include the automation of set-up steps. Mr. McMuldroch also made improvements to the billing systems and the main database software that interacted with the Lavenir visual computer software improvements that permitted the placement of multiple circuit boards on each panel, instead of using manually produced, layered panels as was the case with the old system. In general, the improvements to the processes reduced data input times through synchronization of information and revolutionized the manufacturing process from a 7 to 10 day timetable, to 24 hours, leading to a radical reduction in the number of panels used per project and large cost savings.
[45] The set-up process involved the functions of validation, formatting, and panelizing using the Lavenir software, for which APCI staff worked on visual circuit boards using computers.
[46] Validation, sometimes referred to as verification, involved checking the data received from Calgary to ensure it was properly formatted as imperial or metric and properly sized, which required a check of decimal points. If anomalies were found, APCI would deal directly with the Appellant’s customers’ engineers and a decision would be made as to who would correct these anomalies. Anomalies included diagonal lines appearing on-screen that had to be removed, a lack of drilled holes where such were required, dangling trace lines, i.e., lines not hooked up, or traces improperly joined together.
[47] Formatting was required for all designs and involved drill dynamics (i.e., setting up drill-hole sizes and assigning the drill sizes used by Calgary to virtual view) and “commonizing” (i.e., ensuring all designs had standard numerical data) as well as the drawing of cutlines for the cutting out of panels.
[48] Panelizing involved the creation of virtual panels, maximizing space usage, as well as the optimization of the drilling sequence to minimize passes across the panel – i.e., by using an S-curve pattern – for each hole required of a given size.
[49] The Appellant continued to provide invoicing for both the set-up functions and the actual manufacturing of the circuit boards, shipped the circuit boards directly to its customers, and did not require ACPI to perform any accounting, billing, shipping or collection functions.
Fees paid to APCI
[50] The Appellant’s witnesses testified that the annual contracts allocated compensation for set-up based on the type of set-up, described as either Protocol 1 (P1) or Protocol 2 (P2), and provided for a square inch fee (or bonus) to compensate for the non-set-up part of the contract, namely Parts 1 and 3 as described above. The Respondent takes the position that the square inch fees were at least partly for the set-up functions performed as well; this is obviously the main dispute between the parties, although the Respondent initially took the position that the square inch fees were also entirely for set-up. The charges were negotiated each year and the contracts show that the bonus/square inch charge was reduced each year through negotiations with Wayne Bamber, due to the decreasing role of APCI after the return of Mr. McMuldroch to Calgary in June 1999 and the fact that APCI did not have personnel with sufficient expertise to fully assist the Appellant’s customers, as well as the fact that the website was substantially completed by late 1998. In addition, Mr. Bamber also testified that the fee was reduced from $0.35 to $0.2285 in the 1998 contract because he simply looked at the number and decided it was too much to pay.
[51] The Appellant was APCI’s only customer. APCI’s only source of revenue was the amounts paid by the Appellant as its customer and any interest APCI obtained from investing this revenue in term deposit certificates.
[52] In the annual contracts, the total fees charged for the P1, or Protocol One, panels, which constituted 99% of sales, were stated as follows:*
Contract Term P1 Set-up Fee Fee per Total Square Inch
Square-Inch Fee Paid
Feb 1/97 – Jan 31/98 $60 $0.35 $300,000.00
Feb 1/98 – Jan 31/99 $60
$0.2285
$322,625.13
Feb 1/99 – Jan 31/00 $67
$0.2285
$304,003.35**
Feb 1/00 – Jan 31/01 $67 $0.1143
$293,121.88***
*It should be noted at this time that the manner in which the fees were presented in the annual contracts is a source of dispute between the parties with regard to whether the set-up fees included part of the square inch fees or not. The set-up fee and square inch fee are juxtaposed in the first three contracts and are not in the final contract. This will be discussed later.
