The Canada Revenue Agency appears to be increasing pressure on Cameco (NYSE:CCJ). The agency is speeding up the frequency of reassessments against the company in what may be an attempt to get Cameco to settle out of court.
Cameco reported first-quarter results recently, but perhaps more important than the numbers was management's discussion of the ongoing tax saga with the Canada Revenue Agency. Cameco stated that the reason it is updating its disclosure is to reflect the Canada Revenue Agency's intention to accelerate the frequency of reassessments.
Tax avoidance or good business strategy?
The Canada Revenue Agency has disputed Cameco's offshore marketing structure since 2008 and is reassessing Cameco back to 2003. Cameco established Cameco Europe in 1999 as an offshore marketing subsidiary in Zug, Switzerland, which is 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. Cameco Europe then sells it to the final customer, allowing Cameco to book profits in the lower tax jurisdiction.
The Canada Revenue Agency is arguing that Cameco set up Cameco Europe in order to avoid paying taxes in Canada. Cameco says that it made business sense to have a marketing arm in Europe, closer to its customers there. Cameco is arguing that its transfer-price arrangements are arm's length and are similar to those entered into by other arm's-length buyers and sellers at that time.
Cameco appears confident it will win the case once it goes to court and is making the assumption that its $75 million cumulative tax provision to date will be enough to satisfy any tax liability arising from the outcome of the dispute.
Immediate impact on Cameco's cash
Each time the Canada Revenue Agency reassesses a return, Cameco has to remit 50% of the disputed bill. If Cameco ends up losing in court, then it will have to pay the other 50% as well; if it wins, the money will be returned. The Canada Revenue Agency was moving very slowly in reassessing Cameco's tax returns and had been reassessing one per year. But this year Cameco is anticipating that both the 2009 and 2010 tax returns may be reassessed.
The Canada Revenue Agency may be hoping to force Cameco into a settlement by increasing reassessments, which will tie up more of Cameco's cash. In all, Cameco is projecting that it will have to remit between $625 million-$650 million plus interest and installment penalties. Cameco is projecting that it will have to remit between $115 million-$135 million in 2014 and $450 million-$475 million for 2015 to 2016 . This is worrisome for shareholders, as Cameco's cash flow would likely be affected.
When Cameco's sales agreement with Cameco Europe expires in 2016, Cameco will end up paying higher taxes regardless of whether it is successful in tax court, which will likely result in lower cash flow for the company.
Partially overshadowed by the tax drama, Cameco earned $131 million in Q1 compared to $9 million in Q1 last year, mainly because of $127 million it earned from the sale of its stake in the Bruce Power Limited Partnership. Excluding one-time items, Cameco reported Q1 earnings of $36 million, or $0.09 per share, compared to Q1 earnings of $27 million, or $0.07 per share, last year. Analysts were anticipating earnings of $0.10 per share. Revenue was down from $444 million in Q1 last year to $419 million in Q1 this year.
Cameco reported that it began production at its Cigar Lake Mine in March, which is a major milestone for the company. The ore from Cigar Lake will be processed at the Maclean Lake mill, which is a joint venture between Areva, Denison Mines (NYSEMKT:DNN), and another partner. Processing at the mill is expected to commence later in 2014; it will be a major milestone for Denison Mines and is important to Cameco.
Cameco also guided for increased revenue in the range of 5%-10% for 2014 based on assumptions of a strong U.S. dollar.
Foolish bottom line
Investors should carefully monitor the situation between Cameco and the Canada Revenue Agency, as the reassessment of Cameco's tax returns will pull a substantial amount of cash off the table, 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.
While both sides seem confident they will be successful, this may hang as a dark cloud over Cameco; the case is not expected to go to court until 2015, with a final decision not likely until 2016. If Cameco ultimately loses, it estimates it will be on the hook for $1.2 billion to $1.3 billion in cash taxes and transfer pricing penalties. Win or lose, with Cameco's lucrative sales agreement expiring in 2016, it will be paying higher taxes.
Charles Sherwood has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.