McKesson is a multinational group engaged in the wholesale distribution of pharmaceuticals. Its Canadian subsidiary, McKesson Canada, entered into a factoring agreement in 2002 with its ultimate parent, McKesson International Holdings III Sarl in Luxembourg. Under the terms of the agreement, McKesson International Holdings III Sarl agreed to purchase the receivables for approximately C$460 million and committed to purchase all eligible receivables as they arise for the next five years. The receivables were priced at a discount of 2.206% to face value. The funds to purchase the accounts receivable were borrowed in Canadian dollars from an indirect parent company of McKesson International Holdings III Sarl in Ireland and guaranteed by another indirect parent company in Luxembourg.
At the time the factoring agreement was entered into, McKesson Canada had sales of $3 billion and profits of $40 million, credit facilities with major financial institutions in the hundreds of millions of dollars, a large credit department that collected receivables within 30 days (on average) and a bad debt experience of only 0.043%. There was no indication of any imminent or future change in the composition, nature or quality of McKesson Canada’s accounts receivable or customers.
Following an audit, the tax authorities applied a discount rate of 1.013%, resulting in a transfer pricing adjustment for the year in question of USD 26.6 million.
In addition, a notice of additional withholding tax was issued on the resulting “hidden” distribution of profits to McKesson International Holdings III Sarl.
McKesson Canada was not satisfied with the assessment and filed an appeal with the Tax Court.
Judgement of the Tax Court
The Tax Court dismissed McKesson Canada’s appeal and ruled in favour of the tax authorities.
The Court found that an “other method” than that set out in the OECD Guidelines was the most appropriate method to use, resulting in a highly technical economic analysis of the appropriate pricing of risk. The Court noted that the OECD Guidelines were not only written by persons who are not legislators, but are in fact the tax collecting authorities of the world. The statutory provisions of the Act govern and do not prescribe the tests or approaches set out in the Guidelines.
According to the Court, the transaction at issue was a tax avoidance scheme rather than a structured finance product.