**$50,000 was deducted for Mr. McMuldroch’s services that were provided to APCI while he was in the employ of the Appellant, as well as to take into account APCI’s not having staff with sufficient expertise to service the Appellant’s customers. The net figure was reflected as $344,821.92 in the Appellant’s financial statements due to differences in currency conversion rates for reporting purposes.
*** The actual payment of $196,789.79 was calculated on a bumped-up per-square-inch fee of $0.13681948 and was paid in U.S. dollars. The explanation offered at trial was that since APCI was not paid for set‑ups for the month of December 2000, the bump-up was necessary to take into account those services.
[53] The evidence as to the payment of the base set-up fees during the years in question is substantial and well-informed. Mrs. Bamber, as the bookkeeper for the Appellant, testified in an orderly and very credible manner, substantiating her oral evidence with the volumes of invoice listings in specific ledger accounts, as well as monthly sales reports identifying set-up costs and extras, which included extra drills, mask applications, and mask plots, with all totals summarized below. The following base set-up charges were charged to the Appellant’s Canadian and American customers, who were directly invoiced on a transactional basis, before, during and after the business relationship with APCI:
Fiscal Period Set-Up Fee for P1 Set-up Fee for P2
CDN US CDN US
Feb 1/96 – Jan 31/97 60 48 300 240
Feb 1/97 – Jan 31/98 60 48 300 240
Feb 1/98 – Jan 31/99 60 48* 300 240*
Feb 1/99 – Jan 31/00 67 46 335 230
Feb 1/00 – Jan 31/01 67 46 335 230
Feb 1/01 – Jan 31/02 67 46 335 230
Feb 1/02 – Jan 31/03 67 46 335 230
Feb 1/03 – Jan 31/04 67 46 335 230
Feb 1/04 – Jan 31/05 67** 46 335** 230
*Reduced to $46 for P1 and $230 for P2 due to currency fluctuations
**Reduced to $60 for P1 and $300 for P2 in October 2004 due to currency fluctuations
[54] It should be noted that while the above rates were consistent with the rates published on the Appellant’s website, as Mrs. Bamber testified, many of the invoices show discounts for customers purchasing a P2 set-up, or discounts as a result of reorders where films could be reused for cost savings in the set-up steps. P2 set-ups only accounted for about 1% of sales.
[55] With respect to the base set-up fees charged by APCI to the Appellant, the evidence is that there was no mark-up charged by the Appellant to its customers on the fees it paid to APCI. In other words, the fees paid to APCI were the same as those charged by the Appellant to its customers, which were consistent with the level of fees charged by the Appellant to its customers pre‑APCI and post‑APCI. Accordingly, for the 1999, 2000, and 2001 taxation years in dispute, the set-up fees charged by APCI to the Appellant were identical to those charged by the Appellant to its customers in the same period (see the above table, fiscal periods Feb 1/97–Jan 31/98, Feb 1/98–Jan 31/99, and Feb 1/99-Jan 31/00).
[56] The total amounts paid by the Appellant to APCI during those periods are summarized as follows:
Year Set-Up Fees Paid Square Inch Fees Paid Total Fees Paid*
Including Extras
1999 1,054,572.13 322,625.13 1,377,197.26
2000 1,223,576.30 344,821.92 1,568,398.22
2001 1,124,572.46 293,121.88 1,417,694.34
Total 3,402,720.89
960,568.93 4,363,289.82
*It should be noted that these fees are net of the deductions from the square inch fees taken by the Appellant in 2000, and are adjusted for the average currency exchange rates used by the accountants in the preparation of their financial statements. In other words, these figures are the ones reflected in the financial records and tax returns of the Appellant.
[57] There is no dispute that the square inch fees were only calculated and paid by the Appellant to APCI at the end of each contract year, which coincided with the Appellant’s fiscal year.
