The Canada Revenue Agency ("CRA") recently canceled Information Circular 87-2R ("IC"), which was a primary policy document on how the CRA applied transfer pricing legislation. According to the CRA, the IC was inconsistent with its current interpretation of Canadian transfer pricing legislation and did not reflect the updates to the Organisation for Economic Co-operation and Development (“OECD”) Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (“Guidelines”). As a result of the OECD's Base Erosion and Profit Shifting ("BEPS") project, many sections of the Guidelines have been and continue to be amended.
The CRA’s position about inconsistencies in the interpretation is somewhat surprising, given that the Government stated, in the 2016 Budget, that the proposed Guideline changes coming out of the BEPS project were simply clarifying in nature and supported the CRA's current practices in respect to transfer pricing. It appears that the CRA has had a change of view on this realizing that the Guideline changes went far beyond clarifying the CRA's interpretation of the arm’s length principle and actually changed how Canadian transfer pricing legislation is interpreted and thus applied in everyday practice.
The CRA makes specific note of related party debt and recharacterization as inconsistencies in the now cancelled IC. In the release, CRA confirms that the transfer pricing rules in section 247 of the Income Tax Act ("Act") will apply before other sections of the Act: “Except as otherwise specified in the tax rules, the CRA considers that section 247 applies to all cross-border transactions with non-arm’s length entities that are relevant under the tax rules. The CRA is generally of the view that subsection 247(2) can apply in conjunction with other provisions of the Act.” In some transfer pricing cases, both the transfer pricing rules and other provisions of the Act can apply to the same amount, creating uncertainty as to which provisions should be given priority. The wording in the IC left some room for misinterpretation of how the legislation should be applied.
In respect to recharacterization, the CRA states the updated Guidelines, “consistent with the wording of the transfer pricing provisions of the Act, provide support for a broader application of the recharacterization provision.” Again this is a significant change from the IC, which stated that situations involving recharacterization were limited. It would seem that the CRA is looking to apply the recharacterization provisions more in the future. Unchanged is the fact that the CRA will continue to refer material reassessments involving the recharacterization provisions to the Transfer Pricing Review Committee.
With the cancellation of the IC and in light of the revised Guidelines along with the Tax Court of Canada decision on Cameco Corporation (under appeal to Federal Court of Appeal), we would expect to see new administrative practices in respect to the application of the arm’s length principle. While we wait for new guidance from the CRA and the results of the Cameco appeal, taxpayers and their representatives will have to rely on the CRA’s transfer pricing memoranda and the updated OECD Guidelines to establish their transfer prices in Canada.