Transfer Pricing: What’s new in Canada (Part II)

20 minute read
29 August 2019

This article was created with assistance from Nathan Jin Bao, a summer student at Gowling WLG.

In Part I of this article,[1] we provided an overview of transfer pricing developments in Canada since the start of the Organization for Economic Cooperation and Development's ("OECD") project on Base Erosion and Profit Shifting ("BEPS"). In Part II of the article, we focus on the Canadian court decisions on transfer pricing cases that have been rendered during this period. Leading up to the start of the OECD BEPS project in 2012, there had only been a few transfer pricing decisions rendered by Canadian Courts. However, since 2012, between the transfer pricing cases heard by the Tax Court of Canada ("TCC") and the cases awaiting to be heard, there would appear to be an upward trend in transfer pricing disputes being brought before the Courts.



Transfer pricing disputes in Canada have, predominately, been resolved through either a request for competent authority assistance under the Mutual Agreement Procedure ("MAP") of a treaty, or, to a much lesser extent, through the notice of objection process with CRA Appeals. Regardless of the recent increase in transfer pricing cases being brought before the Courts, the MAP will likely continue to be the dispute resolution process most often utilized by a Canadian corporation in transfer pricing cases because, in the absence of a 100% reversal of a transfer pricing adjustment by either CRA Appeals or a Canadian court, economic double taxation may still exist as a consequence of the CRA upward transfer pricing adjustment. The correlative relief provided by the treaty partner under a MAP settlement resolves that double taxation. However, with so many tax-motivated Canadian structures utilizing subsidiaries in low tax jurisdictions (e.g. Barbados, Ireland, Switzerland, etc.), it can be the reduction of Canadian taxes payable, not the relief of double taxation, that becomes the primary consideration when a corporation is choosing its dispute resolution process.[2] Therefore, notices of objection to CRA Appeals, and, where the transfer pricing dispute is not resolved to the taxpayer's satisfaction at that stage, notices of appeal to the TCC, are becoming increasingly common (e.g. see the Marzen Artistic Aluminum Ltd. and Cameco Corporation cases described below).

Another scenario to consider is where a Canadian corporation has been subject to transfer pricing adjustments resulting in an increase in Canadian taxes payable, but the non-resident related entity is in a loss position for those same taxation years. In these cases, the correlative relief process under a MAP settlement does not always result in immediate or future tax refunds for the non-resident related entity. Consequently, the ultimate benefit of the correlative relief granted by the foreign competent authority, and, more particularly, the projected time it will take for the non-resident related entity to utilize (benefit from) any increased losses arising as a consequence of the MAP settlement, is a key factor that a corporate group will consider in choosing the MAP versus the notice of objection/appeal process.

The main objective of the competent authority officer assigned a transfer pricing case under the MAP is to resolve double taxation. This often involves some form of compromise during the bilateral MAP negotiation process by one or both competent authorities. Consequently, although the MAP settlement is arriving at an arm's length amount which both countries will apply to its taxpayer, the agreed amount may not be fully in line with the arm's length principle. However, in the case of CRA Appeals or a Canadian Court, the focus would solely be on the merits of the taxpayer's analysis of the arm's length principle versus the CRA's analysis. So some taxpayers, particularly i) where the transfer pricing adjustments are significant, ii) they view their initial transfer pricing documentation as being in line with the arm's length principle and iii) there is a material differential between the Canadian tax rate and the tax rate in the foreign jurisdiction (i.e. relief of double tax is not the sole objective in resolving the dispute), are opting for the notice of objection/appeal route, to ensure a fully objective and impartial review of the fundamental issue in its case, that is, the arm's length transfer price.[3]

Other factors that taxpayer's have to consider when deciding between the MAP and notice of objection/appeal process are:

  1. The experience level of the competent authority in the foreign jurisdiction. The Canadian competent authority is highly experienced in MAP negotiations due to the level of CRA transfer pricing audit activity over the last 25 years. This can result in an advantage to the Canadian competent authority, during the face to face bilateral negotiation stage, in defending its auditor's transfer pricing adjustments against a less experienced competent authority (e.g. many of Canada's treaty partners have little experience in negotiating transfer pricing cases under the MAP).
  2. The tax dollars (i.e. tax refund) at stake if full correlative relief is granted by the foreign competent authority. The larger the file, the more serious the negotiations become and the more likelihood of a compromise, that is, a "split the difference" approach in reaching a settlement.
  3. What is the effective tax rate in the country which is being asked to provide correlative relief? For example, would the Canadian competent authority take the arguments of, say, the Barbados competent authority, serious during a bilateral negotiation when it knows the latter is defending the position of its taxpayer who is likely only paying a 2.5 % tax rate? On the flip side, would the competent authority of the foreign jurisdiction defend, full-heartedly, its taxpayer's position when there is minimal costs at stake in its jurisdiction in the event it has to provide correlative relief (e.g. issue a tax refund to its taxpayer) upon the MAP settlement?
  4. The availability of binding arbitration.
  5. The existence of a transfer pricing penalty. The Canadian competent authority under a MAP does not review transfer pricing penalties. Therefore, unless the MAP settlement fully overturns the initial transfer pricing adjustment or at least reduces it to within the thresholds where the penalty does not apply, the taxpayer would still have to deal with the penalty in CRA Appeals or the Courts if it felt it had met the reasonable efforts test in documenting its transactions.
  6. Cost and length of time to litigate a transfer pricing case.

