While much has been made of Cameco's (NYSE: CCJ) troubles at Cigar Lake, the possible timing of Japanese nuclear restarts and the spot price of uranium, investors should also be aware of Cameco's tax troubles. The Canada Revenue Agency, Canada's version of the IRS, has been speeding up the frequency of tax reassessments against Cameco in what may be an attempt to pressure Cameco to settle out of court.
During their second quarter results, Cameco reported that the Canada Revenue Agency has recently issued a notice of reassessment for their 2009 tax return. The Canada Revenue Agency has disputed Cameco's offshore marketing company structure and related transfer pricing methodology Cameco used for certain intercompany uranium sale and purchase agreements. While this is not new news, it is important to note that the Canada Revenue Agency continues to speed up re-assessments which place a greater burden on Cameco's cash. The Canada Revenue Agency has now issued notices of reassessment for Cameco's 2003 through 2009 tax returns and has disputed Cameco's offshore marketing structure since 2008. The Canada Revenue Agency is arguing that Cameco set up Cameco Europe in the low tax jurisdiction of Zug, Switzerland in order to avoid paying taxes in Canada.
Smart Business or Tax Evasion?
Cameco established Cameco Europe in 1999 as an offshore marketing subsidiary in Zug, Switzerland, a well known corporate tax haven. Cameco then signed a 17-year sales deal with Cameco Europe to sell the uranium produced in Canada to Cameco Europe for about $10 per pound, which was the going price of uranium at the time. Cameco Europe then sells it to the final customer, allowing Cameco to book profits in the lower tax jurisdiction. The corporate tax rate in Zug, Switzerland is around 10% which is substantially lower than the rate Cameco would expect to pay if the profits were made in Canada.
Cameco has stated that the reason they created this marketing structure was because the majority of their customers are located outside Canada and that it made business sense to have a marketing arm in Europe, closer to Cameco's customers there. Cameco is arguing that they made reasonable efforts to put arm's length transfer pricing arrangements in place, and that the intercompany contract prices are generally comparable to those established in sales contracts between arm's-length buyers and sellers entered into at that time.
Cameco has stated that they have recorded a cumulative tax provision of $76 million, where an argument could be made that their transfer price may have fallen outside of an appropriate range of pricing in uranium contracts for the period from 2003 to June 30, 2014. Cameco appears confident they will win the case once it goes to court and is making the assumption that their $76 million cumulative tax provision to date will be enough to satisfy any tax liability arising from the outcome of the dispute. Despite Cameco's confidence, investors should be concerned that Cameco has recorded a cumulative tax provision which suggests that they believe they are going to end up owing the Canada Revenue Agency at least some money.
Reassessments Impact Cameco's Cash
Each time the Canada Revenue Agency reassesses a return, Cameco has to remit 50% of the disputed bill. If Cameco ultimately ends up losing in court, then they will be on the hook for the other 50% as well. Of course if Cameco wins, the money will be returned. The Canada Revenue Agency had been moving very slowly in reassessing Cameco's tax returns and had been reassessing them at a rate of one per year. But this year Cameco has already received a reassessment for the 2009 tax year and is anticipating that their 2010 tax return may also be reassessed. It appears that the speeding up of reassessments may be a tactic by the Canada Revenue Agency to tie up more of Cameco's cash which will place more pressure on Cameco in the hopes of forcing Cameco into a settlement. In all, Cameco is projecting that they will have to remit between $625 million to $650 million plus interest and installment penalties. Cameco has laid out a schedule of expected payments and is projecting that they will have to remit between $115 million to $175 million in 2014 and between $410 million to $435 million for 2015 to 2016. This is worrisome for shareholders, as Cameco will be forced to tie up cash while they await resolution through the slow moving tax courts.
Bottom Line for Investors
Investors should carefully monitor the situation between Cameco and the Canada Revenue Agency, as the reassessment of Cameco's tax returns will tie up a substantial amount of cash, at least until the case is settled. With the Canada Revenue Agency accelerating the frequency of reassessments, Cameco will have to remit more cash per year than previously anticipated. If Cameco ultimately loses the case or ends up settling out of court for an amount substantially more than the $76 million tax provision they have recorded, Cameco will be adversely affected.
While both sides seem confident they will be successful, this may hang as a dark cloud over Cameco's share price as the case is not expected to go to court until 2015, with a final decision not likely until 2016. Win or lose, with Cameco's lucrative sales agreement expiring in 2016, they will be paying higher taxes which will likely result in lower cash flow for the company. If Cameco ultimately does lose, they estimate they will be on the hook for $1.25 billion to $1.3 billion in cash taxes and transfer pricing penalties which will significantly affect Cameco's financial position.
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