In 2000 and 2001 the Canadian-resident taxpayer, which manufactured windows in British Columbia, paid Cdn.$4.2M and Cdn.$7.8M in fees under a "Marketing Services and Sales Agreement" ("MSSA") to a wholly owned Barbados subsidiary ("SII"), including a "bonus" in the case of 2001 of U.S.$2M. SII in turn paid US$1.4M (Cdn.$2.1M) and US$1.8M (Cdn.$2.8M) to a Washington subsidiary of the taxpayer ("SWI") for the provision of SWI's employees to perform services for SII at cost plus 10%. SII, which had minimal expenses other than the fees paid to SWI, declared exempt dividends to the taxpayer which essentially were equal to its earnings. The taxpayer had approximately nil operating income after deduction of the "marketing fees" so that these dividends represented essentially all of its profits. SWI, which sold windows principally in California, purchased the windows from the taxpayer at a cost equal to its selling price so that it as well had no significant operating profit.
The Minister reassessed the taxpayer under the transfer pricing rules to limit the taxpayer's deduction of MSSA fees to the amount of the SWI "secondment fees," and imposed s. 247(3) penalties.
Sheridan J found that as SII had insubstantial assets and no personnel other than its managing director, who lacked the marketing experience and know-how of the key managers of SWI and the taxpayer, SII provided nothing of value to the taxpayer beyond the services provided by SWI's employees, and the relatively minor value of the services provided by its managing director (for which she adjusted on the basis that the amounts paid to him were the relevant comparable uncontrolled price). Although SII's managing director may have provided useful advice, such as suggesting moving into the California market, he did so in his personal capacity rather than through SII. In rejecting the approach of the taxpayer's expert, which was to treat SWI and SII as an "amalgam" so that their combined contribution was analysed, Sheridan J found (at para. 191) that the OECD Guidelines (which she found at Para. 208 should be applied in their 1995 rather than 2010 form) instead endorsed a separate entity approach.
In the Court of Appeal, Scott JA stated (at para. 18) that the (1995) OECD Guidelines "are not controlling as if they were a Canadian statute but they are useful in determining the amount a reasonable business person, who was party to the transaction, would have paid if it had been dealing at arm’s length," found that Sheridan J had not erred in applying the principles outlined in ss. 247(2)(a) and(c) and had identified the proper transaction and then, in response to the taxpayer's submission (at para. 40) "that the Judge erred in under-valuing the amounts paid by SII to SWI," stated (at para. 53), that "I cannot find any evidence that was adduced...to challenge the Minister’s assumption that the price for the seconded US employees, set on a cost plus 10% basis, was not an arm’s length price."