As the Canadian tax community becomes more knowledgeable about the dispute resolution processes in transfer pricing cases, the upward trend of transfer pricing cases being heard by the Courts will likely continue.

Key Canadian Transfer Pricing Cases after 2012

1. McKesson Canada Corporation v. The Queen

On December 13, 2013, the TCC delivered a decision that ultimately became more famous for the drama that unfolded between the taxpayer's legal counsel and the TCC Judge on the issue of bias. The TCC Judge ultimately recused himself from completing the court proceedings, which extended to the consideration and disposition of costs. However, on the transfer pricing front, the TCC rendered decisions on two appeals. The first and main appeal dealt with a primary adjustment on transactions between McKesson Canada and related non-Canadian entities, and, in particular, the sale of McKesson Canada's receivables to its Luxembourg parent company at a discount. After analyzing several expert reports on non-arm's length financial transactions, the TCC held that the discount rate used by McKesson Canada and its Luxembourg parent company was higher than it should have been under the arm's length principle. Although McKesson Canada filed an appeal to the Federal Court of Appeal ("FCA"), a settlement between the taxpayer and CRA on the arm's length issue was ultimately reached. The more interesting issues however involved the related appeal which dealt with whether a secondary adjustment could be made beyond the five year time limit set out in the relevant tax treaty. The TCC ultimately ruled that the five year treaty time limit rule did not apply to prohibit CRA from raising a Part XIII failure to withhold assessment on the deemed dividend.

For a detailed discussion on this case, please refer to our previous article entitled McKesson Canada Corporation v. The Queen: Making Secondary Adjustments a Primary Concern After Treaty Time Limits Have Passed at:

https://gowlingwlg.com/en/insights-resources/articles/2014/mckesson-canada-corporation-v-the-queen/

2. Marzen Artistic Aluminum Ltd. v. The Queen

On June 10, 2014, the TCC delivered a decision on a transfer pricing case involving a Barbados subsidiary set up to act as a sales and marketing company. The structure, through its intercompany service agreements, was intended to allow the Canadian parent company to shift most of its profits from its US sales of aluminum and vinyl windows to Barbados. The Marzen case was a perfect example of a tax-driven transfer pricing structure involving a low-tax jurisdiction where there was a clear separation between the location of substantive business activities and the jurisdiction where taxable profits were reported (i.e. the main transfer pricing concern addressed in the OECD BEPS project). This decision came out before the OECD issued its final recommendations on the BEPS project, the transfer pricing component of which was eventually incorporated into the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations ("Transfer Pricing Guidelines") (see comments in Part I of this article). The TCC, however, had no problem upholding CRA's transfer pricing adjustment, as well as the related transfer pricing penalties, on core fundamental BEPS issues (e.g. placing more emphasis on the allocation of profits to the jurisdiction where substantive functions are performed).

For a detailed analysis of this case, please refer to our previous article entitled The Marzen Decision – A Typical Example of BEPS at:

https://gowlingwlg.com/en/insights-resources/articles/2014/the-marzen-decision-a-typical-example-of-beps/

3. Sifto Canada Corporation v. The Queen

On March 10, 2017, the TCC delivered a decision regarding the legal effect of a transfer pricing settlement reached under the MAP Article of the Canada – United States Tax Convention. The Sifto case involved a unique situation where the CRA transfer pricing adjustments that were the subject of the MAP settlement arose as a consequence of adjustments processed by CRA as a consequence of a voluntary disclosure. Subsequent to the voluntary disclosure and MAP settlement, the CRA conducted an audit of the same taxation years and raised further transfer pricing adjustments. The CRA's ability to issue reassessments resulting from this subsequent audit was the issue under appeal in Sifto. Ultimately, the TCC overturned the CRA's transfer pricing adjustments on the basis that the CRA was bound by the earlier MAP settlement, which established the arm's length values of the intercompany transactions in question.

This decision may have had some influence on the CRA's recent change in policy in its voluntary disclosure program that now states, with respect to transfer pricing cases, applications relating to transfer pricing matters are now to be referred to the Transfer Pricing Review Committee for consideration (look for further discussion on this in Part III of this article, addressing self-initiated transfer pricing adjustments).