[58] There is also no dispute that the Appellant paid APCI the total amounts of $1,802,802, $2,046,227, and $2,447,071 in Barbados currency in 1998, 1999, and 2000, respectively, as taken from the Statement of Agreed Facts; however, neither party provided evidence regarding the conversion of Barbados currency numbers into Canadian dollars and, accordingly, the Canadian figures above proven should be used, as the Appellant has proven they were the figures reflected in the preparation of its financial statements and tax returns.
[59] Nevertheless, those totals clearly demonstrate that revenue of the Appellant increased dramatically during the taxation years in question. The volume of data processed and utilized also tripled during this time.
Return to Canada
[60] The evidence ‑ from correspondence between Mr. McMuldroch and Wayne Bamber starting May 21, 1998 ‑ is that negotiations ensued following Mr. McMuldroch’s decision to return to Canada, and the Appellant agreed to purchase the software and goodwill (or non-competition) of APCI in order to obtain control of the set-up software and ensure that it was not sold to its competitors. Initial asking prices started at $1 million, with the final purchase price being $50,000, plus $85,000 for goodwill or non-competition, under an agreement between APCI and the Appellant, executed on May 24, 1999, pursuant to which APCI granted the Appellant an option to purchase APCI’s assets. The Appellant exercised this option on December 5, 2000. Although the correspondence suggests that Mr. McMuldroch was negotiating on behalf of Morville, the owner of APCI, he admitted that, as he would ultimately receive 1/3 of the proceeds, he was really just trying to maximize his return and was not negotiating under the authority of Morville but was merely posturing in order to obtain a higher return. It was clear during the negotiations that Mr. Bamber felt he could develop the software himself in Canada, but he wanted control of that version of the software as he had no one to do set-up for him at the end of 1998. There is a serious credibility issue with respect to these so called negotiations, as the evidence clearly establishes that the ultimate beneficiaries of any profit or payouts from APCI were the Bamber and McMuldroch families through the individual Plans’ ownership of Morville. The purchase of APCI’s assets was completed on December 20, 2000.
[61] Mr. McMuldroch returned to Calgary in 1999 and rejoined the Appellant. The decision was made to wind down APCI by the end of 2000 due to the difficulties and frustration involved in operating in Barbados as a result of the problems with maintaining and training staff and the poorer technological environment generally, as well as due to Mrs. McMuldroch’s health issues.
[62] Mr. McMuldroch resigned as a director of APCI on June 12, 1999, and on that same date Morville accepted his resignation and appointed Brandi R. Lewinske and itself to be its directors. The evidence is that there was no one in Calgary who could perform the set-up function, other than Mr. McMuldroch, at the time of his return and, accordingly, the set-up contract was continued with APCI in order to allow Mr. McMuldroch time to hire and train Canadian staff in Calgary to take over that function once again. The evidence is that APCI did not perform set-up functions after 2000.
[63] The evidence was also that Mrs. Bamber caused BE Ltd. to issue a cheque as a deposit on a house being built for Mr. McMuldroch on his return to Calgary, which, she testified, he repaid.
Other Relevant Facts
[64] During the audit stages, a functional analysis was prepared as a collaboration between the Appellant and APCI (the “Functional Analysis”), with Mr. McMuldroch agreeing that he and Geraldine Bamber were the co-authors. Mr. McMuldroch further admitted he wrote Appendix A to the Functional Analysis, which was a description of the set-up function. Mrs. Bamber confirmed this and stated that Mr. McMuldroch was the one with the set-up knowledge, and thus was obviously more involved with that part of the analysis.
[65] The evidence, as supported by the financial statements of APCI, also shows that that entity paid tax to the Barbados Government at a rate of 2.5% of its income as a Barbados International Business Corporation. The tax amounts totalled $19,014 for its fiscal year ending December 31, 1997, $31,582 for its fiscal year ending December 31, 1998, $38,195 for its fiscal year ending December 31, 1999, and $53,740 for its fiscal year ending December 31, 2000. There is no evidence as to amounts paid for its 2001 fiscal year. The nature of this “tax” will be discussed later.
[66] While the ownership of APCI during the taxation years under appeal remains in dispute, the part