For a detailed analysis of this case, please refer to our previous article entitled The Sifto Decision – Is the Minister Bound by MAP Settlements? at:

https://gowlingwlg.com/en/insights-resources/articles/2017/the-sifto-decision-is-the-minister-bound-by-map/

4. Cameco Corporation v. The Queen

On September 26, 2018, the TCC delivered a decision in favor of Cameco regarding a transfer pricing dispute covering Cameco's 2003, 2005 and 2006 taxation years. The dispute dealt with the marketing and trading structure between Cameco and related foreign subsidiaries involving uranium trades. The reassessments added nearly $500 million to Cameco's income for the taxation years, with even greater potential exposure looming over Cameco for later years. The government has appealed the decision to the FCA. In 1999, the Cameco group reorganized its uranium transactions so that uranium produced by Cameco and other suppliers would flow through a Cameco-controlled Swiss trading company ("SwissCo"). SwissCo then sold the uranium through a related US marketing company to third party customers. The CRA took exception with SwissCo's lack of functionality as it had only one or two employees at any time. The CRA reassessed Cameco on the basis that: i) the transactions were a sham; ii) the transfer pricing re-characterization rules in paragraphs 247(2)(b) and (d) of the Income Tax Act ("Act") were applicable; and iii) in the alternative, the general transfer pricing provisions of paragraphs 247(2)(a) and (c) were applicable. The TCC dismissed all three arguments. Unlike the Marzen decision, the Cameco decision is inconsistent with the revised Transfer Pricing Guidelines and, if not overturned under appeal, could be problematic for tax authorities in combating certain tax motivated transfer pricing structures. The Cameco decision supports that proper tax planning can still be used to shift profits to lower tax jurisdictions and puts into question, at least in Canada, the application of certain elements of the revised Transfer Pricing Guidelines.

For a detailed analysis of this case, please refer to our previous article entitled The Cameco Decision - What it means for Transfer Pricing in Canada.

5. Cameco Corporation v. The Queen

On April 3, 2019, the FCA delivered a decision addressing the issue of whether the CRA can compel employees of a company to attend oral interviews or compel oral answers to questions posed by CRA auditors. The dispute arose as a consequence of CRA's process in conducting compliance audits. In the course of a transfer pricing audit, the CRA sought interviews and oral answers to questions from 25 employees of Cameco and its foreign affiliates. Cameco offered to answer in writing, leading to a compliance order application to the Federal Court ("FC") to force in-person interviews. The FC refused to issue a compliance order, finding that the CRA's request was unreasonable. The CRA appealed the FC decision to the FCA, arguing that the power to "inspect, audit or examine" under paragraph 231.1(1)(a) of Act is broad enough to encompass the authority to compel oral interviews of taxpayers or their employees. Based on a textual, contextual and purposive analysis of paragraph 231.1(1)(a), the FCA upheld the FC's decision.

Although the case addresses the CRA's general power to conduct oral interviews in any compliance audit, it is of particular significance to the transfer pricing community. It is common for CRA to conduct in-person interviews of a large number of employees in transfer pricing cases, to perform their "function, asset and risk" analysis of the cross-border transactions. These interviews can on occasion be prejudicial to the taxpayer because its employees, not being transfer pricing experts and not always understanding the motive behind the auditor's question, may have a different and inaccurate perspective as to the value of the contributions they bring to the company, that may differ from the value accurately described on their behalf in the company's transfer pricing documentation. So this case is highly relevant in regards to transfer pricing because it allows taxpayers and their tax representatives the opportunity, during a tax audit, to better monitor the descriptions given to CRA regarding employee functions, so that such explanations are correct and more consistent with, or at least described to CRA in the context of, the company's transfer pricing documentation.

However, before taxpayers refuse CRA the opportunity to conduct oral interviews of any of their employees, they should review CRA's new guidelines in response to this FCA decision which, on June 3, 2019, were officially incorporated into AS-19-02R "Obtaining Information for Audit Purposes". For example, taxpayers should be aware of the possibility that CRA may make certain inferences and assumptions if denied access to employee interviews.

For a detailed analysis of this case, please refer to our previous article entitled Be Careful What You Ask For: Limits On Oral Interviews Confirmed in Cameco.


[2] In the case of Canadian structures setting up subsidiaries in countries with no tax treaty with Canada (e.g. tax havens), then the MAP is not an option available to the Canadian taxpayer and any transfer pricing dispute would have to be dealt with through the notice of objection/appeal process.

[3] See Sifto Canada Corporation case, where the CRA officers who testified were of the view that the MAP settlement was to provide relief from double tax and did not represent a binding agreement to the arm's length transfer price.


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